When I think about our cousins south of the border, I think about President Herbert Hoover, who chose to give his full salary back to the U.S. government. Some would say that, today, the U.S. government would like everyone to do the same and it's the job of the Internal Revenue Service (IRS) to make sure it happens. The fact is, even Canadians may owe tax – or have tax-filing obligations – south of the border. So, while our tax-filing deadline looms here in Canada on Monday May 2nd, don't overlook the requirement you might have to also file in the U.S. Here's a primer for Canadians on tax filings with Uncle Sam.
I want to speak today to those who are Canadian residents, particularly those who spend some time each year in the U.S. or own real estate south of the border. Snowbirds are a common example. The folks I'm talking about are called "non-resident aliens (NRAs)" by the U.S. government because these people are not resident full-time in the U.S., and are not U.S. citizens. If you happen to be a U.S. citizen (including dual citizens), have a green card, or live full-time in the U.S., my comments today aren't for you. If you're an NRA, it's important to understand your tax-filing obligations in the U.S. because the penalties for failing to file can be steep.
Here's the first question you need to ask: Will the IRS consider you to be a resident of the U.S.? If so, you may have to file a full-blown U.S. tax return – called Form 1040. Uncle Sam will determine your residency by the amount of time you spend in the U.S. Specifically, the IRS will apply the "Substantial Presence Test (SPT)," which follows this formula: Add up the number of days you spent in the U.S. in the current year, plus one-third of the days in the prior year, plus one-sixth of the days in the year before that. If the total comes to 183 days or more, and you're present in the U.S. for more than 30 days in the current year, you meet the test. You'll generally meet the test if you spend more than 122 days (about four months) on average in the U.S. each year.
If you meet the test, you'll be considered a resident of the U.S. for tax purposes that year (you may also be resident in Canada for the same year). Absent any steps to disclaim your U.S. residency, you'll have to file Form 1040 and report your worldwide income to the IRS. But there's hope. You can avoid U.S. residence by filing Form 8840 "Closer Connection Exception Statement" with the IRS. This form tells the U.S. government that you have a closer connection to another country (like Canada). This form is due by June 15 each year for the prior calendar year. If you fail to file Form 8840 on time and you meet the SPT, you'll have to file a full U.S. tax return and could face penalties as high as $1,000 for each item of income involved. In addition, you could be subject to U.S. foreign-reporting requirements if you fail to file Form 8840 on time – and penalties in this case can be $10,000 or more if you fail to file.
As an alternative to disclaiming U.S. residency through Form 8840, you can claim protection under the Canada-U.S. treaty. To do this, you'll have to file a non-resident tax return (Form 1040NR) in the U.S. and attach Form 8833 "Treaty-Based Return Position Disclosure" to your return. Both Form 1040NR and Form 8833 require a U.S. Individual Taxpayer Identification Number (ITIN), whereas Form 8840 doesn't. Forms 1040NR and 8833 are due by June 15 for the prior year as well. To get an ITIN, fill out Form W-7 with the IRS.
If you own rental real estate in the U.S., you should plan on filing annually. You'll face a 30-per-cent withholding tax on rents you collect (your tenants are supposed to remit this amount to the IRS). You can avoid this withholding requirement if you elect to file a U.S. tax return and report your rental income and expenses using the "net rental income method of reporting," which will require that you file Form 1040NR to report those figures. Your tenant may want you to provide Form W-8ECI so that they can pay you the full rent and not hold back 30 per cent. If you sell U.S. real estate, you'll have to report this on Form 1040NR and you might be liable for tax on any capital gains. Speak to a tax pro for more.
Tim Cestnick is managing director of Advanced Wealth Planning, Scotia Wealth Management, and founder of WaterStreet Family Offices.