Blog Alert: Taxes for U.S. Citizens Resident in Canada

February 27, 2023

Taxation Based on Citizenship

U.S. citizens resident in Canada are taxable on their worldwide income in both countries. The real question is which country gets to tax it first, which country gives a credit for the other country’s tax and what happens when both countries don’t tax it at the same time or in the same way. For example:

  • Lottery winnings are not taxable in Canada, but are taxable in the U.S.
  • Installment sales are taxable in Canada within five years but may be taxable in the U.S. over an unlimited period depending on when payments are made
  • The sale of a principal residence in Canada will not be taxable but it may be taxable in the U.S. Vacation homes do not qualify for any exclusion under U.S. tax law

These rules also apply to individuals resident in Canada who hold permanent resident status (“green-card”) in the U.S. or are also residents of the U.S. under its tax law.

Avoiding Double Taxation

Generally, U.S. persons living in Canada may claim the Canadian income tax they paid or accrued, subject to certain limitations, as foreign tax credits to reduce their U.S. tax liability on income earned in Canada. Generally, U.S. tax on income earned in the U.S. can be claimed as a foreign tax credit against the U.S. person’s Canadian tax.

They may also be eligible to exclude qualifying employment or self-employment income up to US$112,000 (2022). This exclusion has the unattractive result of reducing the amount of Canadian tax that can be claimed as a foreign tax credit for U.S. tax purposes. Because U.S. tax law allows foreign tax credits to carry over for up to ten years, their availability in future years may be important.

The Canada-U.S. tax treaty can mitigate double taxation by allowing foreign tax credits for taxes paid or exemption of certain income from taxation.

The taxation of income and the rules on claiming deductions could be different between U.S. and Canada. It is possible that there would still be a U.S. tax payable after claiming foreign tax credits or income exclusion. For example, the U.S.’s Net Investment Income Tax (3.8% of investment income) may not be offset by foreign tax credits.

U.S. and Canadian International Tax Forms

U.S. persons may be required to file certain international tax forms under U.S. tax law. These include disclosing details of a U.S. person’s non-U.S. bank and financial accounts. Other information returns require a disclosure of ownership and interest in certain non-U.S. corporations, non-U.S. trusts and other non-U.S. entities. Investments in mutual funds, exchange-traded funds (“ETFs”) and other entities formed outside the U.S. may also require disclosure.

U.S. International tax forms that may be required to file a complete tax return include U.S. Treasury Form FinCEN 114 (also known as an FBAR) and IRS Forms 3520, 3520A, 5471, 8621, 8858, 8865, and 8938.

Failure to file these U.S. tax forms could be result in penalties generally starting at US$10,000. The statute of limitations will not start so the Internal Revenue Service (“IRS”) may audit the returns for an indefinite period. In certain cases, criminal penalties including imprisonment may apply.

Canada also has reporting requirements for Canadian residents with interests outside of Canada. These must be reported on CRA Forms T1134, T1135, T1141 and T1142. Penalties may also apply for failure to make these disclosures.

Delinquent Filing of U.S. Tax Returns

U.S. persons living in Canada are granted an automatic 2-month extension to file their U.S. personal income tax return. Generally, it extends the filing date to June 15th or the first business day after that date. U.S. personal tax returns may also be extended to October 15th and in limited cases to December 15th with the appropriate filings. The extension of the filing deadline does not extend the due date for any payment of tax. Interest would apply to late payments and, but penalties would not apply unless the outstanding tax is not paid by June 15th.

The Internal Revenue Service (“IRS”) may impose a late filing penalty of 5% per month and a late payment penalty of 0.5% per month up to 25% based on the tax owing.

U.S. persons living in Canada who have not filed his or her U.S. income tax returns in previous years, may avoid penalties for late filing of both their tax returns and required international tax forms and late payment. They must qualify for filing under the IRS’ Streamlined Foreign Offshore Procedure. Filing under this procedure requires them to file their last three delinquent U.S. income tax returns and six years of non-US bank account disclosures.

For more information, please see our webinar on Taxes for U.S. Citizens Resident in Canada: Tax 101.