Paul is a good friend of mine. He's an American citizen, but he's been fully assimilated into our Canadian culture. The proof? He grew up wanting to be a NASCAR driver, but today he's playing shinny hockey every Friday night with the guys from his work and is hoping his son will one day play in the NHL. If that's not the definition of a de facto Canadian citizen, I don't know what is.
Paul recently decided to do some tax planning. The fact that he's a U.S. citizen is a game changer when it comes to his tax planning. In fact, anyone who is a "U.S. person" living in Canada (a U.S. citizen or green card holder) - and there are more people in this category than you can shake a hockey stick at - needs to know the issues to think about. Let me share the highlights.
The fact is, the United States will tax U.S. persons annually on their worldwide income even if they are not living in the U.S. If you think you can fly under the U.S. tax radar, think again. New legislation in the U.S. due to come into effect Jan. 1, 2013, called the HIRE Act, will require financial institutions and investment firms to disclose to the Internal Revenue Service (IRS) the identity of account holders that are U.S. persons, otherwise the institutions will face certain withholding taxes on U.S.-source income. It makes good sense to start filing your U.S. returns now to ensure you're onside with the IRS before 2013.
If you're a U.S. person who is now a resident in Canada, you'll face taxes in Canada. But there's some good news. First, you should track the fair market value of your assets on the day you became a resident in Canada; that value will become your adjusted cost base for Canadian tax purposes, so you'll face Canadian taxes only on gains that accrue over that amount. Also, be aware that you shouldn't face a double tax problem. Although you're filing tax returns in both Canada and the U.S., you'll be entitled to a Foreign Earned Income Exclusion (which eliminates the tax on up to $91,500 (U.S.), for 2010, of Canadian employment income - but not investment income) and foreign tax credits which will often offset all or most of any U.S. tax that might otherwise be owing to the IRS.
Along with your annual U.S. tax return (Form 1040), be aware that you'll likely have to file other forms with the IRS each year as well, including: Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts; beginning with the 2011 tax year, a new form (form number not yet available) required under the HIRE Act to further disclose "specified foreign financial assets" with an aggregate value over $50,000; Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts; and Form 3520A, Annual Information Return of Foreign Trust With a U.S. Owner. These latter two forms may be required if you've set up RESP or TFSA accounts, for example. Finally, if you've got an RRSP and you're a U.S. person, you'll also need to file Form 8891 - U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.
Be aware that certain investments will receive different treatment in the U.S. than Canada. The capital gains exemption will not be available in the U.S., for example, nor will RRSP or flow-through share deductions.
Tax on death
You may be aware that the U.S. estate tax was repealed for the 2010 year. If you failed to meet your demise last year, (congratulations, but) you'll now be subject to U.S. estate taxes once again if you're a U.S. person, regardless of where in the world you live. The good news? On Dec. 17, 2010, President Obama signed legislation that will provide U.S. persons with a $5-million exemption (up from the $1-million exemption we all expected) so that the first $5-million of a U.S. person's estate will not face the tax. In addition, the top rate for the estate tax has been reduced to 35 per cent (down from the expected 55 per cent).
Still, the U.S. estate tax can be a huge burden for those with larger estates. There are many effective strategies to deal with this tax (beyond the scope of this article), so be sure to visit a tax pro to discuss it.
Next week I'll take a look at Canadians with U.S. connections.