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Am I a U.S. tax resident?

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Most Canadians who move to the U.S. have a good understanding of their immigration residency status. However, many do struggle to determine their residency status for U.S. income tax purposes.

While it is common knowledge that U.S. citizens and green card holders are responsible for filing U.S. tax returns, most people who move to the U.S. on a non-resident visa – such as a TN, E1 or E2, O-1, L-1 – are unfamiliar with the U.S. tax residency rules that can subject them to U.S. taxation on their worldwide income.

This is not surprising given that the definition of a resident for U.S. tax purposes is mutually exclusive of a U.S. resident for immigration purposes.

As a result, a non-resident for U.S. immigration purposes, can in fact be a U.S. tax resident who is subject to U.S. taxation on their worldwide income. On the other hand, a non-resident for U.S. tax purposes is subject to U.S. taxation only on their U.S. source income.

To assist our Canadian clients navigate the complicated U.S. tax residency rules, we have prepared the following summary of the most common questions Canadians have when it comes to lodging a U.S. tax return:

How Do I Become A U.S. Tax Resident?
Simply put, if you are physically present in the U.S. for at least 183 days in one calendar year. You can also be considered a resident under the Substantial Presence Test (SPT) if you spend, based on a special formula, at least 183 days in the U.S. during the past three calendar years.

For Canadians who like to visit the U.S. for cross-border shopping, beware because even those short day trips south of the border count as a full day for purposes of the 183 day threshold.

Conversely, a Canadian who is never physically present in the U.S. for more than 120 days in each calendar year will not qualify as a U.S. tax resident.

What Happens if I Become A U.S. Tax Resident?
Since most Canadians moving to the U.S. for work on temporary visas are unlikely to spend less than 183 days in the U.S., they qualify to be taxed as U.S. residents.

Although special rules beyond the scope of this article apply to a first year U.S. tax resident, a U.S. taxpayer lodges a Form 1040 and reports all their worldwide income, including all investment income, capital gains, rental income from non-U.S. rental properties and foreign pension income.

Is There A Way To Avoid Being Treated As A U.S. Tax Resident?
If a Canadian working in the U.S. on a temporary visa qualifies as a non-resident taxpayer, then they lodge a Form 1040NR and generally only pay U.S. income tax on wages earned while working in the U.S.

However, if you qualify as a U.S. tax taxpayer, the following exemptions will allow you to lodge a U.S. return as a non-resident:

1) Closer Connection Exception (CCE)
A Canadian who meets the SPT may avoid lodging a return as a U.S. resident by filing Form 8840.

To qualify to file the Form 8840, one must meet all the following criteria:

  1. Have a “tax home” (usually where your family, permanent home and personal belongings are located) and a closer connection to Canada
  2. Be physically present in the U.S. for under 183 days in the current calendar year; and,
  3. File form 8840 to indicate this connection on a timely basis (filing this form late may cause you to be ineligible to claim the CCE)

2) Non-Residency Under The Treaty
In the event a Canadian working in the U.S. on a temporary work visa is physically present in the U.S. for at least 183 days in a single calendar year, it is still possible to avoid U.S. residency by filing a Form 1040NR with a Form 8833 treaty election.

Generally, a treaty election is used when a taxpayer is considered a tax resident of both the U.S. and Canada. In the case where a taxpayer is a simultaneous resident of both the U.S. and Canada, the treaty acts as a tiebreaker to determine which country has the right to tax the taxpayer as a resident.

The U.S.-Canada tax treaty contains a provision that allows a U.S. taxpayer to be treated as a Canadian tax resident, and hence a U.S. non-resident, if Canada is their permanent home.

If a taxpayer has a permanent home in the U.S. and Canada, then it’s necessary to look at where a taxpayer maintains their center of vital interests, their habitual abode and their citizenship to break the tie.

Nevertheless, a person who uses the treaty to be taxed as a U.S. non-resident is still considered a U.S. tax resident for other filing purposes. As such, Canadians need to report their financial accounts and interests in foreign corporations, trusts and partnerships to the IRS on the following forms:

  • Foreign Bank Accounts (FinCen 114)
  • Foreign Corporations (5471)
  • Foreign Partnerships (8865)
  • Foreign Trusts (3520/A)

Tax filers beware as fees to prepare these foreign compliance forms can be costly because they are complicated and time consuming.

Does California Follow The Same Residency Rules As The IRS?
Sadly, if lodging a federal return in the U.S. wasn’t complicated enough, a whole set of different rules beyond the scope of this article apply to determine if a Canadian working in California is considered a California tax resident, and hence subject to California tax on their worldwide income. Since California is not a party to the U.S.-Canada tax treaty, no foreign tax credits can be taken for any foreign taxes paid to Canada. In addition, since California is a community property state, special California community property tax rules apply with respect to splitting community income.

In Closing
Because few tax professionals work with Canadians temporarily working in the U.S., it is important to partner with a firm that understands the tax complexities involved in cross-border employment. At Cardinal Point, we assist Canadians working in the U.S. on temporary visas and are available to assist with properly assessing your U.S. tax residency and preparing the necessary U.S. and Canadian tax filings.

Marc Gedeon is a CPA (U.S), CPA (Canada) and Tax Attorney at Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada. Marc specializes in providing Canada-U.S. cross-border financial, tax, transition, and estate planning services. www.cardinalpointwealth.com This piece is for informational purposes only and should not be considered legal or tax advice. Online readers should not act upon this information without seeking professional counsel.

Terry Ritchie, U.S. Expatriation and Your Dual Citizen Clients

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In this video, Terry Ritchie speaks with InvestmentExecutive.com’s Rudy Mezzetta about what U.S. citizens living abroad need to know when considering renouncing their U.S. citizenship. Though the numbers of expatriations are reaching historical highs, the process is not an easy one. After filing with the Department of Homeland Security, an individual wishing to renounce citizenship must meet with the consulate. Upon approval, the individual will be issued a CLN: Certificate of Loss of Nationality, from The State Department. This is not a quick process.

In terms of taxes, if you meet one of these rules—a worldwide net worth of $2 million or more, average annual net income tax of more than $150,000 (adjusted for inflation), or have not complied with all U.S. tax responsibilities in each of the five preceding years—you can be defined as a “covered expatriate.” CEs are subject to onerous tax considerations, including a “mark-to-market tax” that takes into account what you would net if you sold all of your assets upon expatriation, and then taxes this amount as a capital gain. Further implications include a tax on qualified assets and tax-deferred investment vehicles.
Finally, Terry reveals the #1 reason that Americans chose not to expatriate: the possibility (based on pending U.S. legislation) of not being allowed to return to the U.S. View the video here.

Advising same-sex couples with U.S. ties

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Terry Ritchie, Director of Cross-Border Wealth Services, was recently featured in an article from Advisor.ca looks at how a recent ruling from the U.S. Supreme Court opened the door to new planning options for same-sex partners with ties to the U.S. The June decision struck down a key part of the Defense of Marriage Act and broadened the federal definition of marriage to include legally married same-sex couples. The new definition also applies to American couples who marry outside the U.S.

Following the decision, the IRS released the tax implications: “Same-sex couples will be treated as married for all federal tax purposes, including income and gift and estate taxes. The ruling applies to all federal tax provisions where marriage is a factor.” The article goes on to give examples of how advisors can help their clients benefit from these changes, specifically in the areas of tax filing, wealth transfer, and principal residence exemption. Read the full article here.

Cross-Border Concerns for Athletes

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Canadian hockey players in the NHL who play for American teams have specific planning needs and require the specialized advice of a cross-border financial advisor. This article by Cardinal Point’s Terry Ritchie looks at what cross-border issues professional athletes may face, including immigration, estate, tax and investment planning considerations.

Ritchie first examines the potential immigration pitfalls for athletes living and playing across the border. It’s important for these athletes to work closely with their advisors and immigration counsel to secure or extend their U.S. work visas, apply for permanent residence with a U.S. Green Card, or ultimately become a naturalized U.S. citizen. Ritchie illustrates potential immigration issues with a case study of an athlete who faced these hurdles and partnered with his advisors and immigration attorney throughout the long, complicated immigration process.

The article goes on to look at the onerous tax consequences that can come with expatriating back to one’s home country after an athletic career in the U.S. The dreaded U.S. Expatriation Tax holds that a player who has a U.S. Green Card for more than eight years is classified as a long-term resident and could potentially face a significant two-fold tax hit when leaving the U.S.

Ritchie goes on to illustrate some of the woes that can come when advisors lead their athlete clients to bend compliance or CRA rules. He uses a case study to show how compliance violations can also result in a number of adverse Canadian and U.S. income tax problems. Finally, the article looks at the need for estate planning if a player is domiciled in the U.S., marries a U.S. citizen, has children in the states, and/or has non-U.S. beneficiaries.

The IRS Offshore Voluntary Disclosure Plan (OVDP) Expands Eligibility for Streamlined Version

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irs1The IRS has recently expanded the eligibility requirements for streamlined OVDP. If you are a U.S. taxpayer with offshore accounts, the streamlined procedures could be beneficial for you, with some penalties waived.

To qualify for the streamlined procedures, you must certify that your conduct (not having reported foreign accounts) was “non-willful.” The IRS defines “non-willful” as negligent, inadvertent or due to a misunderstanding of the law.

Is this an opportunity to come into compliance in an organized, timely manner or, as is asked in this Forbes column, is it the government’s attempt “to entice unsuspecting taxpayers into placing their head onto the FBAR chopping block?”

Read the full article here.