Canadian tax authorities shared nearly a million bank records with their U.S. counterparts this fall, making it more important than ever that Americans and dual citizens living in Canada be aware of their tax obligations south of the border.
The Canada Revenue Agency (CRA) has sent the financial records of 900,000 dual citizens and Canadian residents to the U.S. Internal Revenue Service (IRS) for the 2018 year, according a recent news story. It noted that the number of financial records of Canadian residents being shared with the IRS has risen steadily since an information sharing agreement began – from 150,000 in 2014 to 300,000 in 2015 and 600,000 for the 2016 tax year.
These financial records were shared with the IRS under a controversial U.S. law known as the Foreign Account Tax Compliance Act, or FATCA. Long before FATCA, all U.S. citizens and green-card holders living in Canada – and anywhere in the world – were required to report their non-U.S. financial assets to the IRS, under the Foreign Bank Account Reporting laws – or FBAR.
However under FATCA, Canadian financial institutions are required to actively report to the IRS the assets and identities of any Americans living in Canada, regardless of whether these dual citizens have ever lived in the U.S. These laws also apply to U.S. green-card holders living in Canada.
Here are the legal U.S. tax-filing requirements that Americans, dual citizens and green-card holders living in Canada should know. Keep in mind that renouncing U.S. citizenship does not eliminate past tax obligations to the IRS.
American citizens living in Canada are required to complete a personal income tax return each year, Form 1040, to report and pay U.S. taxes on their worldwide income. That doesn’t necessarily mean Canadians will be taxed twice.
Under the Canada-U.S. tax treaty, these Canadian resident taxpayers will be entitled to a foreign tax credit on their U.S. taxes, for taxes paid to Canada. Generally, with higher tax rates in Canada, the taxpayer will have enough foreign tax credits to offset any tax owed in the U.S. Of course, this is just a general rule, and could vary depending on the taxpayer’s personal financial situation.
In addition to filing 1040s, U.S. citizens must follow other requirements. We’ll go over the most common ones below.
Foreign Bank Account Reporting laws or FBARs
Americans who have bank or investment accounts with US$10,000 or more, at any time during the year, even for only one day, must file an FBAR. These disclosures are made by filing Form FinCen 114. The FBARs must disclose the account number, the name of the financial institution and the maximum balance of any account over which the individual had signing authority during the year. This includes individually and jointly held personal, trust, corporate and investment accounts.
Foreign Account Tax Compliance Act or FATCA
Under FATCA, the same disclosures that fall under the FBAR rules are required on Form 8938, which is also known as a Statement of Specified Foreign Financial Assets, in connection with larger foreign assets.
The penalties associated with failure to file these forms can be quite severe: US$10,000 a year for every account for non-willful violators, and the greater of US$100,000.00 a year for every account or 50 per cent of the unreported balance for willful violators.
Passive foreign investment company or PFIC
American citizens who own an interest in a passive foreign investment company could face potentially severe and punitive consequences as well.
A foreign company is considered a PFIC if 75 per cent or more of its gross income is passive income, such as interest, dividends, capital gains, or if 50 per cent or more of the company’s assets produce passive income. Some not so obvious PFICs include Canadian mutual funds and Canadian ETFs.
American citizens who are owners of PFICs are required to file a Form 8621, an information return disclosing ownership of a PFIC.
Other reporting requirements
The IRS has various other mandatory information returns, including for receipts of foreign trust distributions and foreign gifts (Form 3520), foreign trusts with U.S. owners (Form 3520-A), and interests in foreign corporations or partnerships (Form 5471). Failure to file these returns could also lead to severe penalties.
Finally, even Canadians who are not Americans but who earn any amount of U.S.-sourced income are required to file a 1040-NR U.S. tax return. For example, a Canadian snowbird who sells U.S. property is required to report this income on his or her Canadian return and on a U.S. 1040-NR form.
Under the Canada-U.S. tax treaty, the tax on U.S.-source income is paid to the IRS, and the taxpayer gets a foreign tax credit in Canada for the tax paid to the IRS. If the Canadian tax liability is higher than in the U.S., the taxpayer would pay the difference to Canada.
Thanks to FATCA, it has become exponentially easier for the IRS not only to find U.S. taxpayers residing in Canada, but to identify all of their non-U.S. financial assets as well. Americans and dual citizens living in Canada who are concerned about this should seek the advice of a cross-border tax professional.
David Altro is the managing partner of Altro LLP, which specializes in cross-border tax and estate planning, real estate and immigration. Avi Guttman is an associate at Altro LLP.