Over the past few years, there has been a rise in regulations and monitoring of American citizens and Green Card holders abroad. Because of the seriousness of the consequences for noncompliance, careful tax preparation is essential.
How about Canadian taxation for Americans?
Both the Canada Revenue Agency (CRA) and the United States Internal Revenue Service (IRS) require dual tax filing from U.S. residents and Green Card holders living in Canada. With a few notable exclusions, the Tax Treaty ensures that people will only have to worry about paying taxes in one country.
In effect, this means that Canadian residents can reduce their US tax liability by making payments to the Canada Revenue Agency (CRA) and receiving a tax credit in return.
Since Canadian income tax rates are higher than their American counterparts, you can expect to always have enough "credit" to balance all of your US taxes, leaving you with zero US tax debt.
Earnings Abroad
If a US resident earns more than the required reporting level each year, the income must be reported and taxed. Citizenship, not residency, determines whether or not a person is subject to taxation in U.S.
Wages, interest, Money from rents, and dividends earned outside the country all count as taxable income.
You are still subject to US taxation, but some types of income and expenses can be excluded or credited depending on your situation. American expats can lower their tax bill with these.
Canadian tax implications for Americans
If you invest unwittingly in PFICs (Passive Foreign Investment Companies), you may incur unexpected tax liabilities. You must file more involved tax paperwork if you have any PFIC investments.
On the other hand, 401(k) account holders frequently discover that their funds have been locked and are no longer being managed.
Potential tax pitfalls for U.S. citizens living in Canada
Avoid these situations as an American expat in Canada:
• The Internal Revenue Service (IRS) may treat certain investments held in a retirement education savings plan (RESP) as PFICs, resulting in double taxation. The US parent may be subject to taxation on its growth and grants if it is a grantee, and the CRA will tax the kid when they withdraw the funds.
• The Internal Revenue Service (IRS) recognizes that certain types of TFSAs may hold PFICs. This means you'll have more paperwork to fill out come tax time and won't get any breaks on your taxes.
• PFICs may be held in Canadian Mutual Funds and Canadian Exchange Traded Funds. US-based exchange-traded funds (ETFs) and mutual funds can still be used without running into PFIC restrictions.
• Investing in a Canadian Holding Company that generates passive income, as this can lead to expensive and time-consuming tax returns as the company may be classified as a Passive Foreign Investment Company (PFIC) or Canadian Foreign Corporation (CFC). If a CFC generates earnings in excess of 10% of its depreciable tangible assets, the United States may tax that income as GILTI (Global Intangible Low-Taxed Income).
· In Canada, a tax-free savings account (TFSA) is available to residents of the United States who are living outside of the country. Many Americans living in Canada wonder if they must fill out IRS forms 3520 and 3520-A because they have a tax-free savings account (TFSA).
Foreign trusts that are exempt from filing Forms 3520 and 3520-A are addressed in Revenue Procedure 2020-17, which was released at the start of the year. A college fund or an emergency fund is an example of a designated fund. The provisions of revenue procedure 2020-17 do not apply to TFSAs, thus if your TFSA satisfies the following criteria, you will need to file forms 3520 and 3520-A.
Fortunately, if your TFSA qualifies as a trust, you will only need to file forms 3520 and 3520-A if you are an expat. Since the Internal Revenue Service has never definitively defined whether or not a TFSA is a trust, many taxpayers are left in the dark. This means that the terms under which your TFSA was established will determine whether or not it is considered a trust.
What Are the Key Distinctions Between the Canadian and American Tax Systems? Individual Return or Joint Return for Married Couples
There is no other way to file your tax return in Canada than as an individual. Unfortunately, married couples are not eligible to file jointly.
Taxes on Income
Some states in the United States do not impose an income tax. There is a provincial tax in every province in Canada.
Both the United States and Canada impose federal income taxes ranging from 15% to 33% on earners' money.
Taxes Determined by Nationality or Address
Citizenship, not residency, determines your tax status in the United States. As a result, American citizens living abroad are subject to federal income tax on their worldwide earnings. In contrast, your resident status determines your tax liability in Canada. Therefore, if you are a Canadian resident, you must submit a tax return to the CRA.
Residence/Primary Home
The capital gains exclusion for the sale of a primary residence in the United States is USD $250,000 for an individual or USD $500,000 for a married couple filing jointly. To qualify for this exclusion, you must have owned and resided in the property for at least 2 of the 5 years prior to the selling date, and you cannot have utilized this exclusion on another home within the last 2 years. You will have to pay taxes on any capital gains in excess of this threshold.
In contrast, in Canada you are excused from paying tax on the appreciation of your primary residence.
Death or Estate Duty
The United States levies a one-time tax on the wealth of the deceased, known as the Estate Tax.
A Tax on Capital Gains
Regardless of how long an asset is held, in Canada, half of any capital gain is taxed at the owner's marginal income tax rate. If an investment is held for more than a year, the rate paid by the investor is considered long-term; otherwise, the rate is considered short-term. Gains on investments held for less than a year are taxed as ordinary income at the investor's regular rate. Short-term gains are taxed at a higher rate than long-term gains. The percentage can be anywhere from 0% to 20%.
Payouts for Medicare and Social Security
Here in the States:
Healthcare in the United States is mostly paid for by individuals, who contribute 7.65% of their taxable income to Social Security and Medicare.
Employees in Canada contribute 4.95 percent of their taxable income to the Canada Pension Plan (CPP), which covers medical expenses.
Monthly retirement benefits for U.S. residents are larger than those for Canadians earning the same amount but contributing just to Canada Pension Plan (CPP).
Step-up Difference Between the Basis and the Cost Basis
Inheritors in the United States use the current fair market value of an inherited item as their cost basis, meaning that profits accrued between the time the original owner acquired the asset and the time of the inheritor's death are not subject to taxation.
Unless there is a surviving spouse, the deceased Canadian's estate is responsible for paying any outstanding taxes. Fair market value is presumed to have been realized on all assets on the day preceding death.
Highlights of the United States-Canada Tax Treaty
A tax treaty exists between the United States and Canada to aid taxpayers and prevent double taxation. Foreign tax credits are used to do this. Since a Canadian person will already have paid tax on this income in Canada, they will not be subject to double taxation when filing their taxes in the United States. Personal income tax rates in Canada are often higher than those in the United States when federal and state taxes are added together.
Here are the most important rules to remember:
• In Article X, qualified dividends are taxed at a lower rate than ordinary income,
• In Article XI, qualified interest income is taxed at a lower rate than ordinary income, and
• In Article XV, qualified income from dependent personal services is excluded from taxation up to a maximum of $10,000.
• Qualifying pensioners receive a lower tax rate thanks to provisions in Article XVIII.
U.S.- Canadian taxation system
The US-Canada Income Tax Treaty protects Americans from paying taxes twice on money made in Canada. However, this does not apply when US citizens invest in services or organizations that are not covered by the treaty. When a US resident subscribes to and receives funds from a Registered Education Savings Plan (RESP), they may be subject to double taxation.
Welfare in Canada
Since the United States and Canada have signed a Totalization Agreement, you can avoid paying social security taxes twice on the same income. Paying into the Canadian system will likely exempt you from paying into the US system. Depending on your work situation, you may be required to make payments to either the United States or Canada.
When do I become a Canadian tax resident?
If you meet one of these criteria, you are deemed a Canadian resident for tax reasons and must file your taxes in Canada:
You have significant residential ties to Canada (such as a home, dependents, or a spouse/common-law partner residing in Canada) and you plan to make that country your permanent residence. though you don't meet the criteria for Canadian residency listed above, you can be a permanent resident of the United States even though you spend most of your time in Canada.
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