U.S. President Joe Biden is approaching a year in office. With U.S. multi-trillion-dollar debt and spending now right off the charts, the IRS will be hunting for all the tax revenue it can find. The estimated one million U.S. citizens living in Canada may feel insulated from the IRS's voracious appetite. But that's a false hope because the U.S. levies taxes based on citizenship, not residency. That could cause big problems if you haven't kept up to date with your U.S. tax filing. Here are the key points that Canadian resident U.S. citizens need to know about paying U.S. tax.
U.S. tax filing requirements
As a U.S. citizen living in Canada, you may duly file your annual Canadian tax return and report all of your income, but that's not enough. You are still required to file a U.S. tax return with the IRS and report all of your worldwide income (even if none of that income arises in the U.S.). Happily, this does not mean that you're being taxed twice. The Canada-U.S. Tax Treaty provides relief against any double taxation by allowing you to claim a foreign tax credit on your U.S. tax return for the amount of tax that you pay in Canada (or vice versa.) Of course, the rules in the U.S. are different than those in Canada (including the tax rates), but the idea is still the same.
Some U.S. citizens living abroad may have kept up with their U.S. tax filing obligations; however, many others have not, and many of those may not have even known that there was such an obligation. However, the IRS has been known to be quite aggressive in making sure that non-resident U.S. citizens comply with this obligation. The 2011 "Offshore Voluntary Disclosure Initiative" (OVDI) was implemented to help the IRS ensure that U.S. citizens become fully compliant with filing and reporting obligations.
As part of the OVDI, not only are U.S. citizens required to comply with the filing requirements, there are also various reporting obligations such as the Report of Foreign Bank and Financial Accounts (FBAR) requirement. If you have more than $10,000 in non-U.S. accounts, including Canadian bank, investment, TFSA, RRSP, and RRIF accounts, you must file an FBAR return listing the details of each account (and this is required if such an account has ever hit the $10,000 threshold, even if it has nothing in it now.) The failure to comply could result in onerous fines and potential criminal prosecution. Penalties alone may reach as high as 50% of the highest amount held in an unreported account in a fiscal year.
So, if you are a U.S. citizen and have been living and working in Canada for years, and even if you have filed a U.S. tax return as required, you could still be exposed to harsh penalties for failing to report a single bank account or even an RRSP account, held either directly or perhaps jointly with a spouse. And sadly, you can't hide behind the Canadian flag. The Canada-U.S. Tax Treaty provides the IRS with broad legal powers to collect income taxes and penalties due from U.S. citizens residing in Canada.
And not all things are treated equally on both sides of the border. In Canada, the advantage of RRSPs, RRIFs, and TSFAs is that any income or gains will be deferred until such time as you withdraw the funds; until then, your investments can grow tax-free in Canada. However, per the IRS, any income or gains earned inside these types of accounts will be taxable currently in the U.S., and not at the time of a withdrawal.
Thankfully, the U.S.-Canada Tax Treaty offers some relief to this timing mismatch: A U.S. citizen can elect to defer the recognition of the income and gains in the current U.S. tax return until such time as the income is withdrawn from their RRSP or RRIF. The result is that this election allows for the same timing on taxation in Canada and the U.S.
U.S. estate tax
If you are a U.S. citizen, you will be subject to U.S. estate tax on your death on the fair market value of all of your assets, again regardless of whether you have lived in Canada (or elsewhere) for most of your life. The top rate of estate tax is 40%, with an exemption for estates up to US$11.7 million for 2021 (and for married couples, this threshold is doubled, so they can, together, shelter assets having a fair market value of up to US$23.4 million for 2021.)
For the majority of U.S. citizens, this may never be relevant, because the exemption is quite high; however, the exemption threshold has been the subject of many changes over the years (it was less than half of that amount under the Obama administration.) Note: The U.S. estate tax is not triggered when you leave assets to your surviving spouse (as long as that spouse is also a U.S. citizen.)
There are certain planning opportunities that you can take advantage of, including ensuring that your will is planned to maximize tax efficiency. If you are not a U.S. citizen, but your spouse is, some thought may need to be given to ensure that you don't leave all of your assets outright to your U.S. spouse; otherwise, those assets will suddenly be subject to U.S. estate tax on your spouse's death.
The use of certain testamentary trusts in your will would be useful in shielding those assets from U.S. estate tax. There are also certain credits available to offer some shelter from U.S. estate tax. It would be worthwhile to speak to an estate-planning advisor who has experience with U.S. estate tax planning to ensure that you make the most of these credits and testamentary trusts.
U.S. gift tax
Giving gifts in the U.S. can also land you in hot water. The U.S. taxes its citizens on gifts of all property at a rate equal to the estate tax rates. There are, however, annual gift tax exclusions:
- You can gift as much as you want to your spouse as long as that spouse is also a U.S. citizen; otherwise, the gift limit per year to a spouse that is not a U.S. citizen is US$159,000 per year (for 2021).
- US$15,000 per year (for 2021) to all other recipients. Note: You and your spouse can pool this so that you can together gift up to US$30,000 per year; moreover, the exclusion is per person, which means that you can give US$15,000 to your sister, another US$15,000 to your brother, and so on in the same year. Whether you want to do so, however, is another matter.
- In addition, there is a lifetime gift tax exemption of US$11.7 million for U.S. citizens and residents (for 2021). This mirrors the exemption for U.S. estate tax.
This is a general overview of certain U.S. tax issues affecting many Canadians with U.S. roots - it is not meant to be exhaustive (otherwise this article could be the size of a textbook.) Obviously, it would be important to ensure you speak to your U.S. tax advisor to ensure that you are in compliance with the various IRS rules and that you don't trip into any other U.S. tax pitfalls inadvertently.
Your other choice, of course, could be to relinquish U.S. citizenship. But be warned that this process is not as simple as you would hope. Not only is the red tape pretty thick, but if the value of your assets is over US$2 million or your net income is over a certain amount, you could be hit with a departure tax in the U.S.
Previously published in The Fund Library on January 5, 2022. Portions of this article first appeared in The TaxLetter, ©2021 by MPL Communications Ltd. Used with permission.
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.