Host: Tax season can certainly get complicated, especially if you spend time in Canada and the United States, and on today’s “Talking Tax” we’re taking a look at cross-border tax issues with Matt Altro [Partner at ALTRO LLP]. Matt, good to be with you, thanks for coming in again.
Matt: Hi, great to be here.
Host: Let’s talk first about US citizens living in Canada. You actually say there’s over a million, and that they have a very different tax situation that they have to think about living here in Canada.
Matt: Well yeah, a million of them and they blend in quite well. You don’t always know, but there are quite a lot of US citizens living here and the IRS taxes very differently than the rest of the countries in the world. They actually tax based on citizenship, so that means that US citizens living in Canada as Canadian residents have to file and report their worldwide income to Canada, makes sense, and then they have to go ahead and still file and report their worldwide income all over again to the IRS, and this is problematic. I often say they have the worst of both worlds because they have to file in both countries. If everything works out well, which it doesn’t always, the higher Canadian taxes offset the US taxes because the rates are lower. So it becomes a filing exercise, but things don’t always work out well. Kathryn, there’s so many income tax traps that exist between the two countries. Things that work in one country but don’t work in the other country, and these traps are set by Canadian advisors who may not know the client is a US citizen or don’t understand the US issues.
Host: What’s an example of that then?
Matt: Great question, I mean something as simple and as innocuous as a TFSA, a Tax-Free Savings Account, which is great for Canadian residents, but on the US side the IRS views that as a foreign trust. So that means that every year that you have to file special forms with the IRS, 3520 and 3520-A, the income is taxable, penalties for not filing the forms are exorbitant – something like $10,000 a year if you’re ever caught. So it just becomes a big problem. RESPs are another one, Registered Education Savings Plans for the children, again a great thing for Canadians, but if you’re a US citizen living here the IRS again thinks they’re a foreign trust; tax on the income, filing of those special forms, so definitely another issue there.
Host: Is there another one?
Matt: Oh there’s more!
Host: What’s another common one?
Matt: Oh here’s a real common one, and for your viewers this really hits home, especially for the advisors. Mutual funds, Canadian mutual funds, and Canadian ETFs. Its obviously a go-to solution for a lot of Canadians to diversify their portfolio, but the IRS is very punitive. They do not like when their taxpayers, which are US citizens living here, invest in foreign companies that are producing passive income; and that’s what a Canadian mutual fund is doing. So these types of, these types of funds, Canadian mutual funds or ETFs can result in a very high rate of tax when you go to sell if you’re a US citizen in Canada. So, very problematic.
Host: Yeah, I mean if you’re a US citizen in Canada you’re almost better off not to do any of these investments and to keep it US-focused.
Matt: Yeah, US ETFs is a solution or individual stocks and bonds of Canadian or US investments are ok. There are some work arounds to this PFIC issue I talked about, special filings that you can do but it becomes complicated and expensive.
Host: Let’s talk about what if you’re a Canadian who spends a lot of time in the United States or has a rental property there, what do they need to be thinking about?
Matt: Well, how they’re going to spend more time in the sun in the winter will probably be the first part! But if there’s a rental property, which a lot of Canadians will have, well Canadians aren’t always sure “do I have to file taxes in Canada or the US?” Well the answer is you have to file in both countries.
Matt: Yeah, the income in the US is taxable there (if you’re not a US citizen and just Canadian) you have to pay tax to the IRS on your US rental income. And then, you have to go and file in Canada because you have to report your worldwide income. Again, you do get a credit for the taxes you pay in the US, and then you could offset the Canadian tax.
Host: When you say you get a credit, do you get a credit for the full amount that you paid in the United States to offset the Canadian income?
Matt: Yeah in that case you would, but I mean there are some complicated formulas to determine the ratio of how much credit you can use, but in that scenario you should be able to get a full credit for the taxes you paid in the US.
Host: And then what kind of exchange rate would they use? Average of the year?
Matt: Yeah, they do. They put out rates that they would like taxpayers to use every year.
Host: Ok, and then with respect to Canadians thinking to move to the United States what do you need to be aware of?
Matt: Oh, well if you have either moved or are thinking of moving, Canada in some ways is much nicer to people who move away from Canada, than the IRS. The IRS we said, if they’re still living here you’re still subject to tax. Canada let’s you go. If you’re not a resident anymore then you don’t have to pay tax to Canada on your worldwide income. But, it could give rise to something called Departure Tax. So that sounds scary, it’s not an additional tax. If you’re departing Canada you may have this tax, its just like capital gains tax, and everyone’s familiar with capital gains tax, especially your viewers who are investors with capital gains. You pay that when you sell something, when you die or when you depart. So the earliest of those events will trigger the capital gain tax or the departure tax. Some assets are completely exempt from departure tax.
Host: Oh, like what?
Matt: Canadian real estate, no departure tax. RRSPs, no departure tax. But if you have let’s say shares of private companies or even public companies, if you have accrued gains there could be a tax on departure. It’s like the realizing of that unrealized gain.
Host: For publicly traded companies here is Canada?
Host: But you might want to hold, ok.
Matt: Yeah, if you have shares of Apple that were like $100 and they’ve gone up to $200 you have an unrealized gain, there’s a tax imbedded in there.