This article appears in the November 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Clients based in Canada who have ties to the U.S. may face complex tax-filing requirements. Severe penalties can be imposed on taxpayers who fail to file the necessary forms with the U.S. Internal Revenue Service (IRS). Similarly, Canadians who spend extended periods in the U.S. may be required to file a U.S tax return.
“The United States is unique in that it applies its domestic tax system to every citizen who lives anywhere in the world on the same basis as Americans living in the United States,” said Kevyn Nightingale, international tax partner, tax services group, and business advisor with MNP LLP in Toronto.
Here are tips and requirements that should be incorporated into tax planning for U.S. persons in Canada in 2022. (All amounts are in U.S. dollars.)
What’s new for 2022, by the numbers
$112,000: Foreign earned income exclusion, which exempts some U.S. persons in Canada from paying U.S.taxes on employment income (up from $108,700 in 2021).
$12,950: Standard deduction amount for a single taxpayer in 2022 (up from $12,550 in 2021).
$16,000: Annual amount that a U.S. person can give as a gift to their children or to somebody else (up from $15,000 in 2021).
$164,000: Annual amount that a U.S. person in Canada can give as a gift to a spouse who is not a U.S. citizen.
$12.06 million: Estate tax exemption for single taxpayers (up from $11.7 million in 2021). For married taxpayers filing jointly, those amounts are doubled. This exemption also applies to Canadians who reside in the U.S.
$60,000: Value of U.S. property, or shares in a U.S. company, above which a U.S. estate tax return must be filed. This requirement applies to U.S. persons in Canada as well as Canadians with U.S. assets.
U.S. tax forms — which one and when?
Form 1040: Every U.S. person resident in Canada must file a U.S. tax return, or Form 1040, each year they meet the minimum income threshold. For 2022, the threshold for a single taxpayer under age 65 is $12,950. For a taxpayer who is married and filing jointly with their spouse, the threshold doubles to $25,900.
Form 114: The next most common form that U.S. persons in Canada must complete is the Financial Crimes Enforcement Network Form 114: Report of Bank and Financial Accounts, a.k.a. FBAR.
The FBAR requires disclosure of ownership or signing authority on various financial accounts that a U.S. person may have outside the U.S., such as bank accounts, investment accounts and registered accounts. This form must be completed for each account whose value exceeds $10,000 at any time during the tax year.
Failure to file the FBAR can result in a penalty of $10,000. A case is headed to the U.S. Supreme Court to determine whether that fine should be administered on a per-form or on a per-account basis, Nightingale said.
Form 8938: U.S. persons in Canada with foreign financial assets beyond certain fair market values must file Form 8938: Statement of Specified Foreign Financial Assets, in addition to their FBAR filing requirements. Those values are: $200,000 on Dec. 31, 2022, or $300,000 at any time during the 2022 tax year. For married U.S. persons in Canada who are filing a joint return, those amounts are doubled.
Form 5471: U.S.persons who are officers, directors or shareholders of certain foreign corporations must file Form 5471: Information Return of U.S. Persons With Respect to Certain Foreign Corporations.
A client who has more than a 10% interest in a Canadian corporation must file this form, Nightingale said. In cases in which the U.S.person in Canada does not own the shares directly, that person may be considered to own the shares indirectly or constructively and would still be required to file.
“Form 5471 is very complicated,” Nightingale said. “It’s like inserting a U.S.corporate tax return inside your U.S. personal tax return.” He added that this form can add several thousand dollars to a client’s professional tax-preparation bill.
- FORMS 3520 AND 3520A A U.S. person in Canada with an interest in a foreign trust must file Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. That client may also be required to file Form 3520A: Annual Information Return of Foreign Trust with a U.S. Owner.
Form 3520 is required when a U.S.person receives a gift, or series of gifts, exceeding $100,000 from a foreign person.
TFSAs, RESPs and registered disability savings plans (RDSPs) are considered foreign trusts by the IRS. But the IRS announced in 2020 that U.S. persons in Canada will no longer need to file Form 3520 or 3520A for RESPs and RDSPs, said Jacqueline Power, assistant vice-president of tax and estate planning with Mackenzie Investments in Toronto.
FORM 8891 RRSPs and RRIFs must be reported on Form 8891: Return for Beneficiaries of Canadian Registered Retirement Plans. This disclosure allows RRSPs and RRIFs to be tax-deferred in the U.S. as they are in Canada, Power said.
Canada/U.S. tax treaty
Signed in 1980, the Canada/U.S. tax treaty co-ordinates the way residents of the U.S. and Canada are taxed when they earn income in the other country. A key benefit of the treaty is that it helps reduce the incidence of Canadians and Americans having to pay taxes to both governments on the same income.
“To the extent that a U.S. citizen is a dual-resident taxpayer, they have an obligation to file a return in the U.S. on their worldwide income,” said Terry Ritchie, vice-president, private wealth manager, and partner with Cardinal Point Capital Management LLC in Calgary. “If they have paid tax on the U.S. side, the treaty provides some ability to take a foreign tax credit in Canada to reduce their exposure to double taxation.”
For example, some U.S. citizens in Canada receive U.S. public pension benefits. The treaty states that U.S. social security benefits and Canadian benefits such as Canada Pension Plan and old age security benefits are taxable only in the country in which the taxpayer is physically resident.
There are situations in which the treaty offers no relief, Nightingale said. For example, if a U.S. citizen sells their house in Canada, they may be subject to U.S. income tax, despite Canada’s principal residence exemption of 100% of the gains on the value of the property. That’s because the U.S. principal residence exemption covers only the first $250,000 of gain for a single homeowner, or $500,000 for a married couple filing jointly.
Substantial presence test
Canadians who spend significant time in the U.S. may be considered U.S. residents for tax purposes. A formula called the substantial presence test (SPT) is used to determine whether that person is required to file a U.S. tax return.
A Canadian can spend up to 183 days, as measured by the SPT, over a three-year period without filing a U.S. tax return. Under the SPT, those days are calculated as the total number of days spent in the U.S. in the current year, plus one-third of the days spent in the U.S. in the previous year, and one-sixth of the days spent in the year before that, Power said.
A Canadian who exceeds 183 days, as calculated using the SPT, might not be subject to U.S. tax obligations if that person can demonstrate that they have a closer connection to Canada than to the U.S. “If they have bank accounts here, if they have a principal residence here, family here, then they can likely make a case for having a closer connection to Canada,” Power said.