U.S. EXPATRIATE TAXES IN CANADA
U.S. Federal Income Tax Obligations For U.S. Expatriates Living/Working in Canada
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The Basics – Canada
Canada’s capital is Ottawa, its three largest cities are Toronto, Montreal and Vancouver. Canada is a country in the northern part of North America, just above the United States. It is comprised of ten provinces and three territories, which extend from the Atlantic to the Pacific Oceans and northward into the Arctic Ocean, making it the world’s second-largest country by total area. Its southern and western border with the United States, stretching 5,525 miles, is the world’s longest bi-national land border.
Various Indigenous peoples inhabited what is now Canada for thousands of years before European colonization. Beginning in the 16th century, British and French expeditions explored and later settled along the Atlantic coast. As a consequence of various armed conflicts, France ceded nearly all of its colonies in North America in 1763. Canada was formed in 1867, with the union of three British North American colonies through Confederation as a federal dominion of four provinces. This began an accretion of provinces and territories and a process of increasing autonomy from the United Kingdom. This widening autonomy was highlighted by the Statute of Westminster 1931 and culminated in the Canada Act 1982, which severed colonial ties and legal dependence on the British Parliament.
Canada is a parliamentary democracy and a constitutional monarchy, with a monarch and a prime minister who serves as the chair of the Cabinet and head of government and the country. Still today a part of the Commonwealth of Nations, Canada is also a member of the Francophonie and officially bilingual at the federal level.
Locked in a constant struggle between the English and the French, the Province of Quebec has engaged in two non-Canada binding referendums to succeed from Canada, the first in 1980 and the second in 1995, for which the Quebec independence lost narrowly both times. In 2018 the Parti-Quebecois, the French antagonist separatist movement political party were soundly defeated, having run on a non-referendum platform given the unpopularity of the independence movement at the time.
Canada played a small yet vital role in WWI and WWII fighting alongside the British, Australians and Americans fighting in all major wars and contributing as much as it’s small 20,000,000 population could realistically contribute. The Canadian soldier with a reputation for fierce, die-hard and loyalty fighting force.
Canada ranks among the highest in international measurements of government transparency, civil liberties, quality of life, economic freedom, and education. It is one of the world’s most ethnically diverse and multicultural nations, the product of large-scale immigration from many other countries specifically during the period just after WWII. Caught just north of the United States, yet with significant ties to Europe and the British Commonwealth, Canada is often thought of as a US- Europe hybrid nation. Therefore owing to Canada’s long and complex relationship with the United States, Canada has often tried to differentiate itself from its southern neighbor that has a massive impact on its economy, culture and way of life.
As a highly developed country, Canada has the seventeenth-highest nominal per-capita income globally as well as the thirteenth-highest ranking in the Human Development Index. Its advanced economy is the tenth largest in the world, relying chiefly upon its abundant natural resources and well-developed international trade networks. Canada is part of several major international and intergovernmental institutions or groupings including the United Nations, NATO, the G7, the Group of Ten, the G20, the United States–Mexico–Canada Agreement and the Asia-Pacific Economic Cooperation forum.
Canada comprises a total area of 3,855,100 sq miles is the 2nd largest country in the world by area, has a population of 38,005,238 people and a GDP of 1.971 trillion U.S. dollars. The Canadian currency is the is the Dollar (CAD), the Canadian time zone is -3 to -8 UTC, Canada’s country telephone dialing code is +1 like the U.S., it’s internet TLD is “.ca” and it operates on a 120 volt electrical grid.
The U.S. and Canada share the common language of English, have a complex and interwoven heritage, making Canada a very popular destination for Americans to reside and work. As a U.S. citizen or resident alien (U.S. Expat) living in Canada, however, there is always the possibility of “double income taxation,” i.e., having to pay taxes to both Canada and the U.S. on the same income you earned in Canada. The good news is that there are rules in place to avoid double taxation.
Knowing your obligations as a U.S. Expat are important. The Internal Revenue Code’s (IRC) rules are, however, quite complex, and while this is a simplified, broad overview to familiarize you with your filing obligations and how to avoid double taxation, you should consult a Certified Public Accountant (CPA) expert in U.S. Expat income taxation to learn more. U.S. Expat income taxes are a highly complex niche area of taxation that most CPA’s are not aware of.
U.S. Tax Obligations on U.S. Expats Living in the Canada
The U.S. imposes the same obligations on its citizens and resident aliens living abroad to file and pay U.S. federal income taxes, as it does on its citizens and residents living and working in the U.S.
Requirement to File U.S. Income Tax Returns
Specifically, if you are a U.S. citizen, or “resident alien,” and you meet the annual filing thresholds, you are obligated to file a federal return Form 1040 and pay federal income taxes annually no matter that you live and work in Canada, the fact that you are paid in CAD or USD or where your employer or clients are located whether in the U.S. or Canada. The annual filing thresholds, which are dependent on your filing status- Single, Married Separate, Married Joint, Head of House or Qualifying Widower, age and type of income are indexed annually by the Internal Revenue Service (IRS).
Filing deadlines and Extensions Living/Working in Canada
If you are required to file a U.S. individual income tax return Form 1040, you must file by April 15, however there is an automatic two-month extension until June 15 if you reside in Canada on April 15 and meet certain requirements. There are other extensions beyond June 15 that U.S Expats can utilize, including the filing a Form 4868- for an automatic six-month extension of time to file until October 15, and an additional and little known about white paper IRS discretionary extension to December 15 if you reside in Canada, but, again, you have to meet the IRS requirements to use this extensions.
However, no matter how many extensions are utilized, any income taxes owed are still due by April 15, as the extensions are only an extension of time to file not to pay your U.S. income taxes!
How to Report Income and Expenses Living/Working in Canada
The U.S. Form 1040 is always expressed in U.S. dollars, using exchange rates as prescribed or otherwise allowed by the IRS. Generally, for income or expense items we use the average Ask rate for the calendar tax year in question, and for gains and losses the daily spot rates.
Avoiding Double Taxation
If you meet the annual income tax filing thresholds referred to above, you are technically required to file and report worldwide income for U.S. income tax purposes on the same income you are also obligated to pay taxes on to Canada. The good news is that, if you pay income taxes to Canada on income you earned there, the U.S. IRC has provisions in place to let you avoid double income taxation, using both:
- Use a Foreign Earned Income Exclusion (FEIE) thereby excluding earned income –income earned in Canada when determining U.S. income taxes and / or
- Obtaining a Foreign Tax Credit (FTC) for the taxes you paid, or have accrued, to Canada against the taxes you owe to the U.S.
The Exclusions – FEIE
As always, there are certain tests you must meet to be eligible to claim these special exclusions and credits.
If you meet these IRC requirements, the FEIE is claimed on Form 2555, and allows you to exclude “Foreign Earned Income” (FEI) from U.S. Federal income taxes. FEI is essentially wage or self-employment income that you earn while living and residing in Canada/ outside the U.S.
To qualify to take the FEIE you have to:
- Meet the “Tax Home Test”, (THT) and
- Meet either the:
- “Bona fide Residence Test” (BFR), or the
- “Physical Presence Test” (PPT).
Generally, this means that on a facts and circumstance basis you actually must live and/or work in Canada and meet certain specific requirements. If you do qualify for the FEIE, it is not unlimited. The IRS sets annually indexed amounts as to how much you can exclude.
The Form 114 FBAR and Form 8938 FFA
Not to forget or marginalize the fact that all U.S. persons living in Canada must consider their obligation annually to file Form 114 Report of Foreign Bank and Financial Accounts (FBAR) and Form 8938 Statement of Specified Foreign Financial Assets (FFA) , the former of which is specifically referenced on Schedule B – Interest and Dividends- that accompanies Form 1040, the fact that if you are required to file both the FBAR and FFA Forms as a U.S. Expat living and/ or working in Canada the amounts on both forms must sync and of course that both forms carry a mind boggling non-willful violation penalty of $10,000 per account/ FFA per annum
The Bottom Line
Because Canada sets income taxes on income at much higher rates than the U.S., if the U.S. income tax compliance is done correctly, in general assuming no U.S. source income- no U.S. passive income and no U.S. workdays- you should never have to pay any additional U.S. Federal Income taxes on income you earned Canada.
As you can see, however, the rules are complex, and it is easy to get overburdened if you do not hire the correct CPA firm U.S. Expat specialists.
At Protax, our primary goal and objective is to analyze the interplay of the FEIE, HD, HE and FTC to find the optimum strategy to limit the world-wide taxes you pay. While of course at the same time making sure that you are in full U.S. tax compliance.
Protax is the world’s leading U.S. individual international tax firm, specializing in the delivery of world class professional services to U.S. Expats. For more information, fill out our contact form to speak to one of our expert tax consultants.