Many Canadians have ties to the U.S., whether by virtue of their or their spouse or children’s dual citizenship, ownership of U.S. property, or because a loved one either temporarily or permanently resides south of the border. This can mean added complexity and filing obligations for tax purposes. While some of the obligations may be well known and understood, some aspects of cross-border planning are less obvious and can lead to expensive oversights. What follows are some key considerations heading into tax season.
The accidental American
The U.S. is an outlier when it comes to taxing its citizens. Unlike all but one other country in the world, the U.S. taxes non-resident citizens on their world-wide income. This means a U.S. citizen has tax obligations to the U.S. even if they neither reside in the country nor own any U.S. property. In all but the rarest of instances, anyone born in the U.S. automatically becomes a U.S. citizen. And yes, this is true even if you moved to Canada the very next day.
Individuals who have applied for and were granted citizenship would of course be U.S. citizens, but less well known is that someone who was not born in the U.S. but had at least one parent who was a citizen at the time of their birth and meets other requirements (which vary by historical period) generally acquire U.S. citizenship at birth. The acquisition of citizenship in these instances is automatic. No application or action is required before the individual becomes subject to tax filing obligations and potential penalties for non-compliance. If you believe you may be a U.S. citizen and have not previously filed a tax return with the Internal Revenue Service (IRS), you should seek professional advice at the earliest opportunity.
Additionally, as a Canadian you may have tax filing obligations if you are deemed to be a “U.S. resident” for tax purposes. This may include those who never formally relinquished green cards — simply abandoning them does not generally eliminate tax filing obligations — as well as those who meet the “substantial presence test”. A common misconception here is the notion that the test is having spent 183 days in a year in the U.S. whereas an individual could actually meet the test threshold after spending just 31 days of the current year in the U.S. (if they exceeded the total number of days allowed using the three year formula outlined in the legislation). Again, if you have questions about your obligations you should seek professional advice from a qualified cross-border tax professional.
As with all tax questions, professional advice is highly valuable and recommended, and even more so when cross-border considerations are at play. Your financial advisor and tax advisors can partner together to ensure your investment portfolios and financial strategies contemplate your opportunities and obligations on both sides of the border.
CRA and IRS focusing efforts on Canadians owning U.S. real estate
Many snowbirds chose not to go south this year and some elected to rent out their U.S. properties, perhaps for the first time. These owners should familiarize themselves with the rules related to rental income and the tax reporting and filing obligations in both Canada and the U.S. Be wary of making assumptions because there are differences between the countries, including for example, in how depreciation and deductions are calculated, and when and under what circumstances forms must be filed. Both countries are increasing compliance efforts in this space. In fact, in October of 2020, the IRS announced a new international tax compliance enforcement campaign focused on rental properties owned by non-residents, which would of course include Canadians.
Additionally, in the summer of 2020 the CRA posted a tender notice asking for assistance to mine the data of Canadian residents who purchase, sell, or transfer U.S. real estate. The tender identified the purpose of acquiring this data as providing the ability to sort through historical records, mortgage transactions, property taxes, real property records and deeds dating back to at least 2014. This certainly suggests increased enforcement is a distinct likelihood.
Principal residence exemptions for U.S. real estate
If you recently sold or are planning to sell your U.S. real property, be sure to consider whether the principal residence exemption could be used to reduce your tax liability. Many Canadians are unaware that the exemption may be used against a foreign property, including a condo in Florida, a mobile home in Arizona, or even a live-aboard boat somewhere along the seaboard provided certain requirements are met.
Coordinating the Foreign Tax Credit would be a crucial part of the planning to ensure there is sufficient income to offset any tax in the U.S. related to the sale.
Trusts can certainly complicate tax reporting obligations, particularly when there’s a U.S. citizen or resident trustee or beneficiary. This past year the IRS announced an audit campaign aimed at U.S. individuals who have failed to file annual declarations related to ownership in and transactions with foreign trusts, including Canadian trusts. As with many U.S. tax rules, while the required forms may be informational only, substantial penalties may be triggered if you fail to file the necessary forms. This is the case even if there is no unreported income.
Seeking professional advice to ensure your obligations on both sides of the border have been met is highly recommended.
As a Canadian citizen with no formal ties to the U.S. you may think you’re in the clear, but simply owning U.S. property, including shares in U.S. companies, may create additional reporting requirements for certain investors. For example, a T1135 must be filed by Canadian resident individuals if, at any time during the year, they own “specified foreign property” costing, in aggregate, more than $100,000 (CAD). Specified foreign property is defined in the Income Tax Act and includes shares of foreign corporations (e.g. Apple, Google, etc.), foreign bank account balances, foreign land and buildings, and debts owed by non-residents. There are notable exceptions and the list is not exhaustive, but a key concept often misunderstood is that the threshold is “in aggregate.” This means you must add up the cost of all specified foreign property to determine if you’ve met the $100,000 threshold
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your lawyer or qualified tax professional regarding your situation.