Sourcing of income for dual US/CA citizen, Canada-resident

[nohairleft]

Hi all,

I have some questions about the sourcing of income on US returns. I am a Canada and US dual citizen who moved back to Canada in 2013. (I became a naturalized US citizen after I left Canada, so I never had the US/CA dual-taxation problem in the past.)

My question relates to the correct sourcing of income and which return(s) I should be filing my foreign tax credits on.

By my reading of the tax treaty: I am a US citizen residing in Canada. As a US citizen, article XXIX(2) means that most of the treaty does not apply to me and the US gets to tax everything I earn, with the limited exceptions given to the sourcing rules in XXIV(4) through XXIV(6).

I started by preparing both US and CA returns without the application of foreign tax credits to determine my nominal tax rates.

My current thinking about sourcing is this:

1. I have investment income that was entirely US-source (dividends and interest that were derived from cash and securities held by US banks and US brokers, consisting of cash and US corporations, US ETFs and US mutual funds). My banks/brokerage still uses my US mailing address, so they have not applied any withholdings (not sure if they are even required to) and I get US 1099s for all of the investments. However, my net US tax rate is below 15%, so:

-> there is no deduction made on the Canadian side per XXIV(5) since my taxation level is below the 15% threshold.
-> the IRS keeps 100% of the tax due on the investment income
-> I file a FTC with CRA which reduces my Canadian taxes due by exactly the amount paid to the IRS.


2. I also have US capital gains distributions (that resulted from US mutual funds in the above-mentioned accounts). I have a pile of US capital loss carryforwards from previous years, which wipes out these capital gains and more on the US return, thereby leaving me with a (wasted) $3,000 deduction on the 1040 side of things. So:

-> I pay 100% of the required tax in Canada on these capital gains distributions.
-> I don't get any FTCs to offset that because I didn't actually pay any tax to the IRS (but I burned part of my loss carryforward :-( )


3. I have wage income from working mostly in Canada. I was employed and physically present in Canada for the majority of the year, but I was working in the US for a week and a half on a business trip. My income exceeds the FEIE. Possibly complicating matters is that my employer in Canada is a US corporation (not just a US affiliate: the US corporation is actually registered as a foreign entity in Canada, although I do get paid by them in Canada on a T4).

I think most of the above is irrelevant though. Despite the rules in XV(2)(a) regarding the sourcing of dependent personal services under $10,000 (my work trip to the US falls under that threshold), my read is that XV(2)(a) does not apply to me as a US Citizen because of XXIX(2), and that the US also gets to tax me on 100% of my wage income based on the special rules in XXIV(3) and (4).

-> per XXIV(3), since the US "may" tax me on my worldwide income based on my US citizenship (despite those services being performed in Canada), all of my wage income can be deemed to arise in the US and is thus eligible for Canadian FTCs.
-> per XXIV(4)(a), I file a FTC with the CRA based on the amount of tax paid to the IRS on my wage income for the amount that exceeds the FEIE.
-> per XXIV(4)(a), Canada can allow a FTC of up to the amount payable as if I were *not* a US Citizen. However, since the US does not have separate tax rates for earned income for US citizens versus noncitizens, the allowable Canadian FTC is exactly the same as the taxes actually paid in the US.
-> per XXIV(4)(a), assuming that the entire FTC is permitted in Canada, there are no further deductions to US income.

The alternate reading of XXIV(4)(a) is that if I were not a US citizen, it's not just a question of tax rates, but also of the actual items being taxed. In this reading, the amount taxed by the US would be $0: as a non-US citizen, the Canada-performed work would not be taxable, and the work performed in the US (under $10k) would be exempt under XV(2)(a), so no tax is due to the US (and no tax credit is permitted by CRA). So I don't file any FTCs on the Canadian side for wages, but I do get a FTC with the IRS based on the taxes paid on the wages on the Canadian side. I actually tried doing this in a test run, but some weirdness in the calculations on form 1116 prevented me from deducting 100% of the US taxes that the wages caused, and I was not sure (in terms of form 1116 and whatnot) how one actually applies the re-sourcing permitted by XXIV(6) to eliminate that last bit of double-taxation.

Excluding my alternate reading above of XXIV(4)(a), the end result is that I never seem to file for any FTCs on the US side, and for all of the taxes that I do pay to the US, I generally get a credit back from the CRA for the same amount, so double taxation is eliminated.

Does the above seem correct? I have seen other posts suggesting that people are filing for FTCs with the IRS and not CRA and getting their money back in the other direction, and despite reading a lot of forum posts, I have not seen anyone describe the actual logic behind their sourcing.

Thanks for any input you can provide!

[nohairleft]

After digging a few years further back (and another 100 threads) in the forum, it sounds like:

#1 is correct for dividends, but for interest, I am SOL on getting a Canadian tax credit because US source interest would not have been withholdable for non-US-citizens, so Canada will not credit it. (Or is it just not creditable above 10%?) In any event, this means that I need to go back and re-source the interest income as if it were Canadian-sourced on my US return, right?

My research on #3 now makes me think that the "alternate reading" was actually correct, and that most (or all?) of my wages income is sourced to Canada, and that I should file for the FTCs on the US side rather than the Canadian side. (The main remaining doubt I have about the sourcing to Canada was the fact that I was paid by a US corporation while working in Canada.)

But if it does get sourced to Canada, perhaps I try revoking my FEIE and using a straight form 1116 vs FEIE+1116 to see if that resolves my earlier issue with recouping all of the double-taxation on wages income? (And possibly restoring my $1000 child tax credit?)

[nelsona]

Your post is a little lengthy, so I'll just sum up:

Sourcing is not really important, the tax credit is.

The only thing that canada will allow foreign tax credit is US tax on US-sourced dividends, capital gains related to US real property, employment perfromed in US, and business income from a permanent establishment in US. There are a couple of others, but I'll ignore those for this discussion.

So, for USC's living in Canada, the first thing to do is prepare Cdn and US returns without regard for foreign tax credit. You have to decide at this point however if you will be using FEIE or FTC on your Cdn wages.

This will determine an effective US taxrate for your income. Since it is in all likelihood less than 15%, you needn't worry about the 15% limit. Lets say 12%.

Relif on the Cdn side comes from:
DIVIDENDS:
your US-based dividends (that is dividends paid by US firm REGARDLESS of whre your broker is), are US-sourced, and 12% of that is US tax you can use on your FTC line.
INTEREST:
Since you cannot use the US tax on US bank interest (you can use the interst as foreign), your report the income but not the tax. The 12% gets used on line 256. You then get to RE-SOURCE the income on a special 1116,
CAP GAINS:
Similarly, cap gains tax is not creditable, nor is it considered US-sourced. So the US tax you paid goes on line 256, and you claim it as passive on a separate 1116. It is foreign income. Only US real estate would be considered US-sourced, and all US tax elible for FTC.
WAGES:
Your wages are Cdn-sourced. Relief is from the 1116 (general limit).

US Side:
As you suspected, most of the relief comes from US in the form of 1116:
1116 general limit for Cdn wages (2555 if you choose that), pensions, etc.
1116 passive for Cdn bank interest, Cdn dividends, all cap gains except US real estate,
1116 re-sourced, for US bank interest, US dividends, and, if your effective rate determined at the outset is greater than 15%, sufficient other US-sourced income to bring the rate on those incomes down to 15%.

May not have answered all your questions, but that is a good start.
The only thing I would caution is (a) this was a part-year Cdn retunr so make sure you take care of "newcomer" tax issues from the newcomer guide. (b) Generally, if you want the child tax credit, you need to use 1116 for your Cdn wages. (c) If you are going to continue in the relationship with this US firm, they shoudl either set up a Cdn payroll for you, or make youa a contractor.

[nohairleft]

Nelsona,

Thank you for your response! That was very helpful.

The US company already has me on Canadian payroll, so I am covered there. The tip about the newcomer guide was also good (Turbotax got most of those credits right, but I had missed the correct filing postal address for 1st-year returns).

I have a few final loose ends to tie up...and any help on the following would be greatly appreciated!

1- My capital gains distributions were offset by prior year capital loss carryovers on the US side, so I technically didn't pay any US tax on them...which I assume means that I may not apply for a credit on form 1116 for the Canadian taxes I paid on them? (I do have other passive income and taxes on both sides this year.)

2- You suggested filing a re-sourced 1116 for US dividends. But following your earlier suggestion about first getting a Canadian FTC on the US taxes paid on US dividends, that FTC would be allowable in Canada for the full amount of US tax paid (assuming a US tax rate of under 15%) and thus there would be nothing left to re-source. Right?

3- Do I file the credit for the physically-present-in-the-US portion of the wages (working for my same US "C" corp employer, but under $10,000) as a re-sourced 1116, or can I just leave them as part of the general 1116? (Are they somehow considered foreign source without needing to specify that I am taking a treaty position?) I am already declaring a specific quantity of days and $ earned while physically within the US on form 2555, so I don't know if the IRS is expecting to match up this number somewhere else.

4- Speaking of which, if I file any form 1116s in the re-sourced category, I assume that I need to file a form 8833? And not otherwise, at least within the scope of the other items I've discussed?

5- Does anyone know if Canadian mutual funds held exclusively in an RRSP require the filing of form 8621 (PFICs)? I will obviously be filing an 8891.

Thanks again!
-NHL

[nelsona]

Like I said, this is a move year so some things may of may not change dur to this.

I'm into giving principles, rather than specific to your situation. I'm troubled that as a first year Cdn resisnt you would not have looked at the special rules for first year taxes.

1. The priniples for foreign tax crdit is that you need to have foreign income reported on the tax return AND you need to have owed foreign taxes on that income. You do realize -- from reading the newcomers guide -- that your cap gains in canada are negligible, because Canada re-values ALL your investment cost beses to FMV on the day you arrived. You need to track these values separately from your US cost bases. So, unless you sold investemnts after arriving in Canada, AND these investements grew in the period between arrival in Canada and sale, you have no income to report, and none of it would be considered fooreign in any regard. Add that to the fact you owe no tax in US on your gains, and you can forget about any FTC claim on cap gains, on either return.

2. Yes, re-sourcing only occurs if canada does not accept some or all of your US tax. So if your tax rate is below 15%, the only bank interest is re-sourced.

3. There is no limit on what CRA will allow on foreign wages, and the portion earned in US is US-sourced, so there is no 1116 for this, other than for the portion above the 2555 limit. You wil have a credit on your Cdn return for any US tax you pay on the wages you earned in US after becoming Cdn resident.

4. There are very few instances when you NEED an 8833, but I would include the 8833 as an explanation, so they know what you were doing.

5. RRSPs are exmpt from PFIC. They are not exempt from foreign reporting however.

Next year will be easier.

[nohairleft]

Nelsona,

I did not buy or sell anything after I moved, mostly driven by a desire not to complicate my returns.

Perhaps I did not emphasize this one word as strongly as I should have in my previous posts, but what I am reporting is a capital gains *distribution* (from a US mutual fund), as opposed to a straight-off capital gain. The MF reported the distribution and dumped the corresponding money into my account after the date I moved to Canada, which leads me to believe that it should be sourced to Canada.

Although some of the gains must have originated before I moved (some were classified as LTCGs by the MF and were therefore held +1 year by them), I don't see how it's going to be possible to get sufficient information from the MF to characterize this any differently. (ie. What were their unrealized cap gains as of the date I moved to Canada? There's no hope.)

I realize from reading other posts that I also have to ditch the US brokerage and US MFs to avoid regulatory purgatory, which is next on my list, so I need to sell it anyway. The current unit price is above the new stepped up, post-distribution Canadian cost basis, so unless the fund takes a dive in the near future, at least I will avoid having to take a Canadian loss on it.

(Since I'm not paying US tax on it due to the loss carryforwards, I realize that the question is moot from a tax credit perspective anyway.)

I really do appreciate your comments. I recall looking at the newcomers guide a year ago, but I had forgotten to go over it again now that it's closer to filing time. But you are right to call me on relying more heavily than I should have been on Turbotax, especially for a more-complicated return.

One reason that I am trying to see if I can work this out myself, well in advance of the filing deadlines, is that I dropped a bunch of change on one of the big Canadian accounting firms before I moved, and I got what I considered to be bad advice from their US tax "expert".

One example (although not the only one) relevant to the current discussion, is I told them that I was sitting on a pile of US capital loss carryforwards, as well as a pile of unrealized capital gains (that were at least as large as the loss carryforwards). My specific question to them was whether there was anything that I should do about this from a tax perspective before moving to Canada.

Their answer was that it did not really matter due to the adjusted cost basis on the date I moved to Canada and things "working out".

But with all other things being equal, it seems like the correct answer was to try to wipe out as many of the loss carryforwards as possible before becoming a Canadian resident. The main problem is that the loss carryforwards must always be applied against your current year US taxes, whether or not you want to use them. If you don't use up all of your carryforwards in a given year, you burn $3,000 (MFJ) of your carryforward every year as a deduction off your general income. Since that gets mostly wiped out by the corresponding Canadian tax credit, you've just wasted $3k of your loss carryforward for no reason, and when you go to sell your assets, you will pay more than you should.

I am now in the position where I want to fix this so that my loss carryforwards do not all go to waste, but it's complicated due to the dual taxation. With a capital loss carryforward of (say) $10,000, I need to sort through my portfolio to see if I can find a combination of securities to sell that result in a US gain of $10,000 but as close to a Canadian gain of $0 as possible. Not fun!

Thanks again.

[nelsona]

I think you are misunderstanding the concept of deemed acquisition. It is strictly based on FMV, not unrealized cap gains.

All your MF's had a NAV on the date you arrived in Canada -- that should be public infromation. That will be the Cdn basis you going forward. I don't know what unrealized gains would matter, since you were paid on a specific date -- that is the date they were realized. If it was after you arrived in canad it is all taxable in canada

The distributions are Cdn-sourced, so no ftc will be granted on your Cdn return. It will just be considered passive income for 1116 purposes IF you paid any US tax on any cap gains, which appaerntly you are not.

The advice you got about your carryforwrad was wrong -- why would you have paid for it, they didn't do your taxes, did they?

[nohairleft]

I had originally been thinking that part-year residents could possibly have some special rule for pro-rated CG distributions based on residency duration, but in hindsight, regular CG distributions are simply accrued by the owner on the distribution date without regard to how long you held the fund anyway, so it makes no sense for it to be any different for new residents.

I hired the firm and paid them $$$ to help with tax plannng issues before the move, not just for that one issue, but also to address other substantial complications. (I own a small US company, which ends up having a permanent establishment in Canada due to my mere presence here, so we needed to figure out the best corp structure to minimize bureaucracy, taxes and reporting burdens, to help with registration requirements, and to advise on any needed changes before the move.)

I don't have any concerns about the personal compliance side of the biz ownership and I believe that I have all that covered, but I am not foolish enough to attempt the Canadian corporate tax angle myself for the business. (Know anyone good who is accepting new clients...?)

Thanks again!

[nohairleft]

I have a correction/clarification to nelsona's excellent commentary above for those who stumble across this post:

[quote="nelsona"]3. There is no limit on what CRA will allow on foreign wages, and the portion earned in US is US-sourced, so there is no 1116 for this, other than for the portion above the 2555 limit. You wil have a credit on your Cdn return for any US tax you pay on the wages you earned in US after becoming Cdn resident. [/quote]

I did some further sleuthing, and my sources suggest that CRA does not agree with this view (or at least it did not in 2010) with respect to the situation I originally proposed, which is a worker who earns less than $10,000 of wage income in the US.

CRA ruling 2010-0355551E5 refers specifically to the situation in which a US citizen Canadian-resident taxpayer earns part of his wage income in the US. That ruling says, in part:

[quote]
In accordance with subparagraph 4(a) of Article XXIV of the Convention above, before one can determine the amount of the U.S. tax that is creditable in Canada, a determination must be made of which amounts the U.S. would have been entitled to tax under the Convention, had the Canadian resident not been a U.S. citizen. The provision of the Convention relevant to this determination in the case of Taxpayer2 is Article XV of the Convention. Under that Article, the U.S. is excluded from taxing the salary income of Taxpayer2 if (a) [b]the salary earned in the U.S. does not exceed US$10,000 in the calendar year[/b] or (b) Taxpayer2 is present in the U.S. for a period or periods not exceeding 183 days in any 12-month period commencing or ending in the fiscal year concerned and the salary is not paid by or on behalf of a U.S. resident and is not borne by a permanent establishment in the U.S. [b]If the conditions in either subparagraph 2(a) or (b) in Article XV of the Convention are met, the salary income earned by Taxpayer2 in the U.S. would be deemed to be income arising in Canada for the purposes of subparagraph 3(b) of Article XXIV of the Convention, with the result that in accordance with subparagraph 4(a) of Article XXIV of the Convention, Canada would not be required to provide any foreign tax credit in respect of the taxes paid by Taxpayer2 to the U.S. in respect of such salary income.[/b] Rather, in order to avoid double taxation, the U.S., in accordance with subparagraph 4(b) of Article XXIV, would provide a tax credit against U.S. taxes payable in respect of the Canadian taxes payable.[/quote]

I am far from an accounting rockstar, but from this I infer that Canada does not permit a credit for any of my sub-$10k US wage income. Therefore, to prevent double-taxation, that income is considered to be Canadian sourced by the treaty after all, and the US would be required to permit a credit for it on a re-sourced 1116.

If I had earned more than $10k in the US, the ruling suggests that nelsona's original interpretation is correct.

[nelsona]

What you say is true, and is well known, and I have advised this exemption many times.

However, while it may be that for the period of the year that you were Cdn resident you earned less than $10K from US wages, it was unclear whether, for the entire year, you earned less than $10K in US, so I would say, even based on your original, lengthy post, that you wouldn't qualify for this exception.

It quite simply doesn't apply to part-year returns, unless the income for the entire year from one source or the other was below $10K.

Example: my wife worked in Canada for a year, 9 months as Cdn resident. While she earned less than $10K in the last part of the year, after our move to US, she could not use the treaty to exempt her Cdn wages for the 3 months from US taxation, since she had earned more than $10K for the year. That is the tricky part of that clause when it comes to part-year taxation.

And just so we are clear, the US-sourced wages is NEVER considered Cdn sourced, it is most definitely US-sourced, However, if it were less than $10K, it would be considered NON-taxable to non-US citizens living in Canada, thus denying the credit on your T1, and permitting re-sourcing on your 1040.


Its called re-sourcing for a reason: it IS US-sourced.

There is distinction between income that is sourced and taxed in US, soured in US and taxed in Canada only (social security for example), and income that is sourced in US, but only fully taxed there because of US citizenship.

[nohairleft]

It happens that I did not earn any wage income in the US before my move date, so the sub-$10k amount I earned while a Canadian tax resident is also the total for the year. But you're right, the devil is in the details and things get complicated quickly.

You wrote "unless the income for the entire year from one source or the other ... was below $10k". Reading between the lines, I am guessing that you meant "unless the *dependent personal services income* for the entire year ... was below $10k" which would suggest that the above income still gets re-sourced.

Thanks also for cleaning up my source vs re-source terminology. That's why you have the "accounting rockstar" label and not me. :-)

[nelsona]

Yes, unless the "W-2 reported wages", or in your case, the" T4 wages considered US-sourced", are less than 10K for the entire year, it ius taxable in US for non-US citizens, thus not subject to credit denial and re-sourcing.

Just remember, when you are re-sourcing, that your US credit is limited to the lower of (a) the US tax you would owe on that income, and (b) the Cdn tax you actually paid on that income (ie. the 'denied" credit).

In cases where your US tax is completely denied (like wages less than 10K, cap gains, interest) you re-source all the income. But in cases where the US tax is only partially denied (US dividends , pensions, etc) you would re-source "just enough" US income to reduce the US tax to the treaty rate. That is when it gets more complicated. The form in the 1116 guide can help with this.

And remember to put any denied credit as a deduction on line 256.

[nohairleft]

"And remember to put any denied credit as a deduction on line 256."

In terms of putting "any" denied credit on line 256, am I jumping to conclusions to have interpreted that as "denied credit for dividends, interest or royalties"? The only place that I can see the deduction codified is in XXIV(5), which does not appear to apply to income types other than the above. The tech interpretation seems to be silent on this too (it only discusses independent personal services, or else one example for dependent services +$10k).

Or perhaps there is some aspect strictly in Canadian tax law that permits this without regards to the treaty?

[nelsona]

XXIV (4) (5) and (6) cover all situations.

[nelsona]

http://www.cra-arc.gc.ca/tx/tchncl/ncmt ... 1-eng.html

affirms that the 15% limit is still in place, making those clauses in the Article still valid.