Dear Mr. Ingram,
I am interested in finding out if there is US income tax levied on individuals who have dual US / Canadian citizenship and who are permanently residing and working in Canada . If so, is the tax a flat tax (what would the % be?) or is it progressive based on one's income? If it is progressive, can you tell me what the income brackets and the associated levels of taxation would be?
Would having a US bank account, 401K, Roth IRA and US credit cards have tax implications for an individual in the scenario outlined above?
What would be your fee to advise me of the above?
Thank you,
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david ingram replies:
Any US citizen or green card holder living in Canada must continue to file US tax returns as long as they remain a US citizen. It does not matter if that US citizen is living in Ethiopia, Saudi Arabia, Greece or Australia either. US citizens and green card holders must file US tax returns no matter where they live or no matter where the money comes from.
go to www.centa.com and read the Oct 93 newsletter on Dual citizenship and the Oct 1995 newsletter on what A US CITIZEN LIVING IN CANADA MUST DO.
THESE TWO NEWSLETTERS can be found int eh top left hand box.
I charge $450.00 for this type of consultation in person or by phone. If you are in the US during a phone consult, there is no GST. If in Canada, it becomes $472.50.
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The following is a reprint from my 1991 Ultimate Tax Book. Although rates will be a little different, the method is the same.
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A whole new look at Tax and Borders
Whether your particular venture fails or succeeds, it is still your name that appears at the bottom line of the contract, and it is you and not your consultant that will succeed or fail with the venture.
It is your duty to yourself to take the time to bother with your business affairs. It is your duty to yourself to investigate any possible investment, and to realize that if you act hastily you may be robbed in the same way as Aunt Gertrude, who keeps wondering why her 3% guaranteed perpetual bonds are not keeping up with inflation. - david ingram
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David Ingram
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Canadian Taxes, U.S. Taxes, Visas and Immigration, British Columbia Income Tax,
Real Estate
To Reside or Not
(THE TAXING QUESTION)
excerpt from
david ingram's
BORDER BOOK
Jan 20, 2001
IT ISN'T ALWAYS YOUR DECISION
GOVERNMENT(S) DECIDE FOR YOU!
"WATCH OUT!!!"
AMERICAN CITIZENS LIVING IN CANADA
(or any other country)
Every U.S. citizen or "green card" holder living out of the U.S. (i.e., in Canada) must continue to file U.S. income tax, gift and estate tax returns. They may exempt up to $72,000 U.S. of "earned" income, but if they have more than $72,000 of earnings or any amount of interest, dividends, rents, royalties, or pensions, they must file a U.S. income tax return and use a form 1116 (foreign tax credit) to claim credit for the taxes paid to Great Britain or Canada or Iceland, or Libya, or Borneo. (Note that the $72,000 figure was $70,000 prior to 1998).
CANADIANS OUT OF CANADA
This is a very important matter. In our US "working visa" practice, we counsel our clients on their US and Canadian tax liabilities when they are going to work in the USA. We find that most (certainly 95%) of the Canadians who get US working visas are given incorrect or at least incomplete advice about their US tax liabilities. For instance, a North Vancouver company sent over 200 employees to the US on TC and TN visas. The individual employees were being paid from Canada and were all filing Canadian returns and not paying tax to the USA where their first liability was when they were performing the service in the USA.
US taxation is based upon where you perform the work. Where you "claim" to work is not important. Now, if you work in California and live in Vancouver with your spouse and children and earn LESS than $10,000 US, there will likely be no US FEDERAL tax liability because of the US / Canada Income Tax Treaty. However, there WILL be a California income tax liability.
This chapter was new for the seventeenth (1990) edition of my Canadian Income Tax Preparation book. It came up because of the number of clients I have who are "out of the country." At any moment, I have over 500 clients who are Canadians living in Barbados, Fiji, Australia, New Zealand, New Guinea, Hong Kong, Saudi Arabia, Kuwait, France, Brussels, and another 50 countries. As well, they live in at least 20 of the U.S. states such as California, Alaska, New York, West Virginia, Nevada, Hawaii, Florida, North Carolina, Tennessee, Washington, Virginia, and Arizona. Note that some states have no (or limited) state income tax. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming have no state tax. Tennessee has tax on interest and dividends only. New Hampshire taxes proprietorship business income. And, by the time you read this, there will be changes. North Carolina, for instance is making noises about getting rid of its intangible personal property tax (tax on receivables, etc. - yuk).
Then, of course there are those who live and work on deep sea oil drilling platforms, or work as sailors on Great Lakes freighters (one such fellow sailed between or Air Crew on Qantas, Canadian Airlines International, Air Canada, BOAC, LIAT, etc., and based in Amsterdam, Sydney, Honolulu, Seattle, or Auckland, New Zealand).
And I shouldn't forget people who live in the United States and have property in Canada which they rent out or have made an investment in a brother's Canadian business or a Canadian ski (or even "all season" resort).
Some of our clients have Xmas tree farms in Northfield, Minnesota, orange groves in Florida, and almond plantations in California. Others are Finish citizens who live in Germany and work part of the year in the U.S. and part of the year in Canada. My favourite client (sorry everyone else) is likely a U.S. citizen with a wife in North Vancouver and businesses in the Philippines, New Zealand and Washington State. On his last visit, he brought his 84 year old American mother from Seattle. Wife, mother and client were flying off to Manilla the next day and mother was worried because the Sears store at Capilano mall had turned down her Gold Visa Card. "What was she going to do for money on her trip?" A call to her trust officer in Seattle ascertained that her card was okay and NO AUTHORIZATION HAD BEEN ASKED FOR BY SEARS. We had no trouble getting an approval through our own VISA account, so it must have been the SEARS computer system. However, this dynamic lady, who had $800,000 U.S. on deposit in her accounts, was embarrassed and distraught, and it will be a long time before she shops at SEARS again.
Then there are the soccer players, the hockey players, the basketball players, the seminar presenters, the Hollywood actors, the Ice Capades skaters, and the odd South American or European or Iranian refugee and the question always arises, "who is going to tax them?" In the case of a Hockey player like Wayne Gretzky, he has to file a "state" tax return in every state in which he played hockey or makes a personal appearance, likely about 22 states.
Canadians usually compare their combined federal and provincial taxes to the basic federal U.S. taxes without thinking about the state taxes and extra medical costs. Although some states have NO personal income tax, most do. "Some" (there are over 6,000 current forms) forms and information are given here:
State Tax form Number
Alabama 40
Alaska * No personal state income tax form (estate /corp yes)
Arizona * 140
Arkansas * 1000
California * 540
Colorado * 140
Connecticut * CT-1040
District of Columbia D-40
Delaware 200-01
Florida * No income tax (is tangible personal property / estate / corp tax)
Georgia * 500
Hawaii * N-12
Idaho * 40
Illinois * IL-1040
Indiana * IT-40
Iowa 1040
Kansas * 40
Kentucky * 740
Louisiana * IT540
Maine 1040ME
Maryland * 502 plus city and county taxes
Massachusetts * 1
Michigan * MI-1040 plus 12 city tax returns
Minnesota * M-1
Mississippi * 62-101
Missouri * M)-1040
Montana * 2
Nebraska * 1040N
Nevada * No state income tax (is a $25 / employee business return)
New Hampshire * 1040 for business proprietorship only
New Jersey * 1040
New Mexico * PIT-1
New York * IT-201 plus New York City / Yonkers city returns
North Carolina * D-400
North Dakota * 37
Ohio * IT-1040
Oklahoma * 511
Oregon * 40N
Pennsylvania * PA40R plus Philadelphia city return
Puerto Rico No individual income tax return
Rhode Island RI-1040
South Carolina * SC1040
South Dakota No Individual income tax return
Tennessee * RV-0368 - only interests and dividends included
Texas * No individual income tax return (are estate / corp taxes)
Utah * TC-40
Vermont * 103
Virgin Islands No personal, corp, estate, income taxes
Virginia * 760
Washington * No personal income tax (estate/personal prop / yes)
West Virginia * IT-140
Wisconsin * 1
Wyoming * No personal, corporation or estate taxes
(*) denotes we have recently prepared returns involving this state)
Note that state income taxes range from none to a high of about 10% in California.
The personal property taxes are important as well. In the state of Washington, for instance, you can easily get a retroactive $5,000 personal property tax bill on the boat you have kept there for the last 4 or 5 years. Licensing your new Cadillac in the state of Washington will cost you an extra $600 a year in personal property taxes.
"WATCH OUT BORDER WORKERS"
It used to be that people who lived in the United States and worked in Canada paid no tax to the U.S. because the higher Canadian income tax meant that the U.S. resident got credit for every cent by filing the Form 1116 and claiming a foreign tax credit. That is no longer true if the total income (after the "up to" $72,000 exemption) is over $45,000 for a family or $33,750 for an individual or $22,500 for a married person filing separately. The Alternative Minimum Tax (Form 6251) means that only 90% of the foreign tax credit can be claimed. (Note, AMT kicked in at $40,000, $30,000 and $20,000 from 1987 to 1993 - It is now $22,500, $33,375, and $45,000 for 1994, 1995, 1996, 1997 and 1998).
If you are a U.S. citizen who has not filed your past returns, you should catch up your returns from 1987 to the present. We regularly prepare 1987 to 1998 returns for U.S. citizens who have been "caught" or who are just trying to catch up legitimately.
For example, in a 1990 return for a man earning $70,000 in Canada and a woman earning $10,000 in the U.S., their Alternative Minimum Tax worked out to about $500.00 U.S. However, if she had made $20,000 in the U.S., there would have been enough U.S. Tax paid that the Alternative Minimum Tax would not have kicked in. Since the 1991 rate for the AMT is going from 21% to 24%, it is expected to more than triple the number of people who will be caught in this situation. Persons in this situation should plan on making sure that they have some U.S. income to knock out the AMT in the U.S. In the above case, I had prepared the return and sent it in, before another return pointed out to me that there was a tax liability under AMT and I had to phone the couple and say "mea culpa".
Note that the AMT is 26% for 1993 and 1994, 1995, 1996, 1997, 1998, and 1999.
WHERE DO THEY LIVE?
What country is going to tax them?
The answer is not always easy. I am going to quote directly from the U.S. / Canada Tax Treaty because that is the one we use most often, but the same general rules apply with all treaty countries. At the moment, Canada has signed treaties with 78 countries and is working on another 27. We have had several cases where people have already paid $16,000 or $25,000 in tax to Canada because they are clearly residents under most meanings. However, because of the following "TIE BREAKER" rules, we are getting back all tax paid on dollars earned in the other country.
CANADA / UNITED STATES INCOME TAX TREATY 1980
There are many, many treaties. The articles tend to be fairly consistent so that when some one comes in from Indonesia, I am able to quote Articles IV, IX, X, and XI etc., and look like a real expert on Indonesia, even if I have not looked at it before. The following ARTICLE IV for instance has been used by myself more often for Australia and Germany than for the United States.
Please also note that a NEW US / CANADA TREATY was signed on August 31, 1994 and with various changes took effect on Jan 1, 1996. Parts of it (estate and capital gains) are retroactive back to November 10, 1988. This new Treaty totally changes the rules between the two countries for estate and capital gains tax upon death. It also completely changes the rules for the taxation of U.S. Social Security, Canadian Old Age Pension and Canada Pension Plan. Gambling losses are going to be allowed for Canadians as well. See the December 1995 edition of the CEN-TAPEDE for more information.
The "boxed" parts of the following treaty following are the parts taken out as of January 1, 1996. The treaty as printed is as it should be now. It was slightly different 1980 to 1995.
Article IV - Fiscal Domicile - (it is the same number in most treaties)
1980 to 1995. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, place of management, or any other criterion of a similar nature. But this term does not include any person who is liable to tax in that Contracting State in respect only of income from sources therein.
1996, 1997, 1998 & 1999. For the purposes of this Convention, the term "resident of a Contracting State" means any person who, under the law of that State, is liable to taxation therein by reason of that person's domicile, residence, citizenship, place of management, place of incorporation or any other criterion of a similar nature, but in the case of an estate or trust, only to the extent that income derived by the estate or trust is liable to tax in that State, either in its hands or in the hands of its beneficiaries. For the purposes of this paragraph, a person who is not a resident of Canada under this paragraph and who is a United States citizen or alien admitted to the United States for permanent residence (a "green card" holder) is a resident of the United States only if the individual has a substantial presence, permanent home or habitual abode in the United states and that individual's personal and economic relations are closer to the United states than any other third State. The term "resident" of a Contracting State is understood to include:
(a) the Government of that State or a political subdivision or local authority thereof or any agency or instrumentality of any such government, subdivision or authority, and
(b) (i) A trust, organization or other arrangement that is operated exclusively to administer or provide pension, retirement or employee benefits, and
(ii) A not-for-profit organization that was constituted in that State, and that is, by reason of its nature as such, generally exempt from income taxation in that State.
2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then his status shall be determined as follows:
(a) he shall be deemed to be a resident of the Contracting State in which he has a permanent home available to him. If he has a permanent home available to him in both Contracting States, he shall be deemed to be a resident of the Contracting State with which his personal and economic relations are closer (centre of vital interests);
(b) if the Contracting State in which he has his centre of vital interests cannot be determined, or if he has not a permanent home available to him in either Contracting State, he shall be deemed to be a resident of the Contracting State in which he has an habitual abode;
(c) if he has an habitual abode in both Contracting States or in neither of them, he shall be deemed to be a resident of the Contracting State of which he is a national;
(d) if he is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.
1980 to 95. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall by mutual agreement endeavour to settle the question and to determine the mode of application of the Convention to such person.
1996 on. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the competent authorities of the Contracting States shall by mutual agreement endeavour to settle the question and to determine the mode of application of the Convention to such person. Notwithstanding the preceding sentence, a company that was created in a Contracting State, that is a resident of both Contracting States and that is continued at any time in the other Contracting state in accordance with the corporate law in that other Contracting State shall be deemed while it is so continued, to be a resident of that other State.
You can see that the countries themselves have set it up so that they will get tax. It is up to you to arrange your affairs to pay the least tax possible.
Both Canada and the U.S. will tax you on any money you earn within the country. The BIG question is:
WHEN ARE THEY GOING TO TAX YOU ON THE REST OF YOUR WORLD INCOME?
Canada taxes on RESIDENCY, not citizenship. Basically, if you have been in Canada for more than 183 days (counting the hours - one hour is only one hour, not one day as in the States), you are taxable on your world income, no matter where it is located and under whose name you have your assets stashed away. That is why Howard Hughes left Canada when he did back in the 70's. If he had stayed in Canada (even as a visitor) two more days, he would have been taxable on his world wide holdings.
Note that in March, 1999 Denise Rondpre of Revenue Canada Customs Excise and Income Tax issued a policy letter to Foreign Air Crew flying for Canadian Airlines and Air Canada. This directive stated that it was Revenue Canada's opinion that one hour in Canada constituted a full day in spite of the fact that the courts have ruled against them and the law, itself, has not changed. I do not think that this is enforceable, but you must be aware of it.
If you are in Canada for any period and earn more than $10,000, you must pay tax on the total amount to Canada, or vice versa if a Canadian is in the U.S. Entertainers and sports figures are exempt for up to $15,000 but they are to have 15% tax withheld from their gross salaries or remuneration (including hotel rooms, plane tickets, car rentals, meals, etc.). Remember that even though the first $10,000 or $15,000 above is not "taxable", you must file a return and quote the treaty article number specifically to claim the exemption. The U.S. has a minimum $1,000 fine for failure to report the treaty number to claim the exemption, even if there is no tax owing. In practical terms, this means you only get fined if not taxable. (Although this was always here, Revenue Canada rarely enforced the rule. In this case the enforcement laws DID change in March, 1998 and the US resident MUST file if working in Canada.)
Remember also, this refers to "where" the work is performed, not where the money comes from. Therefore, if you worked in San Francisco for one month for your Canadian employer and were paid $6,000 U.S. by Bell Telephone in Ontario, you would have to file a California return reporting your world income and exempting the amount earned in Canada and would have some tax to pay to California on the $6,000. On the Federal return, you would file for an exemption under Article XV of the U.S. / CANADA Tax Treaty and pay no federal tax to the U.S. You would then claim a credit for the California tax paid on your Canadian income tax return. You should also get BELL to agree to pay the $400 to $1,000 accountant's bill to prepare these complicated tax returns.
The U.S. taxes on citizenship first and residency or physical presence second. If you have another tax home, and are just an extensive visitor in the States, you can escape U.S. tax on your income from other countries. However, if you renounce your other tax home or become a "green card" holder or are in the U.S. for more than 183 days in one year, you are subject to U.S. income tax on your world income.
The U.S. taxes its citizens and green card holders wherever they are and no matter what they are doing. The U.S. taxes its citizens in Canada and they will tax them in the North Sea. The U.S. will add on the benefit of housing allowances, car allowances, servants, and education allowances for people who have not been in the U.S. for twenty years but who are still U.S. citizens. If you want the benefit of U.S. Citizenship, you pays your taxes.) The first $70,000 U.S. of income earned from personal services (as opposed to capital) is exempt if you have been out of the country for a full calendar year in one test or for 330 out of 365 days in another test using a fiscal year.
However, being "exempt" does NOT mean that you do not have to file a tax return. You must still file your U.S. 1040, report the Canadian Earnings in U.S. dollars and claim the "up to $72,000 U.S." by filing a form 2555 with the 1040. If you have investment, [INCLUDING AMOUNTS EARNED WITHIN YOUR CANADIAN RRSP], rental, royalty, or any income other than from services, you must also report the income in U.S. dollars. Since you will have paid tax to Canada first, you will file a Form 1116 with the 1040 to claim your foreign tax credit. A separate Form 1116 must be filed for each kind of income, i.e. rental, pension, dividends, etc.
The RRSP earnings may be exempted under ARTICLE XXIX.5 of the U.S. / CANADA Income Tax Treaty 1980.
Social security (FICA) taxes usually do not have to be paid to the U.S. under Article XXIX.4 of the U.S./CANADA Income Tax treaty or Article V of the CANADA / U.S. Social Security Agreement. (I sure hope all this is impressing you).
Therefore, a U.S. citizen living in Canada who had a rental house, a job, an RRSP, some dividends and some capital gains from the sale of stock would file his or her Canadian return first and then file a U.S. return with these forms:
* 1040 - is the basic return for a citizen or resident of the U.S. or landed immigrant of the U.S. (commonly called a "green card" holder).
* Schedule A - to claim itemized deductions if needed
* Schedule B - to report the dividend income
* Schedule D - to report the capital gains
* Schedule E - to report the rental income
* 4562 - to report depreciation on the rental house
* 1116 - (maybe two foreign tax credit forms) - one for any income from services over
$72,000, one for the rental, capital gains, and dividend income.
* 1116(AMT) - two more forms to calculate the foreign tax credit for Alternative Minimum Tax purposes (AMT)
* 2555 - to exempt up to $72,000 U.S. of earnings from services
* 6251 - Alternative Minimum tax form
* FICA (Social Security) exemption - to exempt income from U.S. FICA
* RRSP election forms to exempt income earned within the RRSP from current U.S. income tax until withdrawal
* TDF-90 form(s) - to report foreign bank accounts including Canadian RRSP accounts which are considered "foreign trusts" - failure to file this form can result in up to a $500,000 fine PLUS up to five years in jail
He or she might also have to file either of the following two specialty forms when he or she owns shares in corporations.
* 5471 form - If you are a U.S. citizen and 5% or more owner of a Canadian corporation. Failure to file this form can create fines of $1,000 every 30 days up to $25,000
* 5472 form - If you are a Canadian who owns a U.S. corporation - failure to file this one has fines of up to $30,000 every 30 days.
Even though you or your friend have not filed your U.S. return for years, you have not necessarily "got away with it". At least once every two weeks, a U.S. Citizen arrives "a little distraught" because the IRS has caught up to them.
And the biggest problem is that they can tax you for many years, whereas you might only be allowed to claim your exemptions and credits for two or three years back.
For instance, In January, 1995, I had a "new" U.S. citizen client bring me a U.S. Tax bill for $194,000 for 1986, 1987, and 1988. He had been "caught" because he had applied for a new passport.
The tax was on the gross income he had received in those years when he sold off a stock portfolio (remember the crash). Although he made about $40,000 to start, he lost after the crash and ended up $30,000 down. A Canadian accountant told him he did not have to file U.S. returns because he was living in Canada.
In another case, a lady who had come to see me ten years ago and had gone to see someone else because (this is what she told me) they had a fancier office, has suddenly received a rude awakening. She and her husband have been losing money on the rental of a large apartment complex in Seattle. The penalty for not filing and reporting this rental income is up to $10,000 a year for not filing on non-resident rentals and 30% of the gross rent with no expenses allowed. In this case the rent is over $500,000 a year and the total penalty and tax could be $2,000,000 with interest. The other accountant told her she did not need to file if she was losing money. I had quoted her $500 to do her return ten years ago and told her she had to file the return. The accountant with the fancier office told her she did not have to file because she lost money. (That advice is wrong in both countries by the way). Even $1,500 a year would be cheaper than the tax bill coming up.
If you are still claiming the protection and advantages of your U.S. citizenship, do yourself a favour. Bring your U.S. income tax returns up to date from 1987 to the present.
It is rare that you will have to pay tax to the States. Higher Canadian tax rates mean that, with the exception of Capital Gains, the exemptions and foreign tax credits "almost always" eat up the U.S. tax.
If you do have Canadian Capital Gains, it is usually important that you do very accurate calculations to determine the tax. If you claim the $ 100,000 exemption in Canada, the U.S. does not recognize it and will tax you anyway. Better to save the exemption or in some cases restructure the deal. Restructuring might be as mundane as selling a business for less purchase price and taking more wages to remain as an advisor.
That takes care of the majority of U.S. Citizens in Canada. Now to the Canadian "visitor" to the U.S. - note that these ten year old "NEW RULES" mean that many "Canadian Snowbirds" are taxable in the U.S. on their World Income, even though they are only in the U.S. for four months a year.
What happens is that after three, four, five or ten years of wintering in Florida, or Texas, or Arizona, or California, the Canadian visitor joins clubs, buys property, attends meetings, becomes active in a condo association and suddenly finds their "CENTER (CENTRE) OF VITAL INTERESTS" is as much or more in the U.S. as it is in CANADA. Under those circumstances, the U.S. government has every right to tax you.
At the back of the book around page 156, I have reproduced the April, 1994 edition of the CEN-TAPEDE newsletter for more information on this.
Long Time Visitors
For long time visitors to the U.S., the IRS uses the 183 day rule that entitles most countries to tax anyone present in the country for more than 183 days. However, they are far harder on their 183 day rule than Canada is. The U.S. counts an "hour" as a "WHOLE DAY". So, if you arrive in Hawaii at 10:50 PM, that is a day, and if you leave at 1:00 AM, that is a day.
In addition, to arrive at the 183 days, the U.S. looks at the two preceding years. You have to take 1/3 of the days you were present in the U.S. in the preceding year and add it to this year's days and then you have to take 1/6 of the days in the year preceding that and add it to this year's days.
Soooooooo! if you were in the States for six months in 1998, that counts as 1 month, or 30 days for 2000. If you were in the States for three months in 1999, that counts as 1 month or 30 days for 2000. You are now limited to stay in the States for 120 (maybe 122) days in 2000, after which you become taxable on your world income unless you can show a tax home in another country (as in the treaty provisions above). There is a form called an 8840 that you may file to claim exemption from this if you can show that your closer connection is to Canada.
This is tough to do however. As I was writing this little part on Sept 29, 95, I received a call from a 55 year old man in Alberta. He has a home in Canada, is retired already and spends the winters golfing at his golf course condominium in Arizona. In Arizona, he golfs, plays cards, goes to church and visits with friends in the same golf course country club estate. In Canada, he visits his kids in B.C. and travels in his motorhome. He can't wait to get back down south where he now lives in his mind and which is fast becoming his centre of vital interest and "closer connection."
His Canadian friends have died, divorced, moved away, are still working or go south to different places to spend their winters. His closer connection, "his home" without much doubt, is now in the U.S.
The following is an article I wrote for Joe Martin's Vancouver Business Newspaper in November, 1989. (note that rates/amounts have been changed)
Canadians with property and investments in the U.S. are looking at a big surprise when they sell out or when they die.
The U.S. government is looking for their pound of flesh and they are getting it.
A Non-Resident and Non-Citizen of the U.S. who owns property in the U.S. can be in for a RUDE AWAKENING when they sell it or die.
For instance (ignore exchange please), if you sell a place in Palm Springs and made $100,000, that $100,000 profit might have been your tax free $100,000 exemption in Canada. But - the U.S. will tax the full $100,000 anyway so there might not be any sense in claiming it tax free in Canada if you have another item you could have used on your T664 Canadian exemption election form. (Report the profit and claim a foreign tax credit on your Canadian Return)
If you die, the situation becomes even worse with the possibility of a capital gains tax and an estate tax.
A form 706NA must be filed and if, for example, The taxable US estate is valued at $100,000 there would be $8,200 to pay (18% of first $10,000, 20% of next $10,000, plus 22% of next $20,000 [$100,000 - $60,000]) of Federal Tax. As well there might be a State Tax (different for each state) which can usually be used as a partial deduction against the federal tax.
The new treaty took effect as of Nov 11, 1988 and will also allow the U.S. estate tax to be credited to Canadian Capital gains tax.
The new rules work like this. Everyone now gets a $625,000 (proposed to go higher) exemption for U.S. estate taxes. If you are a non-resident and non-citizen of the U.S., this exemption is modified in the following manner:
I know that the exemption is going to $675,000 and maybe a million, I have used an old calculation here. The total WORLDWIDE assets must be counted. Let's assume that the total is $1,500,000. If the U.S. part of these assets was a $300,000 U.S. condominium in Palm Springs, the estate exemption would be: $300,000
$1,500,000 x's $625,000 = $125,000
Estate tax would be payable on $175,000 U.S. ($300,000 - $125,000).
Gift tax rates (form 709) and estate tax rates (forms 706 or 706NA) are the same once the exemption is passed.
The reason that the rates are the same is that any gifts made up to 3 years before death are added back into the estate.
Gift tax is dangerous. Remember that the "payer," not the recipient (unless the recipient is not available or broke after giving everything away), pays the gift tax. The exemption for everybody is $10,000. If you have a spouse who is a resident or a citizen of the U.S., you may give any amount to your spouse. However!, if your spouse is a non-resident of the U.S., that gift is limited to $100,000 U.S.
Therefore, if you are a Canadian and you decide to give the $100,000 summer home in Bemidji, MN, or your Palm Springs, CA, condo, or your Cape Coral, FL, condo to your 4 children, if you do not do it in "$10,000 each per year" stages, you will have significant gift tax to pay. The same thing can happen when you put your "new" non-resident spouse's name on the Palm Springs condo when the value is over $200,000 or when you put your children's names on your bank account in Canada if you happen to be a U.S. citizen living in Canada. The following rates of gift and estate tax apply:
Column A Column B Column C Column D
Rates of Tax
Taxable Taxable Tax on on excess Amount
amount amount in over amount
excess
-- 10,000 ---- 18%
10,000 20,000 1,800 20%
20,000 40,000 3,800 22%
40,000 60,000 8,200 20%
60,000 80,000 13,000 26%
80,000 100,000 18,200 28%
100,000 150,000 23,800 30%
150,000 250,000 38,800 32%
250,000 500,000 70,800 34%
500,000 750,000 155,800 37%
750,000 1,000,000 248,300 39%
1,000,000 1,250,000 345,800 41%
1,250,000 1,500,000 448,300 43%
1,500,000 2,000,000 555,800 45%
2,000,000 2,500,000 780,800 49%
2,500,000 3,000,000 1,025,800 53%
3,000,000 10,000,000 1,290,800 55%
10,000,000 21,040,000 5,140,800 60%
21,040,000 ---- 11,764,800 55%
If this sounds like I am only talking about having a house in Palm Springs, Cape Coral, or Phoenix, be assured, it doesn't stop there. It also applies to shareholdings of U.S. companies. If you own U.S. securities or stock (which have to go through a U.S. transfer agent to be sold or transferred), you are also in trouble. The same rules and rates apply even if you have never been to the U.S. and the stock is in a safety deposit box in Regina, or your broker is holding it for you in St John's, Newfoundland.
If your only U.S. asset is less than $1,250,000 U.S. stock there is a special exemption in the new treaty. There would not be any U.S. estate tax in this case. However, if you owned $100,000 worth of U.S. stock located in Canada and a $100,000 condominium in the U.S., you would have to file a 706NA estate tax return plus a state return if the property was in a state with an estate tax.
Right now, we are having trouble getting stocks released from two transfer agents in the U.S. because they want an estate tax clearance from the IRS.
If that isn't confusing enough so far, on the other hand, "money on deposit in a U.S. bank or Savings and Loan or Insurance Company does not count for U.S. estate tax if it is `not effectively connected with conducting a trade or business within the U.S." This means that if you died leaving a $1,460,000 deposit in the Bank of America, there would be no tax on the interest or any estate tax on the capital. But if you died owning $1,460,000 worth of shares of the Bank of America and the shares were in your wall safe at home in Horseshoe Bay, Saskatoon, Halifax, or Sudbury, you would owe tax on the dividends (to the U.S. and Canada) and estate tax to the Federal U.S. government (no state tax as it is not situated in a state).
What is the reason for this? Back in the oil problem days, the U.S. Congress had to recognize that if they taxed non-resident/non-citizen bank deposits, tens of billions of dollars would be pulled out of Chase Manhattan, CitiBank, Bank of America and so on. To keep that money there and stop their banking system from collapsing, they passed legislation which exempted foreign owned bank accounts from U.S. tax if they were deposit accounts only and not effectively connected with conducting a business within the U.S. The only requirement was that the holder have a U.S. `taxpayer identifying number' and report to the bank/savings and loan that he/she is still a non-resident/non-citizen at least once every three years. If the situation changes he/she is to notify the institution within thirty days.
Money on deposit in the U.S. is not subject to U.S. income tax or estate tax provided it is not effectively connected with a U.S. Trade or Business (remember, the interest IS subject to Canadian Tax so report it on your Canadian return). If the money is on deposit to fund your rental house in the states, the interest IS taxable on your U.S. federal income tax return because a rental house is generally considered to be effectively connected with a U.S. business. This is an automatic election which you make when you file your 1040NR and claim expenses against the rent. If the rental house was not effectively connected with a U.S. business, the U.S. federal income tax would be a 30% of the GROSS rents with no expenses allowed.
As you can see from the article, there can be "taxing" moments between the two countries.
So what are the rules?
Well, to leave Canada for tax purposes, you must give up clubs, bank accounts, memberships, driving licences, provincial health care plans, family allowance payments (if you are a returning resident, you can continue to get Family Allowance out of the country), your car, and furniture. You can keep a house here as an investment and rent it out, but it must be rented on lease terms of a year or more. And you MUST have an agent sign an NR6 for you (see example). This NR6 has the Canadian Resident AGENT ** guarantee the Canadian Government that if YOU do not pay your tax to Canada, the AGENT WILL. Even after fulfilling the foregoing, the Canadian government can still tax you or "try" to tax you on your income out of the country. If you are being paid by a Canadian Company, they can quite often succeed.
Even though you can collect family allowance out of the country, don't! One client's wife found out that she could get family allowance out of the country if she said they were coming back to Canada. She got some $3,000 of family allowance and cost the family some $80,000 in income tax when they came back to Canada from Brazil. I will never forget the husband's expression when he found out why he had been reassessed and I will never forget his wife's explanation. She said he was a skinflint and never gave her any money. The total episode cost them their house.
** The "agent" referred to above can be a friend, relative, or a business such as ours. We charge a minimum of $40.00 per month to be an "AGENT" for an NR-6 filing. This $480 per year is "in addition" to any other fees but "well worth it" of course. It stops your mother, father, brother, next door neighbour or ex-best-friend from being plagued by paperwork they do not understand.
OUT OF CANADA AND RESIDENT - IN CANADA AND NON-RESIDENT
It is possible to be physically "in Canada" and be treated as a Non-Resident and it is possible to be out of the country for seven years, or never have even lived in Canada, but wanted to, and be taxed as a Canadian resident as the following three cases show. In case you missed it, the reason for the different rulings is the "INTENT" of the parties involved. Wolf Bergelt intended to leave Canada. David MacLean was only working out of the country. He still maintained a residence and could not ever become a resident of Saudi Arabia anyway. Dennis Lee "wanted" to live in Canada.
In 1986, Wolf Bergelt won non-resident status before Judge Collier of the Federal Court, even though he was only out of the country for four months and his family stayed behind to sell his house. He had given up his memberships, kept only one bank account and rented an apartment in California until his house in Canada was sold. Four months after his move, his company advised him that he was being transferred back to Canada. Judge Collier said his move was a permanent (although short) move and he was a non-resident for tax purposes for those four months.
In 1985, David MacLean lost his claim for non-residence status even though he was gone for seven years. He kept a house and investments in Canada and returned a couple of times a year to visit parents. He had even been to the Tax Office and received a letter on January 29, 1980 stating that his Canadian Employer could waive tax deductions because he was a non-resident. However, he did not advise his banks, etc. that he was a non-resident so that they would withhold tax, he did not rent his house out on a long term lease and he did not do any of the things that makes a person a "NON-RESIDENT". Judge Brule of the Tax court of Canada said that he thought Mr. MacLean had stumbled on the non-resident status by chance rather than by design. In other words, to become a non-resident of Canada, you must become a bone fide resident of another country. As a rule, only a Muslim born in Saudi Arabia to Saudi Arabian parents can become a Saudi Arabian citizen. The best that David MacLean can hope for is that he has a Saudi Arabian temporary work permit.
In other words, when a person leaves a place, they usually leave and establish a new identity where they are because the "new place" is where they live now. Trying to "look" like a non-resident is not the same as "BEING" a non-resident - think about it.
In 1989, Denis Lee won part but lost most of his claim for non-resident status. He was a British Subject who worked on offshore oil rigs. He maintained a room at his parents house in England and held a mortgage on his ex-wife's house in England. For the years 1981, 82 and 83 he did not pay income tax anywhere. in 1981 he married a Canadian and she bought a house in Canada in June of 1981. On September 13, 1981, he guaranteed her mortgage at the bank and swore an affidavit that he was "not" a non-resident of Canada. [As I have said in the capital gains section of this book, bank documents will get you every time.] During this time he had a Royal Bank account in Canada and the Caribbean but no Canadian driver's licences or club memberships, etc.
Judge Teskey said:
"The question of residency is one of fact and depends on the specific facts of each case. The following is a list of some of the indicia relevant in determining whether an individual is resident in Canada for Canadian income tax purposes. It should be noted that no one of any group of two or three items will in themselves establish that the individual is resident in Canada. However, a number of the following factors considered together could establish that the individual is a resident of Canada for Canadian income tax purposes":
a.. - past and present habits of life;
b.. - regularity and length of visits in the jurisdiction asserting residence;
c.. - ties within the jurisdiction;
d.. - ties elsewhere;
e.. - permanence or otherwise of purposes of stay;
f.. - ownership of a dwelling in Canada or rental of a dwelling on a long-term basis (for example, a lease of one or more years);
g.. - residence of spouse, children and other dependent family members in a dwelling maintained by the individual in Canada;
h.. - memberships with Canadian churches, or synagogues, recreational and social clubs, unions and professional organizations (left out mosques);
i.. - registration and maintenance of automobiles, boats and airplanes in Canada;
j.. - holding credit cards issued by Canadian financial institutions and other commercial entities including stores, car rental agencies, etc.;
k.. - local newspaper subscriptions sent to a Canadian address;
l.. - rental of Canadian safety deposit box or post office box;
m.. - subscriptions for life or general insurance including health insurance through a Canadian insurance company;
n.. - mailing address in Canada;
o.. - telephone listing in Canada;
p.. - stationery including business cards showing a Canadian address;
q.. - magazine and other periodical subscriptions sent to a Canadian address;
r.. - Canadian bank accounts other than a non-resident account;
s.. - active securities accounts with Canadian brokers;
t.. - Canadian drivers licence;
u.. - membership in a Canadian pension plan;
v.. - holding directorships of Canadian corporations;
w.. - membership in Canadian partnerships;
x.. - frequent visits to Canada for social or business purposes;
y.. - burial plot in Canada;
z.. - legal documentation indicating Canadian residence;
aa.. - filing a Canadian income tax return as a Canadian resident;
ab.. - ownership of a Canadian vacation property;
ac.. - active involvement with business activities in Canada;
ad.. - employment in Canada;
ae.. - maintenance or storage in Canada of personal belongings including clothing, furniture, family pets, etc.;
af.. - obtaining landed immigrant status or appropriate work permits in Canada;
ag.. - severing substantially all ties with former country of residence.
"The Appellant claims that he did not want to be a resident of Canada during the years in question. Intention or free choice is an essential element in domicile, but is entirely absent in residence."
Even though Dennis Lee was denied residency by immigration until 1985 (his passport was stamped and limited the number of days he could stay in the country) and he did not purchase a car until 1984, or get a drivers licence until 1985, Judge Teskey ruled that he was a non-resident until September 13, 1981 (the day he guaranteed the mortgage and signed the bank guarantee) and a resident thereafter.
My point is made. Residency for "TAX PURPOSES" has nothing to do with legal presence in the country claiming the tax. It is a question of fact. My thanks to Judge Teskey for an excellent list. The italics are mine and refer to the items which I usually see people trying to "hold on to" after they leave and are trying to become non-residents. No single item will make you a resident, but there is a point where the preponderance of "numbers" leap out and say, "He / She is a resident of Canada, no matter what he / she says."
The case above is not unusual in any way. It is a fairly typical situation in my office.
In 1990, John Hale was taxed as a resident on $25,000 of directors fees he had received from his Canadian Employer and on $125,000 he received for exercising a share stock option given to him when he had been a resident of Canada (the option, not the stock). Judge Rouleau of the Federal Court ruled that section 15(1) of the Great Britain / Canada Tax Convention did not protect the $125,000 as it was not "salaries, wages, and other remuneration". It was, however a benefit received by virtue of employment within the meaning of section 7(1)(b) of the act.
Even a car you do not own can make you a resident as the next sailor found out.
In 1988, FrederickReed was claimed by the Canadian Government as one of their own. He lived on board ship and shared an apartment with a friend in Bermuda but only occasionally. He also stayed with his parents in Canada when visiting his employer in Halifax. Judge Bonner of the Tax court ruled that he could not claim his place of employ or the ship as his residence and just because he did not have a fixed abode, did not make him a non-resident. He was also the beneficial owner of a car in Canada which even though of minor consequence, served to add to his Canadian Residency. He had in fact borrowed money from a credit union to buy the car, even though it was registered in his father's name. He had maintained his Canadian Driver's licence as well.
An interesting case in June, 1989 involved Deborah and James Provias who left Canada in October of 1984. They had sold a multiple unit building to James' father on September 21, 1984 but the statement of adjustments did not take place until December 1, 1984. They tried to write off rental losses and a terminal loss against other income as `departing Canadians'. Judge Christie of the Tax Court ruled that they had left before the sale and were not entitled to the terminal loss or another capital loss as these could only be applied against income earned in Canada from October 13, 1984 (the day they left) to November 30, 1984 (the day before the sale) and there was no income, only a rental loss.
But June, 1989 was a good month for Henry Hewitt. He had been a non-resident living in Libya for four years and received some back pay after returning to Canada. DNR tried to tax him on the money but Judge Mogan of the Tax Court came to the rescue. He ruled that although Canadians were usually taxable on money when received, that assumed that the money itself was taxable in Canada, which was not true in this case.
In 1989, James Ferguson lost his claim for non-residency status but from the information, it didn't stand a chance anyway. He had been in Saudi Arabia on a series of one year contracts for four years. His wife remained employed in Canada, and he kept his house, car, driver's licence, union membership, and master plumber's licence. Judge Sarchuk ruled that he had always intended to return to Canada and was a resident.
A similar situation involved John and Johnnie M. Eubanks in the United States. He was working on an offshore oil rig in Nigeria with a Nigerian work permit and attempted to claim non-resident status for the purposes of exempting the foreign earned income exclusion. His wife was in the United States at all times and because he worked 28 days on and 28 days off, he returned to the U.S. for his rest periods using 4 days for travel and 24 days for rest with his family. He did not spend any 330 day period (out of a year) in Nigeria and only had a residency permit for the purposes of working in Nigeria. Judge Scott ruled he was a resident of the U.S. and taxed him some $20,000 with another $6,000 penalties and interest.
The Tax departments in Canada and the U.S. issue Interpretation Bulletins and Information Circulars and Guidance Pamphlets. These documents sometimes get people in trouble because the individual reads the good part and doesn't pay any attention to the exceptions. The following case ran contrary to a Guidance Pamphlet issued by the IRS.
On and Off-shore Oil rigs were involved with William and Margaret Mount and Jesse and Mary Wells. William and Jesse worked in the United Arab Emirates. However, they kept their homes and families in Louisiana and kept their driver's licences in Louisiana and voted in Louisiana. No evidence was shown that they had tried to settle in The United Arab Emirates. Judge Jacobs turned down claimed exclusions of approximately $75,000 each.
There isn't any question about what oil rig people talk about on oil rigs. It has to be "how to beat the tax man". Unfortunately, they all seem to think it is easy. Another such story follows.
In 1989, Clarence Ritchie found out that bona fide residence means just what it says. You cannot be a non-resident of the U.S. for tax purposes if you are not a bona fide resident of another country. He was working on the Mobil Oil Pipeline in Saudi Arabia and although when he left he was married with a couple of kids, by the time he returned permanently, he was a happily divorced man. Judge Scott ruled that though he did not have an abode in the United States, he had not established one in Saudi Arabia and therefore was not entitled to the foreign earned income exclusion which requires you to be away for 330 days out of 365. He had worked a 42 days on, 21 days off schedule and usually returned to the U.S. for his days off although he did spend time in Tunisia, England, Italy and Greece.
On a final note, as explained on page 143 of the "PINK" 17th edition of my ULTIMATE TAX BOOK, it is possible to have three countries after you for tax. If you are thinking of taking a job because a recruiter told you the money is tax free, think twice and check three times with competent individuals about what the rules "really are". No government likes giving up the right to tax its citizens.
DEBT SECURITIES - BANK ACCOUNTS
Non-residents of Canada with investments in Canada are subject to a 25% non-resident withholding tax on any money paid to them while they are out of the Canada. Therefore, if they have $10,000 in the Bank of Montreal and they live in Argentina, The Bank of Montreal must withhold 25 cents out of every dollar of interest paid to the account. Most tax treaty countries such as Great Britain, Germany, the United States, and Australia have a reciprocal agreement with Canada that limits the withholding to 15%. So we have the anomaly that a Canadian with money in a bank in the U.S. has no withholding but an American with money in a Canadian Bank has 15 cents out of every dollar withheld as a foreign withholding tax. The American would report his interest on schedule A of his 1040 tax return and claim the tax withheld as a foreign tax credit on a form 1116.
RENTAL PROPERTIES - CANADA - OWNED BY U.S. RESIDENT
More important perhaps is the problem with rental properties in Canada. When owned by a non-resident, they are subject to a 25% withholding (or 15% if living in Bangladesh) tax. If the renter does not pay this tax, the government can come along two years later and demand the tax.
Imagine the consternation of a tenant of a house in the British Properties in West Vancouver, or Rosedale in Toronto. Assume the tenant has been paying $2,000 a month for a $500,000 house owned by a Hong Kong resident. After three years of paying $24,000 a year to the `non-resident', they finally buy a house and move. Two months later, there is a knock on the door and a National Revenue representative is standing there demanding 25% of $72,000 for NON-RESIDENT withholding tax (this is a true story by the way, only the owner was in London).
There is a way around this problem. The tenant can ask to see, or rather DEMAND to see a copy of the landlord's filed and accepted NR6 form. (See forms in back of book). This form allows the tenant or agent of the landlord to deduct a lesser amount (or nil if a loss) than 25% of the gross rent. It allows for expenses to be taken off and the tax can then be withheld at 25% of the net, rather than the gross. The property management division of david ingram & Associates Realty Inc. files about 300 of these NR6 forms a year. (This is only necessary if you are paying directly to a landlord whom you KNOW to be a non-resident of Canada. If you are paying to an agent or Canadian Resident, you are okay.)
Please note, the NR6 MUST BE FILED BEFORE the first rent cheque is received or 25% of the gross rent must be remitted. For years, we were in the habit of filing `this years' NR6 late with last years tax return. In 1989, National Revenue stopped accepting this sloppy practice and demanded them on time.
IF YOU SIGN THIS FORM AS AN AGENT, AND THE OWNER DOES NOT FILE HIS OR HER RETURN BY JUNE 30TH OF THE FOLLOWING YEAR, YOU, THE AGENT, ARE RESPONSIBLE FOR THE 30% OF THE GROSS RENT WITH NO REFUND PROVISIONS FOR ANYONE.
RENTAL PROPERTIES - UNITED STATES - OWNED BY A CANADIAN
If paying 25% of the GROSS rent to Canada sounds bad, cheer up. The United States taxes the Canadian 30% in the same situation. To avoid this, the Canadian needs to notify the U.S. Government that he wishes to be taxed as a business rental house on the "net income" received. But if you do not notify the IRS in advance, the IRS CAN tax you at the 30% of gross rate.
SALE OF REAL ESTATE - IN CANADA
The situation is different with the sale of REAL ESTATE. A non-resident with property in Canada who sells the property is subject to a withholding tax of 33 1/3% on the GROSS sale price unless they fill out a form 2062A (sample at back of book) and submit it to Revenue Canada for approval. You cannot use the form in the book, it is the wrong size. It must be obtained from Revenue Canada and filled out in quintuplet (5 copies). It does not have to be filed before the sale unless you need the money immediately to close a back to back deal - the lawyer can keep money in his trust account until the form is approved.
CAUTION - This is serious, a Realtor and lawyer who were not aware of this fact are at possible risk of law suit from a purchaser. The purchaser was called upon to pay 25% of the purchase price of the property to Revenue Canada for failure to withhold. The rate was 25% up to 1987, 30% for 1988 and 1989, and is now 33 1/3%). There is a proposal to make it 50% unless the form 2062 is filed. The situation is serious enough that one should not accept a person's declaration that they are a resident as sufficient reason to "not withhold tax". In one case, the purchaser and the real estate agent drove the vendor to the airport to fly back to Hong Kong. The vendor is not a resident of Canada. Is it any wonder that National Revenue wants to collect the tax from the purchaser and the purchaser wants to sue the real estate agent and lawyer. "THE ONLY SAFETY IN THIS SITUATION IS FOR THE PURCHASER TO REQUEST A T2062 EXEMPTION FROM REVENUE CANADA."
What form T2062 does is allows you to calculate the actual gain WHICH WILL BE EARNED AND TAXABLE. The purchaser may then only DEDUCT/pay a withholding tax on the taxable gain, not the gross sale price. Revenue Canada is wonderful when it comes to quick approval of this form. I would love to give out names of people who have gone overboard to accommodate clients but they have said, "NO, NO, NO! " (Please note. Even though Real Estate Commissions and other costs of sale are deductible when calculating the actual taxable income for tax purposes on a return, they may NOT be deducted for the purposes of the T2062).
If you are having trouble with a sale or purchase with a non-resident, feel free to call upon the services of our office. David Ingram at (604) 649-4755 or FAX (604) 649-4759 is available to assist your lawyer or real estate agent. In addition, if you need the services of a lawyer for this special service, David Stoller, LLB shares office premises with us and is available at the same numbers.
SALE OF UNITED STATES REAL ESTATE
The U.S. government does the same thing when a Canadian is selling property in the states. They have a 10% withholding tax on the gross as well and there is usually a state government withholding of another 3 1/2%. However, all is not lost. The U.S. government has a form as well. It is form 8288-B and is reproduced at the back of this book as well, next to the 2062. You can use this form or a photocopy to request a reduction or total cancellation of the 10% withholding. For instance, if you inherited a condo in Wheeling, West Virginia and sold it right away, the estate tax would be paid already and you would have inherited it at its present value. There would be no capital gains expected and therefore, you could get the withholding cancelled.
In addition, if the property is being transferred for $300,000 or less and is being used as a personal residence by the purchaser, and the purchaser will sign a letter saying that they intend to live it for six months or more a year for the next two years as a principal residence, they or the escrow agent do not have liability for withholding tax. However, it is still my opinion that if on either side of this problem, one should read pages 17 and 18 of the 1990 edition of Publication 17 for more information and following that format, write to the Internal Revenue Service with an 8288 and ask for the exemption formally. Remember also that individual states like California also have a withholding of (California 3 1/3%) non-resident tax and it is necessary to write to them as well.
