If you are a U.S. citizen living in Canada, you probably know that one of the responsibilities attached to United States citizenship is to file an annual income tax return reporting your worldwide income, unless you are under the filing threshold. You will also pay U.S. income taxes, to the extent they are not offset by foreign tax credits for taxes legally paid or payable to Canada – your country of Tax Residence.
Looking at how a particular transaction and business/trust organization will affect your Canadian income tax liability without evaluating the effect on your U.S. return may lead to lost opportunities and poor outcomes.
It is essential that you and your advisors be aware of constantly changing tax laws on both sides of the border that may affect you. Please check out our country-specific 2021 Income Tax Highlights.
Here are the ‘headlines’ of what changed for 2021 in Canada for your federal return. See the Canada Highlights article for more detail on these items.
- Tax brackets crept up 1%.
- The Disability Tax Credit is more flexible.
- The Canada Workers Benefit phase out ranges increased.
- Interest free CMHC loans are available for green renovations.
- Canada Child Benefits increased.
- The stock option deduction is limited to $200,000 CAD in vested options per year for stock options granted by larger, non-CCPC, corporations after June 30, 2021.
- Immediate expensing of asset purchases is expanded for up to $1.5 million CAD per associated company group.
- New rules may allow the intergenerational transfer of a Qualifying Small Business to be treated as a capital gain as opposed to a higher tax rate dividend.
- Business-facing pandemic program repayments can be deducted in the year of repayment or original year of receipt (on an amended return).
- Have you incurred work from home expenses due to the pandemic? The rules for T4 employees aren’t settled quite yet for 2022. Ask your employer to issue a Form T2200 to lock in deductibility of your expenses.
- Personal Protective Equipment (PPE) may qualify as a medical expense credit or for deduction as a business expense or as an employment expense depending on the situation.
On the horizon for Canada, we are tracking the following proposed changes.
- Expanded information reporting for trusts, projected to begin for trust year-ends beginning December 31, 2021
- Potential for an increase in the Capital Gains Inclusion Rate
- Anti-flipping rules limiting the Principal Residence Exemption
- Tax on non-resident, non-Canadian citizen owned vacant or under-used housing
Here are the ‘headlines’ of what changed and what didn’t for 2021 on your U.S. tax return. See the U.S. Highlights article for more detail on these items.
- The lifetime Gift and Estate Tax Exemption escaped the axe! The limit is $11.7 million USD for decedents in 2021 and $12.06 million USD in 2022.
- Step-up of asset basis on death also survived in the Build Back Better Act (BBBA), although this legislation hasn’t passed the Senate yet.
- Capital gains taxation was unchanged in the BBBA.
- Annual gift tax exclusion rises to $16,000 USD per person in 2022 from $15,000 USD per person in 2021.
- The top federal marginal tax rate remains at 37%, plus Alternative Minimum Tax (AMT) and Net Investment Income Tax (NIIT), if applicable.
- All brackets and standard deductions are indexed higher – as per usual.
- Required Minimum Distributions (RMDs) cannot be waived as they were in 2020. However, you still have the option of making Qualifying Charitable Distributions (QCDs) from your IRA to take it out of U.S. taxation and to take the Canadian charitable donation tax credit. Watch the percent-of-income-by-country limits on charitable donations if you are directing your donations to Canadian charities.
- If you are making the Foreign Earned Income Exclusion (FEIE) vs full inclusion decision for the first time, consider both options in context with your personal situation. Taking the FEIE isn’t always the optimal choice and once a method is chosen, it can be difficult to change.
- The 50% paid in advance child tax credit is only available for families where one spouse lives at least six months in their main home in the United States, so this likely will not be available to you, unless you moved from the US in the second half of 2021. The regular child tax credit remains available for families with qualifying children living in Canada.
- PPE used to prevent or slow the spread of the coronavirus is a deductible medical expense (if itemizing deductions makes sense for you) and does not need to be physician-prescribed.
On the horizon for the U.S., the Build Back Better Act passed the House on November 19th and is currently in the Senate where some revisions are likely to be made. We are tracking the following proposed changes in the BBBA that are of note for U.S. citizens living in Canada:
- The current version of the BBBA changes the taxation and tightens the reporting of Foreign Derived Intangible Income (FDII) and Global Intangible Low Taxed Income (GILTI).
- The State and Local Tax (SALT) Cap rises to $80,000 USD under the BBBA. This will only affect you if you have U.S. real property taxes payable and/or U.S. employment/business income subject to state income tax.
- The 3.8% Net Investment Income Tax (NIIT) would be expanded to include flow through and foreign entity income. If this passes, we will have some major planning to review with our Canadian business owners.
Since the Senate will want to put its stamp on this BBBA legislation, we expect that there will be further changes to the details but that some version of these three above items will pass. We will let you know more if/when the Senate passes the BBBA.
With the COVID-19 pandemic, government support programs grew on both sides of the border. The income from these programs is mostly taxable to the recipients, except for a handful of items. U.S. citizens living in Canada may have received three U.S. Economic Impact Payments, two in 2020 and a larger one in 2021. This is not taxable income on either the U.S. or Canadian return.
Both the Canada Revenue Agency and the Internal Revenue Service have been struggling to keep up with a record flood of taxpayer inquiries and all the new programs resulting from the pandemic. Response times are very slow and setting up a CRA MyAccount or an IRS Secure Account is a great tool for keeping on top of your tax filings and information.
The Tax Tug-of-War
The U.S. citizen living in Canada reports worldwide income to both the Canada Revenue Agency and the Internal Revenue Service and generally pays tax first to Canada and their province or territory of residence. That Canadian tax then becomes a foreign tax credit on the U.S. return and can offset U.S. income tax, but not the U.S. 3.8% Net Investment Income Tax (NIIT). The United States gets first right of taxation for: U.S. situated real property and real property business income, 15% on U.S. corporate dividends, as well as compensation for services provided in the U.S. (subject to the days of presence and permanent establishment rules). You will take a foreign tax credit for the U.S. tax liability (except for NIIT), due to those income items, on your Canadian T1.
That’s the basic tax system for a U.S. citizen living in Canada. But wait – there’s more.
Many types of income, like stock options and trust income, are calculated differently on each country’s tax return. The adjusted cost basis of stocks is tracked at a moving average cost for Canadian purposes, but either on a FIFO basis or at specific lot prices for U.S. purposes. Each country has different rules about what can be deducted from taxable income and when you can take the deduction. In Canada, foreign tax credits are on a country-by-country basis. In the U.S. foreign tax credits are grouped based on seven categories of foreign (any country) income.
Currency and exchange rates play a major role. Periodic income is translated at the average exchange rate for the year. Big payments are translated at the rate in effect on the actual day paid or received. We use the official exchange rate on the specific date of asset buys and sells to calculate gains and losses.
Canada will see your U.S. LLC or S-Corp as a corporation unless elections are made to treat them otherwise. Your U.S. revocable living trust may be considered a separate entity and as a reporting trust in Canada.
The Canada – U.S. Income Tax Treaty settles most disputes about what gets taxed where. For instance, Social Security, CPP and OAS are only taxable in the country of residence (but reportable on both country’s tax returns).
One of the most confusing things about being a U.S. citizen and a Canadian tax resident is knowing what is foreign and what it domestic. It depends on who is asking. If Canada is asking, your IRA is foreign and your RRSP is domestic. If the U.S. is asking, it’s the opposite.
Both countries have stringent foreign asset and income reporting requirement. The U.S. has particularly intense and intrusive reporting. The Tax Cuts and Jobs Act of 2017 (TCJA) enacted legislation that requires detailed information reporting regarding your Canadian corporations, trusts and businesses on your U.S. return and also expands the U.S.’ ability to tax that income and those retained earnings, whether or not they have been distributed.
A few defined terms to know if you have a non-U.S. business entity:
CFC – Controlled Foreign Corporation
GILTI – Global Intangible Low Taxed Income
FDII – Foreign Derived Intangible Income
FDE – Foreign (or Fiscally) Disregarded Entity
Final thought – It’s complicated.
Both countries want to be sure that you are paying your full liability and reporting your foreign assets and activities to them. The rules are complex and specific. Only a handful of the rules will actually apply to you. The trick is in knowing which of the many Canadian and U.S. rules affect you. We don’t recommend doing your U.S. and Canadian taxes yourself unless you are a couple of years past your entry date to Canada and your situation is exceedingly simple. If you don’t want to monitor all the changes happening both sides of the border, you also may not want to prepare your tax returns yourself. What looks simple on the Canadian side might be more complicated and subject to reporting and taxation on the U.S. side. There may even be significant penalties for not reporting something you didn’t know needed to be reported. Using the services of a competent cross-border tax professional to keep you in compliance and up-to date is a good choice, and well worth the cost.
If you have any questions regarding any of the topics that we have covered in this newsletter please reach out to us. The Private Wealth Managers at Cardinal Point are part of a robust team of cross-border investment, planning and tax professionals.