Every year, when Anu Nijhawan looks at her investments and her retirement planning, she also looks over her shoulder.
“I’m a dual citizen of Canada and the United States, so I personally have to deal with these issues,” says Ms. Nijhawan, a tax partner at the Calgary office of Bennett Jones LLP.
In addition to helping her law clients navigate the craggy shores of international tax law, Ms. Nijhawan needs to take into account how her own financial decisions will be viewed at tax time not just by the Canada Revenue Agency, but also by the U.S. Internal Revenue Service.
The tax situation can be tricky, as many as a million Canadians are also U.S. citizens. It can become especially complicated for dual citizens who hold Registered Retirement Savings Plans, Registered Education Savings Plans, Tax-Free Savings Accounts and for those who are already retired.
Call it a complicated case of American exceptionalism. “The U.S. is different,” Ms. Nijhawan says.
Dual citizenship is less of a problem for Canadians who hold a second passport from other countries aside from the United States. Under various international tax treaties, all the CRA demands is that you show you’re paying taxes to the country where you’re located.
Most foreign countries reciprocate, taxing people based on where they live and work, not their citizenship. It has been estimated that 2.8 million Canadians live outside of Canada.
Unlike nearly every country in the world, the United States insists that if you are one of their citizens living in Canada, or anywhere in the world, you must also file a U.S. return. It will likely cost you money to comply – and could hit you hard if you don’t.
Dual Canada-U.S. citizens “are faced with a choice,” Ms. Nijhawan says. “They can continue to do nothing and hope that it all works out. The other thing is to start filing U.S. returns [as well as their Canadian ones], dating back for a specific time, say three to five years. The big issue is the time and effort it takes to get into compliance.”
It’s not simply a matter of downloading and filling out a U.S. tax return, either.
“It’s a disaster, a horrible disaster, because of all the reporting requirements and the cost of compliance,” says Michael Bondy, partner in London, Ont., at Collins Barrow KMD LLP, a nationwide chartered accounting group.
It’s about to get worse, he adds.
U.S. citizens have always been expected to self-report to the IRS, and, until recently, the tax implications have more or less been neutral for dual citizens with low and moderate incomes.
Under Canada-U.S. tax treaties, a U.S. filer living in Canada can deduct the amount of tax paid in Canada from his or her U.S. bill. Generally, Canadian income tax is higher than U.S. tax.
“If everything worked the way it’s supposed to work, you would pay Canadian taxes but you’d pay little or no U.S. tax,” Ms. Nijhawan says. This is generally true for individuals with up to about $200,000 a year in income.
The money you put away in an RRSP, and your RRSP’s gains, are generally not subject to extra U.S. tax while you’re contributing and the money stays in the plan, because the Canada-U.S. treaty recognizes these retirement savings.
U.S. citizens in Canada are supposed to fill out a U.S. form electing to defer any possible taxes until after the RRSP is converted into a Registered Retirement Income Fund at age 71.
RESPs and TFSAs are in the IRS’s sights, though. The tax treaty doesn’t recognize these plans, so the grant money that the Canadian government contributes to the education plans and the income you earn on both TFSAs and RESPs are subject to U.S. tax if you hold U.S. citizenship.
In addition to filing a tax return, U.S. citizens in Canada are required to file a foreign bank account report (FBAR) before June 30 of every year. They’re supposed to report any “foreign” account that had more than $10,000 – remember, to the United States, your Canadian savings account is in “foreign” currency.
Until recently, many dual citizens simply ignored the U.S. tax rules; in many cases they weren’t aware of them, or didn’t even know that they were U.S. citizens as well as Canadians.
“You may have moved here when you were 3 with your parents and have no idea you’re also an American,” Mr. Bondy says.
It’s a bigger problem now because under a new U.S. law, the Americans have ways to find out.
Passed in 2010, the Foreign Account Tax Compliance Act (FATCA) takes effect this year – ironically on Canada Day. It requires Canadian banks and those around the world to go through all their accounts and tell the IRS which customers might be subject to U.S. tax.
FATCA has been criticized by international law experts, the Canadian Bankers Association and even mildly by Finance Minister Jim Flaherty, but banks and their customers face huge penalties if they don’t comply.
The U.S. law is intended to combat money laundering and the exploitation of tax havens. No one considers Canada to be a tax haven, but it applies to U.S. residents living here nevertheless.
U.S. citizens in Canada can always renounce their U.S. citizenship, but this can bring complications, too. U.S. citizens must declare that they are not renouncing to avoid taxes, and they can be penalized if it’s found out that they were.
There has also been legislation introduced (though not passed) in the U.S. Senate that would give U.S. Customs the right to refuse entry to anyone who has renounced their citizenship.
Ms. Nijhawan and others say the bottom line is that if you’re a dual Canadian-U.S. citizen, it’s wisest to try to comply with their rules. It will cost at least $500, in many cases more, to have an accountant prepare your forms. You should fill out the proper forms to declare your bank accounts and RRSP – and, unfortunately, stay away from RESPs and TFSAs.