US Tax vs. Canadian Tax

December 3, 2012

There are many similarities between the U.S. and Canada, but there are some significant distinctions between U.S. and Canadian tax law especially for U.S. citizens resident in Canada, including permanent residents of the US (“green-card” holders). For the unwary those distinctions may result in substantial U.S. tax liabilities where those differences are not identified in advance. The discussion below highlights three differences, among many, that may trigger unexpected U.S. tax liabilities for U.S. persons resident in Canada.

Sale of Principal Residence

Under Canadian tax law, a “principal residence” is exempt from capital gains tax when it is sold. In contrast, under US taw law there is an exemption of US$250,000 (US$500,000 if married filing jointly). A U.S. citizen or green card holder living in Canada must report the sale of property on a U.S. federal individual income tax return. In addition, the US$250,000 exemption only applies if during the five-year period ending on the date of the sale or exchange the property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating two years or more. The amount of gain excluded from gross income with respect to any sale or exchange cannot exceed US$250,000. A taxpayer must convert purchase and sale prices of the principal residence to US dollars to calculate the taxable gain upon disposition. The conversion to US$ may result in additional taxable gain due to currency translation disparities. As a result, the unsuspecting U.S. persons resident in Canada may have an unexpected t U.S. tax liability from the sale of his or her principal residence in Canada. Where there is no Canadian tax on the sale of the principal residence, the U.S. person would be barred from claiming offsetting foreign tax credits.

Stock Options

Under Canadian tax law, in most cases only half of employment benefits from stock options are subject to tax as ordinary income. Generally, stock option recipients incur a tax liability on stock options when the options are exercised. The amount that must be included in income from employment on exercise is equal to the difference between fair market value of the stock on the date the option is exercised and the strike price. There is a special Canadian tax deduction which allows individuals to deduct 50% of the income derived from exercising stock options. In contrast, the U.S. taxes 100% of the difference between the fair market value of nonqualified stock option shares on the date of exercise and the amount paid by the employee to acquire the shares as ordinary income without a similar deduction. This difference may result in a residual U.S. tax liability for U.S. persons who exercise stock options.

Capital dividends

Under Canadian tax law, private corporations resident in Canada keep track of certain income resulting from the non-taxable portion of capital gains over the non-deductible portion of capital losses separately from other types of income. A corporation with a capital dividend account can distribute these amounts tax-free to shareholders. The US does not recognize the concept of a capital dividend and all distributions from the earnings and profits of a corporation are treated as taxable dividends. In 2012, qualified dividends are taxed at a maximum tax rate of 15% in the U.S. Beginning in 2013, the U.S. tax rate will rise to 43.4%. Because of this disparity, a U.S. person may have an unexpected U.S. tax liability from a capital dividend without a corresponding tax in Canada.