By now, it is well-known in Canada that U.S. citizens must file
U.S. tax returns, no matter where they live. However, the U.S. also
taxes people based on residency – the same concept that is
used by most of the world's advanced nations.
The U.S. has some peculiar residency rules and it is surprisingly
easy to run afoul of them. Mistakes can be very costly. For
clarity, we're talking about income-tax residency here; the
gift and estate taxes use different rules.
Impact of U.S. residency – tax and filing
Residents must file tax returns annually and a host of
information returns. Even if there is no U.S. tax, the filing
process is usually onerous, intrusive and expensive.
A resident files form 1040, reporting worldwide income (yes, this
duplicates the Canadian reporting). The income tax rules are
similar to Canada's. The U.S. offers certain exclusions and
foreign tax credits to people abroad, so usually there is no actual
tax. However, since the rules aren't the same, it's
possible to have U.S. tax, even after paying the higher Canadian
tax.
Residency definition
There are two ways a person can be resident:
1) A green card holder (also known as a lawful permanent resident, under immigration law) is deemed to be a resident, no matter where he or she lives.
- Many people think that once the card expires, the status also expires. In order for a green card to cease to be valid, it must be voluntarily relinquished or retracted by a court. As a result, there are quite a few Canadians who think their status has expired, but are mistaken.
2) A person who spends a lot of time in the U.S. is also a resident. This determination is called the Substantial Presence Test and is the test most Canadian snowbirds need to be concerned about.
Substantial Presence Test (SPT)
Under domestic law, an individual who spends at least 31 days physically present in the U.S. in a year and meet this formula, is considered a resident:
Days in the U.S. in the current year +
1/3 days in the U.S. in the prior year +
1/6 days in the U.S. in the 2nd prior year
≥ 183
Any portion of a day is a day.
A person who spends 122 days per year in the United States for
three years running will meet this test for year three.
Governments are tracking days
In the past, the IRS largely relied on individuals'
representations of their time in the United States. While it has
always been possible for the IRS to glean the necessary information
from border-crossing records, it was not practicable to do so on a
mass basis.
The U.S. government is now tracking the number of days Canadians
(among others) south of our border. Any individual can find out the
government's record of their number of days on the Department of Homeland Security's
website.
Exempt individuals
Some days in the U.S. don't count: Those for someone on
foreign government-related business, a teacher or trainee, a
student or a professional athlete competing in a charitable sports
event.
The important exclusion here for snowbirds is for someone whose
medical condition prevents them from leaving the country.
Form 8843 must be filed on a timely basis. This phrase, in most
cases, means by June 15 of the following year. The due date can be
extended, but late filing almost always means the form will not be
accepted and the days will not be excluded.
Closer Connection Exception (CCE)
A Canadian who meets the SPT may be able to avoid U.S. residency
by filing form 8840. To do this, one must meet several
criteria:
1) Have a "tax home" (usually the place one works) and a
closer connection to Canada, based on their facts and
circumstances;
2) Be physically present in the U.S. for under 183 days in the
current year; and,
3) File form 8840 to indicate this connection on a timely
basis.
An individual who meets the SPT, but does not file this form is
deemed to be a U.S. resident under U.S. domestic law.
Again, late filing means the form will not be accepted and the
individual will not be eligible for the CCE.
Treaty residency – a last resort
Just about every snowbird will have a tax home in and closer
connection to Canada. But it's not uncommon to see people
exceed the 183-day threshold (even if that causes them to be
offside for immigration purposes as well). And many people are
unaware of form 8840, so they can't use the CCE.
It is still possible, even for these people, to avoid residency by
filing a U.S. return with a treaty disclosure. The treaty contains
tiebreaker rules, allowing a snowbird to be taxed as a resident of
only Canada.
The tiebreaker tests are applied in order. If one rule breaks the
tie, then the subsequent tests are ignored. If a test results in a
tie, the subsequent one is examined. An individual is a resident of
the one country where they have:
1) A permanent home available to him / her;
2) A closer connection (similar to the Canadian domestic law
residency test);
3) An habitual abode; or,
4) Citizenship.
For most snowbirds, the process ends here. If none of these tests
are definitive, then, in order to obtain treaty relief, the
individual must ask the "competent authority" of each
country to make a decision.
The treaty overrides domestic law. Assuming Canadian residency,
the individual files form 1040NR (not form 1040), along with form
8833. There is a $1,000 penalty for failing to file this form. If
the individual has no U.S.-source income, there will be no U.S.
tax.
Supplementary filing required anyway
A person who uses the treaty to be taxed as a U.S. non-resident is still considered a resident for most filing purposes. The IRS doesn't have easy access to the same information about potential foreign (say, Canadian) payors of income, so it demands the individual taxpayers provide the data. For example:
- Foreign Bank Accounts (FinCen 114)
- Specified Foreign Financial Assets (8938)
- Foreign Corporations (5471)
- Foreign Partnerships (8865)
- Foreign Trusts (3520/A)
These forms require disclosure of quite a bit of information many
people would rather keep private. It goes without saying that
preparation of these forms is time-consuming and therefore
expensive.
Bottom line – watch how many days you spend in the United
States!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.