Taxes for US Citizens in Canada - quick reference guide

[droste]

I’m a US citizen in Canada, and as I prepare to do my taxes this year, I thought I’d like to write down a summary of the basics on how to deal with several common forms of personal (i.e. non-business) income. I’ve gotten a lot of good information on this forum and elsewhere on line, but it would be nice to have it all in one place. Plus, I’m not entirely sure that I’ve got my facts straight. So I’m going to write down what I think I know, and I’d like to invite you all to correct any mistakes. So, future reader – please do not use this original post as a definitive guide! I’m hoping that this will generate a thread of corrections, and I can post a revised summary at the end that will serve as a useful reference. Keep in mind I’m no pro, I’ve just been trying to work this stuff out on my own. Read at your own risk.

I’m going to describe my situation, although I will add a few extra complications that aren’t true but are situations that I wonder about. I think these facts are fairly typical for a USC working in Canada. Feel free to add more situations to the “guide.â€￾

- US citizen, full-time employed in Canada on a work permit. Planning to stay indefinitely and get PR status.

- Chequing and savings accounts in US$ with an American bank, and also chequing and savings accounts in Can$ with a Canadian bank, as well as a $US chequing account with the Canadian bank.

- Mutual fund investments in the US with an American company. Can no longer buy into these because of Canadian residence (I could always use a relative’s address but let’s not go there).

- Non-registered investment account in Canada. Due to the PFIC rules, I hold no Canadian mutual funds (who would want those expensive funds anyway), no Canadian-domiciled ETFs, no packaged investment product of any kind from Canada really. Any money I want to invest, I convert to $USD and buy US-domiciled ETFs from my Canadian broker (who happens to also be my bank). However, let’s say I’m going to buy a few individual Canadian stocks for the fun of it.

- Considering contributing to an RRSP. Have no traditional IRA. Hold a Roth IRA in the states, but I consider it “frozen,â€￾ won’t touch it until I retire, since any contributions to it while living in Canada would be taxable in Canada and create a bookkeeping nightmare.

So, on to the list of income items:

1. Canadian wages. I deduct these on IRS form 2555 to subtract them from my income for the US return. I pay normal Canadian tax on them, mainly via paycheque withholding. I understand that I could either use 2555 to exclude the income, or instead 1116 to take a tax credit for foreign taxes paid to Canada. The main reason for me to go the 2555 route is if I want to contribute to an RRSP, the same income is “deductedâ€￾ both in Canada and the US. Otherwise it would be confusing to deduct it “pre-taxâ€￾ in Canada but not in the US.

2. Interest from Canadian bank account (yes, all five bucks or so). This is ordinary Canadian source income. I pay taxes on it in Canada, and would also owe tax on it in the states, but I get full credit for tax paid on it via form 1116. Leftover credit can be applied to future years.

3. Interest on US bank account. This is considered “US source,â€￾ but I can re-source exactly enough of it to Canada to cancel out any US tax owed. So I pay full tax on it in Canada, but I am allowed to deduct the US tax owed on it via line 256 of the CRA return. This deduction is kind of a bonus, since I don’t actually pay any tax to the US on the income. In the US, I use form 1116 to re-source exactly what I owe and claim credit for it, as long as I’ve paid that much to Canada. This is much like the dividend procedure (item 9 below) but without the 15% part – Canada credits 0% tax on US-source interest, so I get to re-source it all to Canada on form 1116.

4. Capital gains from sale of US mutual funds or stocks. These are considered Canadian source. So I treat them as capital gains on my Canadian return, paying at my marginal rate X 50%. I also have to include them in my US income, owing tax at US capital gains rates (15% for long term, etc), but getting credit via 1116 should cancel this out.

5. Capital gains from sale of Canadian stocks. Treated EXACTLY the same as the capital gains from US investments in #4 above.

6. Capital gains from sale of US-domiciled ETFs held with Canadian broker: again, treated exactly the same as #4.

7. Capital gains from US mutual fund growth that are automatically reinvested. I’ve heard that these are not supposed to be treated the same as capital gains from sales, but I’m not sure. Input requested!

8. Dividends on Canadian stocks. Paid on Canadian return, and I would mostly get the dividend tax credit if it’s a Canadian company. However, I also owe tax in the US at standard non-qualified dividend rates for these, so the dividend tax credit in Canada may not help me that much; I could end up owing some money to the IRS unless I have other 1116 credit to cancel it out. I do get credit for tax paid in Canada, but the US tax on the same income could be higher. Is this correct? I’m confused about this part.

9. Dividends on US mutual funds and US-domiciled ETFs. Here’s the headache! These apparently are still considered “US-sourced,â€￾ and the IRS expects to get a cut of tax on them even if I’m a Canadian resident. It’s kind of like interest, but Canada only lets me deduct the US tax over 15%. (Still, that’s kind of a bonus). So I think the steps are:

1) Do US tax return, excluding wages on 2555 but not taking 1116 credits yet.
2) Figure out what percentage of total income was the dividend. Multiply total tax by that percentage, and that’s the US tax attributable to the dividends (effective rate, not marginal).
3) Figure out what that tax rate was – tax on dividend divided by amount of dividend.
4) Any of that tax owed to US up to 15% is not deductible on Canada’s form 256, but the rest is.
5) Work out Canadian return owing full tax on the dividend (minus the deduction in step 4), but take foreign tax credit in Canada for the 15% still owed to US.
6) On the US return, get tax credit for exactly the tax paid to Canada on the dividend, having taken all the above into account.
God that’s so complicated! Is it right? So it seems like due to this part, you end up owing a little bit to the IRS – 15% of your US-based dividends, even if you owe nothing else.

US Forms to file:
1040
TDF 90-22.1. Report what’s in your Canadian accounts and mail to Treasury Dept.
2555 – exclusion of Canadian wage income.
1116 – foreign tax credit
8891 – Deferment of tax on RRSP if you have one.

Pub 514 – worksheet for the crazy dividend procedure.
Re-sourced income – separate 1116 from Canadian source income.

Special considerations for the first year:

Foreign income exclusion (form 2555) – technically you need to be living abroad for a whole year BEFORE you can use this, so you can’t use it your first year… unless you take advantage of this weird loophole. You can file form 2350, which requests an extension of your time to file until you have lived abroad for a whole calendar year. So in my case, I arrived in Canada in October 2010 but didn’t file 2010 tax return until January 2012. Weird but that’s how you’re supposed to do it. However you still have to pay your taxes when they’re due, (June 2011 for me). So you have to fill out your 1040 on your own and figure out what you owe, pay it, but don’t actually send in the 1040 until the extended time.

Things to avoid in Canada:
TFSA – taxable in the US and requires form 3520, crazy paperwork, not worth it.
RESP – no way to get deduction for this, the US will tax the income in it.
Canadian mutual funds (unless in RRSP) – subject to PFIC tax treatment, probably not worth it.
Canadian ETFs – same reason.

[nelsona]

Your initail steps all loohk fine.

You asked for input on 7. The "dividends" from your US mutual funds: unfortunately CRA takes the position that all such distributions are taxed as ordicnary income (ie. interest) regardless of how IRS would treat them.
So do not expect any tax credit on your Cdn return on this.

Your tax prep step however need a little work, maybe just some confusion on your part:

1. correct
2/3. Figure out your effective taxrate. This will be the rate applied to all types of income, not just dividend income, so know this ammount. Realize that itis nearly impossible, after 2555, for youreffective taxarte to be 15%, it will be much less.
4. You have this backwards. Dividends are creditable upto 15%, It would be the excess that is included on line 256. For interest and cap gains tax, any US tax attributable to this will go on 256.
5. calculate your Cdn tax return, completely. Its done.
6. Now that you have your figure on 256, apply re-sourcing rule to get credit for exactly that amount on 1116 (all passive income btw).
6. on a separate 1116 (passive), determine the tax paid on Cdn dividends, all cap gains and all interest and get as much credit as you can for this, based on your 1040 taxrate.
Your 1040 is now complete.

[droste]

Thank you Nelson, as always you are incredibly helpful. I understand it a lot better now thanks to the reply, but I'm still confused about a couple of things:

1) Effective tax rate = tax owed after deducting 2555 income but before taking 1116 credits, divided by total income including 2555 income. Correct? I can see that that would indeed be under 15%, so there won't be any additional deduction on Cdn line 256.

2) In your instructions, I put US tax on all interest and cap gains in line 256 (both US and Canadian sources?) So these are 100% taxable in Canada, no credit, but all US tax on them is fully deductible via 256. But I thought there was a difference between capital gains and interest, in that capital gains were considered automatically Canadian sourced from the beginning, so no "re-sourcing" necessary, and I could get US tax credit on any tax paid to Canada on them, including carrying over the excess. Whereas for dividends and interest, I only get to re-source exactly enough to cancel the US tax owed. I don't see how that distinction is made here.

Because then in your point 6, you say get as much credit as I can on Cdn dividends, all cap gains, and all interest - if that is the case, how can I have put all that stuff into the figure on line 256?

Sorry this is so confusing, it's hard to put it into writing.

[droste]

Oh one more question:

The "re-sourced" dividends/interest is one form 1116, but it's still marked "passive" and not "certain income re-sourced by treaty," correct? The latter designation is for some other more obscure thing that doesn't apply in my case?

And then the other passive income (just capital gains I guess) would be a separate 1116, also marked "passive." The difference being that the first one is limited to exactly what I paid in the US, while the second can have excess that carries over to future years. Do I have that all straight?

[nelsona]

1) correct
2) No. Only the US tax on US-source interest and US-sourced dividends (in ecess of 15%) and the "cap gain" that CRA treats as ordicary income.

You will have 2 1116's one will be "re-sourced by treaty" and one will be "passive". I was merely telling you that all your income that is subject to FTC is passive, not what the form should say.

On the re-sourced, you should only have income related to US-sourced interest, US-sourced "capital gains distributions", and US-sourced dividends.

On the passive, you should have Cdn-sourced interest, dividends and cap gains.

[MikeRitchie]

Very helpful. I have another question: on my US source dividends, my broker already withholds 15% as a US tax payment. Do I put this on line 62 of my 1040 (Federal income tax withheld)? Does it matter if I don't receive a 1099?

[nelsona]

Ys, it is merely tax withheld.

You should however be informing your broker, with a W-9, that you are US citizen, and he will stop withholding.