Tax FAQs for U.S. Citizens

What are the common tax forms a U.S. citizen living in Canada should file each year with the IRS?

The typical U.S. tax forms to be filed by American citizens living in Canada are:

Form 1040, U.S. Individual Income Tax Return, and its related schedules:
Form 2555, Foreign Earned Income Exclusion
Form 1116, Foreign Tax Credit
Form 8938, Specified Foreign Financial Assets
Form 8621, Passive Foreign Investment Corporations (reports interest in Canadian mutual funds)
Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans (includes election to defer tax on the earnings within an RRSP or RRIF for U.S. tax purposes)
Form 8833, Treaty Based Position Disclosure (for various Canada–U.S. Income Tax Treaty elections that may be required in your U.S tax return)

The following forms may also be required for certain persons:

Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations (for Americans with an ownership interest in private non-U.S. corporations)
Form 3520-A and Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Foreign Gifts (for U.S. owners or beneficiaries of Canadian RESPs or certain tax free savings accounts)
FinCen Report 114, Report of Foreign Bank and Financial Accounts (previously Form TDF 90-22.1)

Failure to file these forms could result in minimum penalties of $10,000 for non-willful infractions.

I am a U.S. citizen and have lived in Canada for most of my adult life. I pay taxes on my worldwide income on my Canadian tax return. I just realized that I should have been filing U.S. tax returns for this entire period and haven’t been doing so. What is the best action I can take here? Why would I start filing these now?

While it’s not a great feeling to discover you’re delinquent in your U.S. tax filing obligations, the IRS has introduced two programs (one of which will be discontinued in September, 2018) that encourage U.S. citizens to come forward and correct this issue.

The first is the Streamlined Disclosure Program, which requires you to back-file your delinquent U.S. tax returns for the past three years and your Report of Foreign Bank and Financial Accounts (FBAR) statements for the past six years, and to respond to some questions regarding your non-filing. Being accepted under this program could save you tens of thousands of dollars in potential penalties for failure to file certain forms. There are several tests you must meet to qualify for this program and we encourage you to contact us on this matter.

If the Streamlined Disclosure Program does not apply in your situation, the IRS also has an Overseas Voluntary Disclosure Program. Although it doesn’t fully exempt you from penalties, your penalty exposure could be reduced significantly if you are accepted into this program. The IRS announced in March, 2018 that this program will be discontinued effective September 28, 2018.

We understand a person’s resistance to filing tax returns and potentially paying tax or penalties to a country to which they have limited or no ties (with the exception of citizenship or a Green Card), especially if they have never lived in the United States. But it’s no longer in your favour to take a ‘head down’ approach and ignore the issue. Since 2008, the IRS has increased its focus on U.S. citizens living abroad or U.S. residents holding (but not disclosing) assets outside of the United States. The U.S. Foreign Account Tax Compliance Act (FATCA) will soon require non-U.S. institutions around the world to identify, report and possibly withhold on any U.S. citizen or U.S. taxpayer accounts held at those institutions—which means ‘doing nothing’ is not an option for U.S. citizens who are not compliant on their tax and reporting obligations. Voluntary disclosure is always the preferred option—and one that allows for greater leniency on penalty application than being ‘caught’ by the IRS.

My U.S.-based employer is sending me to Canada for five months. I live in the United States and my family will remain there while I’m away. My compensation during this time will be more than $20,000 USD. Are there any Canadian personal tax consequences I need to know about?

This question needs to be looked at from two angles: your personal obligations and your employer’s obligations.

Your personal obligations
As you will be in Canada for only five months, you will likely not be considered a tax resident of Canada, which means you may not be subject to a final tax in Canada on your Canadian source income (i.e., the employment income related to the services performed in Canada). You will, however, be required to file a Canadian T1 income tax return no later than April 30 to report your Canadian source employment income, regardless of the ultimate tax liability.

If you are, in fact, subject to Canadian tax on your earnings, you will be eligible to claim a foreign tax credit (for Canadian tax paid) on your U.S. federal tax return, which will offset some (or all) of the U.S. tax otherwise payable on the same income (thereby reducing the risk of double taxation). Depending on the state in which you live and pay tax, there may be a similar foreign tax credit mechanism that will allow for a reduction of your state income tax.

If you were issued a work permit to enter Canada, you will likely need to apply for a Canadian Social Insurance Number (SIN), which is a requirement of everyone who is working in Canada.

Your employer’s obligations
If you are working in Canada, your employer (Canadian or non-Canadian) has payroll withholding obligations in Canada. Whether you remain on the U.S. payroll or not, your employer will have a requirement to withhold Canadian income tax, Canada Pension Plan (CPP) and other payroll taxes (such as the Ontario Employer Health Tax) and remit these to the Canada Revenue Agency (CRA) on a periodic basis, just as would be done for employees resident in Canada. Your employer may also subject to penalties for failing to withhold, remit and report on your employment income.

Even if you are not subject to tax in Canada, your employer still has a responsibility to withhold and remit unless a tax waiver is obtained from CRA. Employers are also required to withhold and remit (CPP) premiums unless exempted under Social Security ‘totalization agreements’ with your country of residence. Regardless of whether or not a waiver is obtained, your employer would be required to issue to you Form T4, Statement of Remuneration Paid (the equivalent of a W2,), no later than February 28 the following calendar year.

Citizen Abroad can assist you and your employer in meeting these requirements.

I have heard that owning Canadian mutual funds can result in unintended negative tax implications and requires additional reporting in my tax return. What are the additional reporting requirements and what are the tax implications?

Under U.S. tax law, most Canadian (or non-U.S.) mutual funds and exchange-traded funds are considered to be passive foreign investment corporations (PFICs). If you own these funds, you may be required to file Form 8621 with your annual U.S. tax return. In addition, your interest in these funds should be disclosed on the annual Report of Foreign Bank and Financial Accounts (FBAR) form.

A non-U.S. corporation is a PFIC if it meets one of two criteria:

1. At least 75 percent of its gross income is passive income (e.g., interest, dividends, rents)
2. At least 50 percent of its assets are passive assets (e.g., cash, non-operating assets, investments)

Any income you earn from a PFIC investment is recognized as income only when funds are distributed to U.S. shareholders. At that point, a calculation is done to determine if the distribution is considered ‘excess’—meaning taxable at the highest ordinary tax rate in effect. If not excess, PFIC distributions are taxed at ordinary U.S. tax rates (i.e., not at qualified dividend rates), even if for Canadian tax purposes the distribution is considered a dividend.

Capital gains on PFICs for U.S. purposes are prorated as earned over the holding period of the PFIC fund, and are taxed at the top rates in effect over that period (recently as high as 39.6 percent), with an interest charge on the tax on the portion of the total gain allocated to prior year.

Most tax specialists consider the additional reporting for mutual funds or ETFs held within an RRSP to be unnecessary for U.S. tax purposes (as the U.S. tax on these funds is deferred until the funds are withdrawn from the RRSP). As such, the negative tax implications would not apply.

I am a former Canadian resident who now lives in California. I don’t have any non-U.S. bank accounts with the exception of my Canadian RRSP, which has a balance of $120,000. What do I need to report on my U.S. tax return?

You will likely need to complete the following forms with your 1040 tax return:

• Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans (RRSP disclosure) is required if you are receiving distributions from an RRSP in the current year
• Form 8938, Statement of Specified Foreign Financial Assets (this form is required because the value of the asset is more than $100,000 on the last day of the year)
• FinCen Report 114, Report of Foreign Bank and Financial Accounts (previously Form TDF 90-22.1, this form is required because the balance is greater than $10,000 in the year)

Additionally, as California does not recognize the Canada–U.S. Income Tax Treaty, you will need to disclose and pay tax on all income and gains earned within the RRSP annually on your California tax return.

I don’t live in Canada but I am considering buying a residential investment property in Canada. What are the tax considerations?

With the understanding that you are not considered a resident (for tax purposes) of Canada, your property manager or a Canadian resident agent will have to withhold non-resident tax at the rate of 25 percent on the gross rental income collected on your behalf. This is a tax that must be sent monthly to the Canada Revenue Agency (CRA) and is refundable only if your tax is computed to be less on the filing of a tax return with CRA.

Many of our clients find their own tenants and do not use a formal property manager. As non-residents, they must appoint a Canadian resident to act as an agent on their behalf—often a family member or friend. Because there are significant responsibilities with this role, Citizen Abroad Tax Advisors can help you understand them to ensure your agent meets his or her obligations.

After property taxes, insurance and mortgage payments, I expect to experience a loss on my Canadian rental property. Does tax still have to be withheld?

You can have the 25 percent gross rental income tax reduced throughout the year by filing a ‘budget’ for the rental property with the Canada Revenue Agency (CRA). The budget is submitted with Form NR6, Undertaking to File an Income Tax Return by a Non-Resident Receiving Rent from Real Property, which is signed by you and your agent or property manager and then sent to CRA for approval.

Form NR6 is your notice to CRA that you are choosing to file a tax return annually under Section 216 of the Income Tax Act. Until you receive approval from CRA, your property manager or agent must withhold tax on the gross rental income. Once approved, your property manager or agent can withhold non-resident tax at the rate of 25 percent on the net rental income, which, if you expect a loss, would be zero withholding. It should be noted that Form NR6 has an annual filing requirement.

Form NR4, which is an annual reporting statement of rents collected and tax withheld, must also be filed by your agent or property manager each year.

Finally, if you are a non-resident property owner you will also have a tax filing requirement for your rental property on or within six months of the end of the calendar year. This is a separate and distinct tax return (commonly referred to as a ‘Section 216’ tax return). If it is not filed in a timely way, CRA may assess non-resident tax of 25 percent on your gross rental income. While this return is due in June, any tax owing must be paid on or before April 30, otherwise interest will be assessed.

I am selling my rental property in Canada. I have never resided in this property. Although I was a prior resident of Canada, I left many years ago and have been filing non-resident rental tax returns annually. Is there anything I need to do for Canadian tax purposes?

As a non-resident of Canada disposing of a rental property, you will need to advise the Canada Revenue Agency (CRA) of the sale by completing Form T2062, Request by a Non-Resident of Canada for a Certificate of Compliance Related to the Disposition of Taxable Canadian Property, no later than 10 days after the property is sold. Additional documents will also need to be forwarded to CRA along with Form T2062, including your original purchase and sales agreements.

With the Certificate of Compliance, your real estate lawyer will be required to withhold non-resident tax of 25 percent of the net gain on the sale. Without the certificate, not only will there be a requirement to withhold 25 percent of the gross proceeds but you will also be subject to a penalty of $25 per day to a maximum of $2,500 for failure to file.

Finally, you will be required to file a T1 tax return by April 30 of the year following the sale, disclosing the gross proceeds, the original purchase amount and additional outlays or expenses related to the sale. You will also need to include Copy 2 of Form T2068 with your tax return.

I have recently moved to Canada but I am not yet a permanent resident or a Canadian citizen. What are my tax obligations?

Residency status determines how individuals are taxed in Canada. ‘Tax residents’ of Canada are subject to Canadian income tax on their worldwide income regardless of where it is earned, paid or credited. Non-residents (for tax purposes) are subject to Canadian income tax on Canadian source income only (e.g., income from a Canadian rental property, employment income earned while physically working in Canada, dividends from Canadian companies).

You may be deemed a tax resident of Canada if you spend more than 183 days in the country in any calendar year. However, the more common situation is ‘factual’ residency: if you have created or severed significant residential ties in Canada—regardless of the number of days spent in Canada in the calendar year—you may be considered to have changed your residency status.

Determining Canadian tax residency
Residency (outside of deemed residency) is not defined in the Canadian Income Tax Act. The Canada Revenue Agency (CRA) relies on standards created by court cases, tax treaties and CRA communications to assist in residency determinations. In general, residency is determined by looking at one’s primary and secondary ties to a country or countries.

Primary ties include:

• Location of home (rented or owned, as long as it is available for your use)
• Location of spouse and dependents
• Location of employment or business interests

Secondary ties include:

• Location of bank and investment accounts
• Location of memberships and associations
• Location of vehicle registration
• Voting registration location
• What jurisdiction issued the driver’s licence
• Location of health care

If it appears an individual could be resident in two countries (because the ties are split), the terms outlined in tax treaties are used as a ‘tiebreaker’ to determine residency.

Residency can affect all of your tax filings and exposure to compliance risk. We encourage you to contact us to discuss your specific situation.