By now you know that the US retains the right to tax your worldwide income so long as you retain your US citizenship, regardless of residency. You also know Canada taxes your worldwide income if you live in Canada. That may leave you wondering how any American can live in Canada, short of committing tax fraud.
The answer is simple: tax treaties.
If only it were so simple to carry out! You’ll need to file taxes in both countries, even if you’ll almost certainly only owe taxes in one. It’s going to be a little tricky, but it’ll be fine.
How much of this do you need to know?
Most people don’t share my enthusiasm for learning about taxes. It’s not the dry tax code I enjoy, it’s the ability for me to take control of my own financial future I get excited about. I like the social safety net, but I’d also like to avoid paying more taxes than I’m required to.
Don’t simply hand a stack of paperwork to your accountant and hope for the best. They’re not the ones on the hook for their mistakes. It’s in your best interests to have a basic familiarity with taxes on both sides of the border.
In case this isn’t already clear, I’m not an accountant or an attorney. I’m an American living in Canada who files her own taxes. This is a starting point for your own research and/or a discussion with your trusted advisors, not legal advice.
I’m not attempting to explain the intricacies of the tax codes of two different countries. I’m focusing on the hiccups that occur for Americans living abroad.
I refer to US citizens, but US greencard holders are subject to the same reporting requirements.
Filing taxes in both countries
If you’re living in Canada, it’s easiest to file your Canadian return first. Once that’s done, convert the amounts to US dollars and file your American tax return.
US taxes are infamous for their complexity. They can get quite convoluted. However, for many Americans living in Canada, the 1040EZ or 1040 is all you need to worry about. If you’re in the position to panic about your tax situation, you probably already have a team of professionals to worry about the details for you.
You’ll need to file your Canadian tax returns in Canadian dollars and your US tax returns in US dollars.
The IRS doesn’t have an official exchange rate. As long as you use a posted exchange rate consistently, you’ll be fine. Most people seem to use the yearly average exchange rates posted by the IRS. This makes the most sense if you earned your income throughout the year, as you would with a salary. If you earned a large amount of income or incurred a large expense on a single day, you may want to use the exchange rate on the day that occurred.
Make sure you’re no longer a state resident
Filing a US federal return is mandatory for US citizens, but you may or may not have to file a US state or municipal return. Moving from Brooklyn to Toronto in 2016 means we have to file taxes in the US, New York, New York City, Canada, and Ontario.
Every state and municipality has different rules to determine who needs to file income tax returns, so you’ll want to check the requirements for the last state and city you lived in before you moved to Canada. If you moved from a US state that doesn’t have income taxes and no longer have US-based income, you don’t need to worry about it.
Some states require you to take specific actions to demonstrate that you’re no longer a resident. Don’t just stop filing taxes in a state, check the domicile requirements first. You may have to file a form to officially change your tax residency. This is generally referred to as your ‘domicile.’ Your domicile is your permanent address. You only have one domicile at a time.
In order to change your domicile, you need to leave your old domicile, physically move to a new locality, and intend to permanently or indefinitely stay in your new location. This is demonstrated by how much time you spend in a place, where you have a home, where your job is located, where your family lives, where you own property, your driver’s license, your car registration, the address on your bank accounts, where your children attend school, and where you procure professional services (like going to the doctor). They’ve even been known to consider the location of cemetery plots.
If I was sent to work in Toronto for two years and knew I’d return to Brooklyn, I’d probably be considered a New York State resident during that time. New York State (and City!) could require me to file and pay taxes for those two years.
Some states require you to pay taxes if you earn money there or spend 183 days a year there, regardless of the location of your domicile. This is especially important if you continue to work for a US-based company. Even if your state or municipality doesn’t require a form, if you’re moving from a place that charges income taxes, you may want to include a letter with your last tax return stating that you are no longer a resident and demonstrating that your domicile has changed.
While the federal governments recognize foreign tax credits, state governments may not. Individual US states are not bound by the tax treaty and you may have to pay state income taxes.
Michigan, Florida, California, and Massachusetts are known for going after residents who leave the state temporarily or fail to notify the state of their change in domicile. Check the rules for any state and city you’ve lived in to make sure you’re following the rules.
When you become a Canadian resident
We get asked when we moved to Canada all the time. It’s surprisingly tricky to answer. Was it the day we declared landed immigrant status? The day we bought our condo in Toronto? The day we sold our home in Brooklyn? The day we moved all of our belongings across the border? The day one of us starting working at a Canadian company? When we traded in our New York drivers licenses for Ontario ones? The CRA and IRS recognize that this is a bit of a gray area.
CRA form NR74 can help you make sure the day you decide your residency began, for tax purposes, will be okay with the CRA.
You’ll want to file form 8938 to provide the IRS with your new address.
Your old home in the US
In the US, gains on your primary residence are tax exempt up to $250k (or $500k for couples). Once you move to Canada, your home in the US will become a second home or investment property.
You can still claim this capital gains tax exemption if a home was your primary residence for 2 of the 5 years before the sale, so you have 3 years after you move to sell your old home and avoid capital gains taxes.
US federal taxes
The US offers exclusions and deductions for Americans living abroad. This is a boon to Americans organizing their life around tax avoidance. As an American living in Canada, you’ll most likely have enough Canadian foreign tax credit to cover any amount of taxes you do owe in the US.
Foreign earned income exclusion
The first $101k of income earned through salaries, wages, commissions, bonuses, professional fees, and tips earned outside of the US is excluded from taxation thanks to the foreign earned income exclusion (FEIE). If you’re married, you can exclude $202k. The FEIE amount increases each year. Use form 2555 or 2555-EZ to calculate your foreign earned income exclusion. You then subtract this amount from your earned income.
Other types of income are not excluded by the foreign earned income tax exclusion.
|Earned income||Unearned income||Variable income|
|Salaries & wages
Gambling & lottery
Social Security income
Scholarships & fellowships
If you’re married to a non-US citizen
If it’s advantageous to file married filing jointly and your spouse is not a US citizen, you can elect to have them file as a US citizen and claim the foreign earned income tax exclusion. This is usually helpful when the US spouse earns over $100k and much more than the non-US spouse, allowing them to use the full FEIE for a married couple. They’ll need to get an individual taxpayer identification number (ITIN).
If your spouse is not a US citizen and they have income not covered by the FEIE, you would not want to treat them as a US citizen for tax purposes.
Foreign housing exclusion
If you max out the FEIE, you’ll also qualify for the foreign housing exclusion (FHE). This is included on form 2555. Things are different if you’re self employed.
The base amount that you can’t include in the FHE is 16% of the maximum FEIE based on the days you lived abroad within the tax year. This is explained by the fact that you would have to pay housing costs anywhere you live. Housing costs above that amount can be deducted, up to a limit.
Generally, you cannot deduct more than 30% of the FEIE unless you live in a particularly expensive city. All major Canadian cities make the list of expensive locations. The 2016 limit for Toronto is $113/day or $41,400/year.
Your housing expenses include fees for obtaining a lease, rent, furniture rental, building maintenance fees, property insurance, repairs, utilities (not phone and cable), and parking spot rentals.
You can’t include taxes or interest that are deductible separately, the cost of purchasing a house, home improvements, mortgage payments, cleaning services, buying furniture, or depreciation.
If you take the FEIE, you cannot take the earned income credit or a deduction for moving expenses connected to the excluded income. If you make more than the FEIE, you may be able to deduct a portion of your moving expenses.
The Simple 1040 scenario
If you earn a salary and make less than this year’s foreign earned income exclusion (roughly $100k for a single person or $200k for a couple) and don’t have any other income, your tax forms will be quite simple. This is assuming you live in Canada permanently (or have spent at least 330 days outside of the US).
If you have a Canadian tax-free savings account (TFSA) or retirement account aside from an RRSP, things will be more complex.
Your Canadian employer will give you a T4. Convert this amount into USD and fill in line 7 of the 1040.
Assuming your FEIE is equal to or greater than your gross income, you have no taxable income.
You don’t have to worry about other exclusions, deductions, taxes, and credits. You cannot claim both the FEIE and the earned income credit (EIC) if you have no taxable income.
Because your Canadian employer did not withhold any US taxes from your paycheck, you are not eligible for a US tax refund.
Yes, it feels a bit like you’re submitting a blank 1040, but that’s normal.
More complex 1040 scenarios
Unfortunately, not all of us are so lucky when it comes to tax filing. If you’re like us, your taxes are quite a bit more complex than a salary (or two) and standard deductions. Here’s how to handle some common tax scenarios.
Canada and the US have different ideas of what’s taxable income on a W-2 or T4. If you’re concerned about this, you can ask your employer for a breakdown and check with the IRS to see what’s taxable and non-taxable income. This is probably not worth the hassle in most instances.
Interest and dividend income
You’ll get a T5 and/or a 1099-INT to report any interest or dividend income you’ve earned. If you have more than $1,500 in interest and dividend income, you’ll have to complete a Schedule B.
If you have a TFSA in Canada , you’ll have to report the interest income to the US.
You may have heard about the net investment income tax. This tax can’t be eliminated with foreign tax credits, so people really don’t like it. Luckily for us, if you don’t have $200k or more of adjusted gross income (AGI), you don’t have to worry about this. The sale of your personal residence is not included in that amount.
As someone who does freelance work for US companies, it can occasionally take some wrangling to get them to issue me 1099s. Many bookkeepers fail to realize that US citizens are still US persons, regardless of their residency status. If a client doesn’t issue you a 1099, you should calculate the amount and report it yourself.
Capital gains and losses
If you’ve sold a capital asset, you’ll need to report the gain or loss to the IRS. The most common capital assets are homes, stocks, bonds, and cars.
Remember that in most cases, if you sell your primary residence in the US you can exclude the first $250k if you’re single or $500k if you’re married from taxes, as long as you’ve owned your home for two years. You do not have to report the sale to the IRS. You cannot deduct a capital loss on your primary residence, but you still have to report it.
You can use your capital losses to reduce your income up to $3k a year. You can carry over unused losses.
Real estate income
All real estate income needs to be reported, even if deductions are greater than the income. It is mandatory to claim a deduction for depreciation.
Real estate losses are handled several different ways, depending on the circumstances. Generally, if you own and actively manage an investment property, you can deduct up to $25k of losses against your ordinary income.
Real estate is typically considered unearned income. However, if you actively manage your property, up to 30% of net rental income can be considered earned income. If you’re a real estate professional and spend an average of 20 hours a week managing your real estate business, it can all be considered earned income. Be sure to check Publication 527 for your specific situation.
Canadian Pension Plan (CPP) and Old Age Security (OAS) income is not taxable and doesn’t have to be reported.
Registered retirement income fund (RRIF) income and withdrawals from your RRSP does need to be reported. Convert the amount from your T4RIF or T4RSP and enter it on line 16(b) of your 1040.
Pension plans and annuities are generally taxable, since they are usually tax-deferred amounts. Check with your individual plan to make sure you’re reporting the correct amounts. You need to report all retirement income on line 16b. If all of your pension and annuity income is taxable, you can leave 16a blank. If not, you’ll need to report all non-taxable pension and annuity income.
Payments for unemployment insurance, illness, and disability benefits are taxable in the US. As this is not considered earned income, this cannot be covered by the FEIE.
Social Security benefits
If you’re a Canadian resident, you do not have to pay taxes on your social security income (SSI). Report your benefits on line 20a and leave 20b blank, since no portion of your benefits is taxable.
This is also where you report gambling income, lottery winnings, and cancelled debts.
You don’t have to report child support, life insurance payments, bequests, gifts, damages for injuries, veteran’s benefits, welfare benefits, or workers compensation payments.
Most US tax deductions are included in your Schedule A.
Taxes paid can be deducted from your US income taxes. This includes Canadian federal and provincial taxes and property taxes as well as any other taxes you pay around the world, including the US.
If you claim the FEIE, you cannot deduct taxes based on that income (the first $100k or $200k you earn). If you have foreign income over the FEIE maximum, you can determine what percentage of the income taxes you paid were for your US taxable income and deduct that amount.
If you deduct your foreign income taxes, you cannot also take the foreign tax credit. Because the deduction reduces your taxable income while the foreign tax credit reduces your taxes dollar for dollar, the foreign tax credit is often more advantageous.
Property tax in Canada can be deducted here without interfering with your FEIE or your foreign tax credits.
You can deduct the mortgage interest for your primary residence in Canada. In the US, banks will give mortgage holders a form 1098, outlining the interest paid. For your Canadian mortgage, they may be willing to issue a 1098 or they can simply provide you with the necessary information.
Charitable contributions made to qualifying institutions in the US or Canada are eligible to be deducted.
Your Canadian school will likely provide you with a T220A form detailing the tuition you paid. You can convert this into USD for your US tuition and fees deduction, along with any eligible expenses. Remember to reduce this amount by the total of any tax free scholarships or fellowships received. Similar to the student loan interest deduction, your school must be listed on the Federal Student Aid website.
Generally, foreign medications are not a deductible medical expense. Medications that you purchase and consume abroad are allowed.
You can only contribute to an IRA or Roth-IRA if you have US taxable income. You can’t contribute to an IRA if you only have passive income. If either you or your spouse have earned income, you can contribute. Any income over the FEIE can be contributed to a traditional IRA up to the annual contribution limit, reducing the amount you owe in taxes.
If you make enough gross income or passive income in order to owe over $1k a year in taxes to the US, you may need to pay a quarterly estimated tax.
Foreign tax credit
Most Americans living in Canada who find themselves owing taxes at the end of the year are able to use foreign tax credits (FTC) to reduce or eliminate the amount owed.
You have two options for how to handle your foreign taxes paid: take the foreign tax credit or deducting them. If you take the FTC, you can still claim the standard deduction or itemized deductions (just don’t include your Canadian income taxes).
The FTC will be complicated if you, like us, have US-based income.
Any taxes you pay in the US are recognized dollar for dollar by Canada and vice versa. This is intended to save you from double taxation.
You get two types of tax credits: earned and passive income.
You can use foreign tax credits the year you earn them, the prior year (to refile), or 10 years into the future. The IRS limits how many foreign tax credits you can use each year, based on the ratio of your US to world income.
Eligible taxes include Canadian federal and provincial taxes on non-US income. Property taxes and sales taxes (GST, HST, VAT) are not eligible. If you got a Canadian tax refund, you cannot include the refunded amount.
You’ll need to sort your income into US and non-US income. For your non-US income, you’ll need to determine if your income is passive or active and if it’s covered by the Canada-US tax treaty. You’ll need to complete a form 1116 for each category of income.
For each form 1116 you complete, you can also include any related deductions and losses. You can’t include deductions or losses from income included in the FEIE.
In order to determine the foreign taxes paid for each category, you can divide the Canadian taxes you paid by the percentage of each type of income.
Form 1116 will also calculate the limit to the amount of FTC you can use this year. You can carry FTC back one year and forward 10 years.
Some tax credits are refundable, meaning if your tax burden is zero the IRS will send you a cheque for the refundable tax credits. Non-refundable tax credits can simply bring your tax burden to zero.
If you are owed a tax refund, do not list a Canadian bank account, including a USD Canadian account. You can only get your refund direct deposited into a US bank account.
Tax filing deadlines
If you mail your tax return from abroad and the postmark date will count as the date of filing. Payments, however, are only recognized the day they are received. If you owe US taxes, you will want to ensure you mail any payments with sufficient time to arrive by the deadline. If you defer your tax deadline and expect to owe taxes, you should submit your estimated payment by the April 15th deadline or you may end up owing additional interest and penalties.
Most Americans living in Canada will find it easier to file electronically. Electronic payments can be made through a US bank account, US debit or credit card, wire transfer, or foreign bank accounts.
Americans living abroad are eligible for an automatic 2 month tax extension. This means the April 15th deadline is pushed back to June 15th. To take advantage of this, simply attach a letter listing your address in Canada or write “Taxpayer Resident Abroad” at the top of your tax return.. If you owe US taxes, you will have to pay interest from April 15th, not the extended deadline.
You can push the deadline back to October 15th by filing form 4868. This automatic extension also applies only to the filing deadline, not the payment deadline. You’ll owe interest and penalties from April 15th.
You can request a further tax extension for special tax treatment using form 2350.
Prior to October 2014, if you had an RRSP, had to file form 8891 in order to maintain their tax-deferred status in the US. This is no longer a requirement. Your RRSP is automatically recognized to have the same tax benefits as an IRA or 401k. You can deduct your RRSP contributions as if they were IRA or 401k contributions.
TFSA, RESP & RDSPs
Tax free savings accounts (TFSA), registered education savings plans (RESP), and registered disability savings plans (RDSP) were not included in the tax treaty and are not sheltered from US taxes like they’re sheltered by Canadian taxes. You’ll have to report and pay taxes on any income in these accounts.
The IRS is not clear on how these accounts should be treated. Some accountants view them as trusts and suggest filing form 3520 and 3520A. Other tax experts believe they’re not trusts and the 3520 and 3520A are not necessary. The IRS has not made a statement to clarify the matter, much to the consternation of tax specialists and Americans living in Canada.
Given the well-documented lack of clarity regarding TFSA, RESP and RDSP, it’s likely the IRS would not impose penalties for improper reporting, so long as you’re reporting the income. Because your Canadian bank will likely not provide you with tax reporting information for these accounts, you will have to specifically request it or calculate it based on your financial statements.
You may find that these accounts are still beneficial for your specific tax situation.
If you have a non-US spouse (both in terms of citizenship and tax treatment election) you may wish for them to hold any TFSA, RESP, and RDSPs.
Foreign bank accounts
If you have more than $10k in foreign bank accounts, you’ll have to complete the FBAR form. Even if no individual account exceeds $10k, if the total value of all accounts was over $10k at any point during the year you’ll have to file the FBAR.
Foreign account tax compliance act
The foreign account tax compliance act (FATCA) combats tax evasion. If you have $50k or more in any Canadian bank, they’ll report this to the IRS. Many banks simply report all accounts held by US citizens.
You’ll want to file form 8938 to declare your foreign financial assets if you have more than this year’s required reporting amounts. This includes stocks, bonds, deferred compensation, interests in a trust, interests in a foreign entity, or a pension. You don’t have to file a 8938 if you already report these assets in form 3520, 5471, 8621, or 8891.
You’ll need to declare your RRSPs and other accounts on form 114.
Canadian mutual funds
Nearly all Canadian mutual funds and Canadian-traded ETFs are considered passive foreign investment companies (PFIC) by the IRS. If you own shares in a PFIC you need to file form 8621. If you hold these PFICs in an RRSP, you don’t have to worry about this.
As a US citizen, you should probably avoid owning Canadian mutual funds outside of an RRSP, as the tax requirements are unfavorable and the reporting requirements are considerable.
Other tax-treaty items
The IRS has a lot of forms, but there isn’t a form for every possible situation covered by the Canada-US tax treaty. This is what form 8833 is for.
American citizens living abroad must also file estate tax returns and gift tax returns.
Compliance issues and getting audited
If you aren’t sure how to report income or if income needs to be reported, you can include it in form 8833 and/or a letter explaining the situation with your tax return. Of course, you should research the topic thoroughly yourself and speak to a tax professional before you do this. The IRS is not going to humor questions it finds routine, but many expats face novel tax situations where answers may not be available.
The IRS isn’t unreasonable. If you make mistakes in your tax filings and you’re audited, you generally won’t be penalized for it. You’ll simply be required to correct them. If you realize you made a mistake and you weren’t audited, you can amend tax returns from prior years.
I was audited in my early 20s when I raised flags for declaring my freelance income and not filing self-employment taxes. Looking back, it’s obvious to me what I filed incorrectly. The IRS reviewed my paperwork and determined that I had overpaid by a small amount and sent me a refund. An audit doesn’t necessarily mean you’ll have IRS agents swarming through your house looking for receipts or whatever other nightmare scenario people imagine.
The IRS is understanding when taxpayers make honest mistakes, but they really don’t like tax evasion.
Canadian and US tax forms
|Trust income||1099-DIV or 1041||T3|
|Social Security benefits||1099-SSA||T4AP|
|CPP/QPP/OAS||NR4, NR4OAS||T4AP, T4OAS|
|Personal tax return||1040||T1|
|Updated personal return||1040X||T1-ADJ|
|Capital gains/losses||Schedule D||Schedule 3|
|Dividends/interest||Schedule B||Schedule 4|
|Qualifying donations||Schedule A||Schedule 9|
|Partnership tax return||1065, K1||T5013|