US Filing Obligations of Non-residents of the US
There has been a lot of attention in the media about U.S. citizens who live in Canada and their U.S. tax filing obligations. Non-U.S. citizens who are not resident in the U.S. (“NRA” for non-resident aliens) may also have U.S. tax filing obligations where they work in the U.S., sell U.S. real estate or even travel to the U.S.
Work in the US
In general terms, NRAs who earn employment income while working in the U.S. are subject to U.S. federal income tax and are required to file US income tax returns even where tax was withheld at source. NRAs can reduce their U.S. tax liability by claiming certain employment expenses or by claiming an exemption under the Canada-U.S. Income Tax Convention (“Treaty”) in certain situations. Failure to timely file a US Federal income tax return may result in the Internal Revenue Service (“IRS”) denying a deduction of certain expenses, delaying acceptance of the application of a Treaty provision or assessing a $1,000 penalty for late notification of the use of a Treaty provision. For Canadian resident NRAs, unless a US Federal income tax return is filed, Canada Revenue Agency will generally not allow a foreign tax credit claim which may result in double taxation of US sourced employment income. State income tax returns may also be required.
Selling US Property
NRAs who realize a gain or loss on the sale of U.S. real property are also required to file a U.S. federal income tax return for the year of sale. This is true even where the buyer withheld 10% of the gross proceeds on sale and remitted this amount to the IRS as is generally required. Failure to file a timely U.S. tax return may result in the IRS assessing a capital gain on the gross proceeds from the sale. As the IRS would not have such information, an assessment by the IRS will not include selling costs or the adjusted cost basis of the property and may be in excess of the 10% tax withheld.
Spending Time in the US
NRAs who spend less than half the year in the U.S. may still become U.S. residents for US Federal income tax purposes. Under US tax law, the substantial presence test states that an individual who spends more than 182 days in the U.S. based on a formula is a resident of the U.S. This formula adds the number of days spent in the U.S. in the current year plus one-third of the days in the U.S. in the prior year plus one-sixth of the days in the U.S. in the second prior year. Where the total of this formula is 183 days or more and the individual has spent at least 31 days in the current year, the individual is a U.S. resident for U.S. federal income tax purposes unless he or she has a closer connection to another country. As a result, an individual spending more than four months a year in the U.S. over consecutive three years may meet this test.
The individual can file IRS Form 8840 – Closer Connection Statement with the IRS to establish a closer connection to Canada and avoid treatment as a U.S. resident. The advantage of filing this form with the IRS is that no other U.S. tax returns or other informational reporting forms are required to be filed by the individual. Failure to timely file IRS Form 8840 would require the individual to file a complete U.S. federal income tax return and could expose them to a penalty of $1,000 annually for late-filing a claim under the Treaty. The individual can make a determination under the Treaty that he or she is a resident of Canada and a non-resident of the U.S. for income tax purposes to avoid U.S. tax. However, such a determination is accepted under US tax law only for the purposes of calculating the individual’s income tax liability. Such individuals would still be required to file U.S. federal income tax returns reporting their worldwide income and all other disclosures required of U.S. persons even though their tax computation would be limited to US source income.
Every state in the U.S. has its own tax laws and with a few exceptions is not subject to restriction under either U.S. federal tax law or the Treaty. As a result individuals must separately determine their state tax liability even if they would not be subject to U.S. federal income tax.