David A. Altro featured in the Globe & Mail

David A. Altro and Jonah Z. Spiegleman’s book Americans in Canada – Smile the IRS is Watching You! has been excerpted in The Globe and Mail twice, most recently last week. The excerpt is a primer on filing U.S. income tax returns for American expats in Canada, who are obligated to file taxes with the IRS due to the U.S.’s citizenship-based taxation policy. In the excerpt published by the The Globe this summer, “U.S. expats in Canada, the IRS is eyeing your RRSPs”, David and Jonah deal with the cross-border tax consequences for Canadian-resident U.S. citizens who contribute to RRSPs. Both articles can be found below or by clicking the links above.

Book Excerpt: U.S. expats in Canada, the IRS is eyeing your RRSPs

David A. Altro and Jonah Z. Spiegelman
Contributed to The Globe and Mail
August 5, 2014

From Americans Living in Canada – Smile, The IRS is Watching You, by David A. Altro and Jonah Z. Spiegelman. Copyright © Altro LLP, 2014. Reprinted with permission of Altro LLP

The Registered Retirement Savings Plan (RRSP) program is fundamental to Canadian retirement planning, and most Canadian residents participate. The beauty of the RRSP is that any contributions in a given year are deductible from income (up to a limit), and growth within the account is not included in the owner’s income as earned. Rather, RRSPs are only taxed upon withdrawal from the RRSP account, presumably occurring after retirement when the taxpayer is earning less and consequently paying less tax.

US domestic law considers RRSPs to be foreign grantor trusts, and the income is taxable to the contributor as earned.

This can cause compliance problems for Canadian-resident US citizens who assume that RRSPs do not need to be specifically dealt with on the US tax side and therefore do not report them.

The Canada-US Tax Treaty (Treaty) does provide some relief in this situation. Under Article XVIII(7), a US taxpayer may elect to defer tax on the growth within an RRSP account for US purposes. Form 8891 must be completed to obtain these benefits under the Treaty, and (of course) the FBAR requirement still applies to RRSPs.

In particular, US law does not allow for a deduction from income for contributions made to an RRSP. As such, maximizing contributions to an RRSP may result in a higher taxable income for US purposes than Canadian purposes. Usually, the higher rate of Canadian tax will still provide sufficient foreign tax credits to offset the US tax payable in that year. However, there could be situations where US tax is payable due to the difference in taxable income levels.

Book Excerpt: American expats in Canada, here’s a primer on filing U.S. taxes

David A. Altro and Jonah Z. Spiegelman
Contributed to The Globe and Mail
October 29, 2014

From Americans Living in Canada – Smile, The IRS is Watching You, by David A. Altro and Jonah Z. Spiegelman. Copyright © Altro LLP, 2014. Reprinted with permission of Altro LLP

The US is the only western country in the world that imposes tax on its citizens regardless of where they live and no matter where income is earned. Most countries require only residents to pay tax. If you exit Canada, for example, you don’t have to file any more Canadian tax returns.

The US policy is different. Moving away from the homeland doesn’t mean you are free from the Internal Revenue Service (IRS). You are required to file your US tax returns every year, report your worldwide income to the IRS and pay any tax imposed by the US tax laws.

Since Canadian residents report worldwide income to the Canada Revenue Agency, US citizens living in Canada have heavy compliance requirements in order to keep up with filings in both countries on income from every source.

US citizens must file personal income tax returns on Form 1040 each year. All worldwide employment income, interest, dividends and gains are reported. US tax rules, which often differ from Canadian rules, apply to determine whether US tax is payable in a given year.

Thankfully, there are a number of mechanisms available that prevent double taxation on most of these types of income. As discussed below, most US citizens living in Canada can stay compliant merely by filing correctly. Generally there is no excess tax payable in the US.

Foreign Earned Income Exclusion

The Foreign Earned Income Exclusion (FEIE) is available to exclude up to $99,200 (in 2014) of employment or business income earned outside the US. As long as you are actually living and working most of the time in Canada, the IRS will not tax even a very good wage. However, unearned income, such as interest, dividends and capital gains, cannot be excluded under the FEIE.

For those living a more cross-border lifestyle, the residency limitations of the FEIE could pose problems as well. The FEIE is only available if you meet the “bona fide foreign resident” (BFFR) test or the “physical presence test” (PPT).

To demonstrate status as a BFFR in Canada, an individual would most often have to file a Canadian tax return as a resident of Canada throughout the whole year. There are special relieving provisions for people who move to or from the US in a year.

The physical presence test requires the individual spend at least 330 days in a twelve-month period outside the United States.

To take the FEIE, an individual must have his or her “tax home” outside the United States throughout the year (for a BFFR), and for the 330-day period (under the PPT). A tax home is generally the main place that an individual works, if he or she works, and the main residence, otherwise.

Foreign Tax Credits (FTCs)

Where annual income is greater than the FEIE exclusion amount or non-wage income is received, FTCs are fundamental to ensuring that most kinds of income don’t get taxed twice. Generally, taxes paid to a foreign country on income earned will generate a nonrefundable credit in the US, canceling out the US tax on that item of income.

Canadian personal tax rates are, for the overwhelming majority of people, higher than US rates, so the FTC regime will almost always ensure that Americans in Canada who have no US-source income pay no US tax.

Those who have US income will usually find that the Canadian FTC will offset the US tax, so there is no double taxation. In these cases, the total tax is the same as if all the income were earned in Canada; all one is doing is allocating how much goes to each revenue authority.

However, there are many complicated rules related to the source, timing and character of income that can limit the amount you can claim. Therefore, especially when entities such as companies or trusts are involved, careful planning is important to maximize the FTCs available.

Problems Remain

The biggest problems arise when an item of income is taxed in one country and not in the other. A good example is when a US citizen sells their principal residence in Canada for a substantial gain. Under the Income Tax Act of Canada, the transaction is exempt from capital gains tax. The historic increase in property values, especially in big Canadian cities, means that baby boomers looking to downsize their homes will receive windfalls of tax-free cash.

However, under US law, each person can only claim $250,000 as a capital gains exemption for a principal residence, with any excess taxed by the IRS at rates up to 23.4 per cent. So, if Jane, a US citizen, sells her home for a $500,000 gain, she may have to write a cheque to the IRS for more than $57,000 of tax without credits in Canada. If Jane co-owned the home as a joint tenant with her husband, she would usually only claim her half of the gains, so that a total capital gain of $500,000 could occur without tax. This exclusion of capital gains tax only applies if Jane has owned the home and lived in it for at least two years in the past five year period. Again, there are exceptions to this rule, such as for people who are required to move for their work.

There are other instances where the mechanisms in place intended to prevent double taxation fall short. As discussed in later chapters, the tax treatment of certain types of entities can complicate tax planning for a US citizen living in Canada.

As well, fluctuations in the relative values of the Canadian and US dollar can result in disproportionately high capital gains in one country with tax owing as a consequence.

For the most part, maintaining compliance with US tax requirements is little more than paperwork. Nonetheless, as discussed in the next chapter, the paperwork can be quite burdensome all by itself. And then there is the estate planning that should be implemented to keep US tax exposure as low as legally possible.