Top 5 Tax Issues for Americans Moving to Canada
Moving to another country is the most significant tax event in most people’s lifetime. There are wins to be taken advantage of and potential traps to be avoided. Americans have a unique issue in Canada, they will be subject to tax in both Canada and the U.S. and enter the complex world of tax disclosures required of Americans living outside the U.S.
This article considers the top five tax issues for Americans moving from the U.S. to Canada. For this purpose, “Americans” includes both U.S. citizens and lawful permanent residents of the U.S. (“green-card holders”). Our commentary is a high-level discussion of issues and does not constitute tax advice. Please contact Andersen for further guidance.
Topics:
- Tax Residency
- Tax-Free Gains and Canadian Departure Tax
- Maximizing Tax Efficiency with Foreign Tax Credits
- Canada Pension Plan v. US Social Security
- Investments in Canadian Corporations by US Persons
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1. Tax Residency
The issue?
The country in which you are a tax resident gets to tax you on your worldwide income and subject you to its disclosure requirements.
Why does it matter?
Your tax residency is different than your immigration status, residency for health care insurance or for other purposes. Canada uses both objective and subjective measures of tax residency. It is possible for individuals to be tax residents of both countries under their respective tax laws. The Canada-U.S. tax treaty (the “Treaty”) provides a tie-breaker test in those situations. Savvy taxpayers seek to arrange their facts in advance in order to obtain the best tax result. Americans are required to file U.S. tax returns reporting their worldwide income even when they are not tax residents of the U.S. under the Treaty.
Scenario 1: Americans Who Move to Canada from the US prior to July 2nd
An individual physically present in Canada for more than 182 days in a calendar year will be a Canadian tax resident for that year.
Scenario 2: Americans on Temporary Assignment to Canada
Americans on temporary assignment to Canada may become liable for tax in Canada on their worldwide income even if their spouse and dependents continue to live in the U.S. Americans who are present in Canada for more than 182 days in the year and the Treaty tie-breaker test determines them to be a Canadian tax resident.
Americans who do not become tax residents of Canada but provide employment services in Canada will generally be taxable in Canada on those services subject to limitations under the Treaty.
Scenario 3: Americans Who Move to Canada after July 1st
Americans who are present in Canada for less than 183 days in the year may still become tax residents of Canada if they have residential ties to Canada, including a place of residence, family and employment in Canada.
Scenario 4: Green-Card Holders Moving to Canada
Green-Card holders are limited by U.S. immigration law on how long they can remain outside the U.S. and retain their U.S. immigration status. There are U.S. tax implications if a green-card is formally abandoned or judicially rescinded.
What’s the solution?
Solutions will depend on the facts and circumstances, but may include:
- Evaluating the tax implications of becoming a Canadian tax resident and whether they can modify their facts pro-actively to optimize their overall tax results.
- Retaining a permanent home in the U.S. may help Americans present in Canada for more than 182 days that don’t establish residential ties in Canada avoid Canadian tax residency.
- Enquiring whether their employer has filed for a Regulation 102 (Employment Withholding) Waiver to avoid Canadian tax withholding on temporary assignments to Canada.
- Green-Card Holders
- Comparing the costs and benefits of retaining Green-Card status and those associated with abandoning it. The tax cost of abandonment may be significant where it was held for more than 7 of the last 15 years.
- Obtaining a re-entry permit from U.S. Immigration to maintain their U.S. immigration status while they are resident outside the U.S. Failing to do so could result in its involuntary abandonment.
- Canadian citizens who are also U.S. citizens may wish to consider renouncing their U.S. citizenship if the compliance and tax burdens exceed the benefits of that status.
2. Tax-Free Gains and Canadian Departure Tax
The Issue?
Immigrants to Canada are not taxable on the disposition on pre-residency appreciation of their worldwide assets. Individuals who cease Canadian tax residency are subject to Canadian capital gains tax as if they disposed of their worldwide capital assets.
Why Does it Matter?
Canada only taxes appreciation while resident in the country but on departure it taxes that appreciation even though it has not been disposed of, with some exceptions.
Scenario 1: Resident of Canada Moves Out of Canada
Resident of Canada owns corporate shares and bonds, stock options, a Registered Retirement Savings Plan and real property in Canada and Mexico and leaves Canada after being resident there for over 5 years.
Scenario 2: Short-Term Resident of Canada Returns to U.S.
An American resided in Canada for less than 60 months. When they became a Canadian resident they had a portfolio of investments in U.S. equities and debts. During their residency they acquired shares of Netflix which tripled in value prior to their departure from Canada.
Scenario 3: Taxpayer Owns a Pension, Stock Options and Registered Accounts
Pensions, stock options and registered accounts such as Registered Retirement Savings Plans, Registered Education Savings Plans, Tax-Free Savings Accounts, etc. are not subject to Canadian Departure Tax.
What is the Solution?
Solutions will depend on the facts and circumstances, but may include:
3. Maximizing Tax Efficiency with Foreign Tax Credits
The Issue?
Canadian and US tax law has many similarities, but the differences can be expensive
Why Does it Matter?
Americans resident in Canada, are still liable for U.S. tax and reporting. Being liable for tax in both Canada and the U.S. on the same income creates double taxation potential where tax law in Canada and the U.S. differ.
Scenario 1: American Resident in Canada Exercises Stock Options
An American resident in Canada exercises stock options qualifying for preferential Canadian tax treatment. His or her spouse is not an American. The top U.S. federal income tax rate on the options goes up to 37%, but in Canada it would be taxed at a maximum tax rate of 27% or less depending on the province of residence. The American resident in Canada can use foreign tax credits from income tax payable outside the U.S. in the preceding ten years to offset the U.S. tax payable.
Scenario 2: American Departs Canada but has Business Travel Outside the U.S.
Americans who cease Canadian residency but have business travel or provide substantive work on personal travel outside the U.S. will have the income earned from those activities as arising outside the U.S. As noted above, the American can use foreign tax credits arising in the prior ten years to offset the U.S. tax otherwise payable. Generally, Americans providing services outside the U.S. will not be taxable in the foreign jurisdiction subject to provisions in U.S. tax treaties, where applicable.
What is the Solution?
Solutions will depend on the facts and circumstances, but may include:
- Maximizing foreign tax credits claimable on the American’s U.S. tax return allows the American to offset U.S. tax payable when it exceeds the tax payable in Canada. Foreign tax credits arise from income tax payable outside the U.S.
- Foreign tax credits can be carried forward up to ten years and back one.
- Claiming the Foreign Earned Income Exclusion allows Americans to exclude up US$107,600 (2020) of employment or business income earned outside the U.S. when they meet certain tests. But claiming the exclusion impairs your foreign tax credit carryover.
- Filing a joint U.S. tax return with your non-American spouse can maximize your foreign tax credit position without increasing your U.S. or Canadian tax liability.
- The same rules applicable to use foreign tax credits to offset U.S. tax otherwise payable on employment and business income earned outside the U.S. also apply for investment income earned outside of the U.S.
- Examples of circumstances where Canada and U.S. tax rules differ on either taxing or timing include:
- Gain on the sale of principal residence
- Lottery, gaming and prize-winnings
- Exemption of gains from Qualified Small Business Corporation
- Installment sales
- Transfers to corporations and certain re-organizations
4. Canada Pension Plan and US Social Security
The Issue?
Both the U.S. and Canada require employees to be covered under their respective social security programs. In Canada that is the Canada Pension Plan (CPP) and the U.S. it is the US Social Security and Medicare Tax (also known as FICA).
Why Does it Matter?
U.S. Social Security benefits are substantially higher than CPP, but so is the cost. For an employee earning US$100,000 their FICA would be US$7,650. The CPP on that individual would be C$2,900 (US$2,150) in 2020. If self-employed, you need to match the employee’s tax, making it an US$11,000 annual difference before claiming the tax deduction.
Both FICA and CPP are government mandated compulsory savings programs. They will repay what you put in with a meagre return. Actuarilly, neither are competitive with putting those same monies into government-insured bank account that has a nominal return in today’s economic climate of 1-2%. CPP is a better program because it minimizes your investment in either program and allows you to use the savings any way you like, including putting the additional monies into your own savings plan. Importantly, your employer realizes the same savings that you do.
Scenario 1: Executive Transferred to Canada by Employer
Employees temporarily transferred by their U.S. employer to their Canadian affiliate may be required to remain on FICA.
Scenario 2: Self-Employed Individual Moves to Canada
When a self-employed individual moves from the U.S. to Canada they cannot remain on FICA and enroll in CPP.
What is the Solution?
Solutions will depend on the facts and circumstances, but may include:
- For employees temporarily transferred to Canada by their U.S. employer they should seek to avoid remaining on FICA
- Being self-employed to avoid FICA and qualifying for CPP when transferring to Canada;
5. Investments in Canadian Corporations
The Issue?
Ownership of corporations formed outside the U.S.
Why Does it Matter?
U.S. tax law is concerned that income earned in corporations formed outside the U.S. defers or avoids U.S. tax. Its rules may attribute undistributed income earned corporately to U.S. shareholders or subject them to adverse tax results.
Scenario 1: Shares in a Closely-Held Canadian Corporations
A corporation formed outside the U.S. that Americans directly or indirectly own more than 50% of the voting shares will be treated as a Controlled Foreign Corporation (“CFC”). CFC net income may be attributed to certain U.S. shareholders. The attribution of this income may result in tax in Canada and the U.S. without offsetting tax credits.
You may be required to make U.S. tax disclosures, even where your interest in the non-U.S. corporation is 50% or less because of shares attributed to you from your ancestors (parents, grandparents, etc.) or lineal descendants.
Scenario 2: Investments in Non-U.S. Mutual Funds and ETFs
Generally, all mutual funds, exchanged-traded funds (ETFs) and similar investment vehicles formed outside the U.S. will be treated as Passive Foreign Investment Companies (“PFICs”) for U.S. tax purposes, even where they are formed as trusts under Canadian law or invest in U.S. entities. Operating companies may also qualify as PFICs.
U.S. shareholders of PFICs are taxable when they receive distributions or realize a gain on disposition. Their proceeds are taxable federally in the U.S. at the top marginal tax rate (39.6%) over the holding period vs 20% for qualifying dividends and gains. U.S. shareholders of PFICs are charged interest on their notionally deferred income and face restrictions on foreign tax credits and loss carry-forwards.
What is the Solution?
Some solutions may include:
- Avoiding CFC status by using a hybrid entity.
- Distribute the Canadian corporation’s tainted assets to avoid income attribution.
- Minimize the Canadian corporation’s taxable income to avoid attribution.
- Making an election to allow you to claim the Canadian corporate income tax as a foreign tax credit to offset your U.S. tax otherwise payable.
- Disposing of PFICs prior to U.S. tax residency.
- Investing only in PFICs that allow you to make a Qualified Electing Fund election.
- Electing under the Mark-to-Market tax regime.
- Reviewing acquisition of future investments outside the U.S. in advance.
Further information
If you want more information on any of the above issues or others, please contact any the following:
Warren Dueck, Partner T: 604-242-1401 or 587-390-1610
E: warren.dueck@ca.Andersen.com
Steven Flynn, Partner T: 604-242-1416
E: steven.flynn@ca.Andersen.com
Krista Rabidoux, Principal T: 587-390-6568
E: krista.rabidoux@ca.Andersen.com
Emily Yu, Principal T: 604-242-1405
E: emily.yu@ca.Andersen.com
Catherine Shen-Weafer, Senior Manager T: 604-242-1407
E: catherine.shen-weafer@ca.Andersen.com
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- Canadians Doing Business in the U.S.
- Canadian Investment in U.S. Rental Property
- Canadians Buying U.S. Vacation Property
- Americans Doing Business in Canada
- Americans Investing in Canadian Real Property
- Americans Buying Canadian Vacation Property
- U.S. Estate and Gift Tax for Canadians
- Impact of Biden’s Tax Proposals on Canadians
