If you’re an American expat living in Canada, you probably have questions about your U.S. tax responsibilities. Do you need to file U.S. taxes? Will you have to pay taxes in both Canada and the U.S? Are tax exemptions in Canada the same as in the US?
Let’s explore US tax issues as they pertain to you – the Canadian US expat.
US citizens and Lawful Permanent Residents (Green card holders) are required to file United States income tax returns, regardless of their current country of residence. (There is an exception for certain low-income individuals). The income tax return must report your worldwide income, regardless of where the income is sourced.
In addition, there are other filing requirements that may apply to you if you fulfill certain conditions. The most common is the Foreign Bank Account Report (FBAR), a FinCEN information return. Others include Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations), Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts), and Form 8938 (Statement of Specified Foreign Financial Assets). These are filings that report required information, but generally do not result in the assessment and payment of tax.
As a US citizen living abroad, you are entitled to an automatic two-month filing extension through June 15th, with no need to apply. In addition, you can apply for another extension through October 15th, either via mail or e-file; this must be done before June 15th. If you still need more time, an additional two-month discretionary extension can be requested, which can extend the filing due date to December 15th.
These extensions only extend your time to file, not your time to pay taxes due. Interest on taxes due begins to accrue on April 15th. However, the late-paying penalty will only apply if taxes are not paid by June 15th. In contrast, the late-filing penalty does not apply unless the tax return is filed after all valid extensions.
In regard to the FBAR, the deadline is April 15th, but if you missed that, your deadline is automatically extended to October 15th. There is no need to file for this extension.
No one wants to pay tax twice on the same income. US tax laws and the US-Canada tax treaty provide for several helpful ways to avoid double taxation.
Residents of Canada with Canadian-sourced income can use Canadian taxes paid to offset US taxes due with the use of the foreign tax credit. Taxes paid to Canada generally tend to be higher than US taxes due: the highest Canadian tax rate (provincial and federal) for 2019 could be as high as 54%, whereas the highest 2019 US federal tax rate is 37%. As such, US expats residing in Canada will most often be left with no US tax obligations on their Canadian-sourced income. If you paid more tax to Canada than you are utilizing for the foreign tax credit, the excess foreign taxes can be carried forward for up to ten years to be used as future credit.
Furthermore, as per the US-Canada tax treaty, certain types of income sourced in the US can be re-sourced to Canada for foreign tax credit purposes, thereby allowing Canadian taxes paid on that income to be used as a credit. For example, interest from US sources will first be taxed by Canada; any Canadian taxes paid will then directly offset any US taxes assessed on the interest income. Dividends from US companies and pensions from US pension plans can be taxed by the United States at a rate of up to 15%; after that, Canada has rights to taxation on this income.
Another option available to US expats residing in Canada is to utilize the US foreign earned income exclusion. Use of this exclusion will allow Canadian expats to exclude up to $105,900 of earned income in 2019.
Another related tax relief option is the Foreign Housing Allowance Act, which allows an additional exclusion for high-cost foreign housing expenses, including rent payments. Residents of Toronto or Vancouver often benefit from this exclusion, as housing costs in these cities are considerably high.
The Totalization Agreement between the US and Canada in 1984 helps taxpayers avoid paying double social security tax on their self-employment income. It allows for an exemption from US self-employment tax for US expats covered under the Canadian Pension Plan. Taxpayers still need to report the self-employment income on their annual income tax return, but they then claim the exemption from the related social security tax.
Contributions paid by or on behalf of a US person to a Canadian employer-sponsored pension, as well as benefits accrued under the pension scheme, are not taxable for United States purposes in the year of contribution or benefit accrual. This is assuming that these contributions and benefits qualify for similar tax relief in Canada.
Income earned on individual Canadian pension plans, which defer revenue recognition to the year of withdrawal, can be deferred for US tax purposes as well. According to Rev. Proc. 2014-55, income earned from such plans is automatically eligible for tax deferral as long as: the taxpayer filed and continues to file US tax returns for any year that he held an interest in the plan, he never reported income accrued from these plans, and he included any distributions from these plans on his US returns. In the past, to receive this tax deferral treatment, a US citizen had to file form 8891 with his US tax return and elect for this tax treaty benefit. Form 8891 no longer needs to be included with one’s return; the benefit is automatic. However, as a result of the discontinuation of Form 8891, accounts holding these plans need to be reported on Form 8938, Statement of Specified Foreign Financial Assets.
All high-earning individuals with income from passive sources are subject to US net investment income tax (NIIT). This is a 3.8% flat tax assessed on passive income of individuals who earn more than $200,000 ($250,000 threshold for married filing jointly taxpayers), and it applies even to passive income from Canadian sources. Many Canadian residents in this situation are unpleasantly surprised by this tax, as the Canadian income tax they paid on their passive income cannot be used to offset the NIIT.
The Canadian tax code allows for pension splitting: taking the pension withdrawal of one spouse and splitting the income between the tax returns of the two spouses, thereby reporting half the income in each spouse’s name. The Internal Revenue Code (IRC) does not allow for splitting pension payment amounts between spouses; as such the full amount of pension income will be reported on the US return of the spouse receiving the pension income. As such, Canadian taxes paid on the foreign pension amount reported, but not received, by the other spouse will not be allowed as a foreign tax credit by the spouse who received the pension income, unless the spouses file a joint return.
As per the Canada Revenue Agency (CRA), 50% of the gain upon sale of qualified small business Canadian corporate shares is deductible from income. Additionally, the sale may qualify for the Lifetime Capital Gains Exemption (LCGE): up to $866,912 of the gain from sale in 2019 may be excludable for tax purposes. There is no corresponding deduction or exclusion in the IRC. However, the IRC does provide preferential tax rates to long term capital gains: for tax year 2019, taxpayers with $38,600 or less of ordinary income will not pay tax on long term capital gains; a taxpayer with ordinary income of up to $425,801 will be taxed at a flat 15% on long term capital gains; and if the income is higher, the rate will be a flat 20%.
For CRA purposes, medical expenses are limited by the lower of $2,302 or 3% of a person’s net income. For US purposes they are limited by 7.5% of a person’s adjusted income (assuming an individual is itemizing deductions instead of using the standard deduction.)
Interest earned from Registered Education Saving Plans and Tax-Free Savings Accounts are taxable for US purposes, even though Canada offers tax-free interest accrual.
Under Canadian law, sale of one’s personal residence is exempt from capital gains tax. This exemption can be very substantial in cases of homes in cities such as Toronto and Vancouver, where property may have doubled in value over a five to six-year period.
Under U.S. law, however, only $250,000 of the capital gain ($500,000 for married filing jointly) is exempt from taxation, with the excess taxed at rates up to 23%. In order to qualify for this exclusion, the taxpayer must have lived in the home for two out of the five years prior to sale. Choosing to make both spouses co-owners on the primary residence can help reduce this extreme taxation.
RRSP and RRIF contributions do not reduce taxable income for US tax purposes, even though they do reduce Canadian taxable income. Therefore, for US purposes, only earnings from the plan, but not the principal, are taxable upon distribution (assuming the individual qualifies for an automatic deferral, as explained above.
US social security payments and Canadian OAS and CPP payments
As per the US-Canada tax treaty, US social security payments and Canadian OAS and CPP payments paid to Canadian residents are not taxable for United States purposes.
Taxation of Emigrants
According to Canadian law when an individual leaves Canada, he is considered to have sold certain types of property at their fair market value, hence recognizing a capital gain. The treaty allows for United States citizens to be treated as having disposed of their property for United States tax purposes as well; keeping US taxation consistent with Canadian emigration tax.
If a US citizen or green card holder is married to a spouse who is neither a citizen nor resident of the US, then the spouse’s income is not required to be reported to the IRS at all. That being said, one has the option to elect, via section 6013(g) election, to file jointly with the non-US spouse in order to take advantage of a higher standard deduction; in some situations, this can lower the overall tax liability. Another scenario where making this election is advantageous is when adding the spouse’s income to the return will increase eligibility for the “Additional Child Tax Credit Refunds” (Form 8812).
The above being said, the election is not advisable in most cases, as the results will often be worse than when filing alone. Once the election is made, all of the spouse’s worldwide income must be reported to the IRS. By not making the election, there exists an option of transferring ownership of income-producing assets to the non-US spouse, thereby decreasing the taxable income reportable to the IRS. Once the election is made, that possibility is lost. For more information see ELECTION TO TREAT NON-RESIDENT ALIEN SPOUSE AS A US RESIDENT (IRC 6013(g)).
For expert help in filing your US taxes from Israel, contact Expat Tax CPA’s at 416- 800-1915, or via the form on this page.
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