Taxes for U.S. Citizens Living Abroad

A significant number of American citizens who have relocated to foreign countries, either on a short- or long-term basis, are not aware that they are required to continue filing U.S. income tax returns, even if no tax is owing. U.S. tax compliance does not end at the border.

Through the use of domestic tax laws, international income tax treaties and conventions, and social security or totalization agreements, double taxation can be eliminated or substantially reduced.

An excellent working knowledge of the U.S. Tax Code, with a heavy emphasis on the expatriate and foreign tax credit provisions and the tax laws of Canada, is crucial to minimizing tax liabilities arising from a U.S.-Canada move. Because of the complexity inherent in the filing procedures, very few taxpayers are able to meet their compliance requirements correctly.

Aaron Rumley, CA, CPA (US), CFE, of Rumley & Associates, provides United States and Canadian income tax preparation, planning and consulting for clients in Canada and the U.S.

Services

Services offered include:

• U.S. federal 1040, 1040NR (nonresident) and 1040X (amended) tax return preparation including all necessary Form 1116 (foreign tax credit) and Form 2555 (foreign earned income exclusion and housing deduction) computations

• U.S. federal 1120, 1120F corporation tax return preparation and corporate state returns

• U.S. Reports of Foreign Bank and Financial Accounts filing preparation

• State return preparation (resident and part-year resident)

• Canadian federal and provincial tax preparation

• Canadian 'departure tax' projections

• Totalization (Social Security) coverage certification preparation

• U.S., Canadian and cross-border tax planning and consulting

• U.S. and Canadian non-resident tax return preparation

Canada/US Tax Treaty

To resolve some of the complications of its citizens created in moving back and forth, Canada and the US negotiated a Tax Treaty to prevent the double taxation of their citizens on the same income.  As a result, the “Convention between the United States of America and Canada " (simply the Canada/US Tax Treaty) was negotiated and originally signed on September 26, 1980 .  Since then, the Treaty has been revised four times - June 14, 1983, March 28, 1984 , March 17, 1995 and July 29, 1997. 

The Canada/US Tax Treaty "overrides" certain areas of the tax code in both Canada and the US to afford protection from, among other things, double taxation in both countries.  An example may help. If you are residing in the US and you generate C$100 in Canadian interest from a bank account, Canada retains the right to tax this income as "Canadian source" income.  However, as a US resident, you are required to declare your worldwide income on your US return, including the C$100 from Canada.  Per the Canada/US Tax Treaty, the Revenue Agency takes a 10% withholding tax on the interest and the US taxes the interest at your ordinary income tax rate (assume 25% or U$25). In sum total, you have now paid more than C$35 (because of the US exchange rate on U$25) on C$100 of income (see detailed example in Foreign Tax Credit Planning section of this website). This is one of the issues the Canada/US Tax Treaty attempts to resolve. This requires a thorough understanding of the Treaty coupled with the experience in knowing how to apply it optimally to your unique situation.

The key provisions of the Treaty include:

Sharing Information - To catch those who might evade taxation on income from one country while resident of the other, Canada and the US agreed to share their information with each other.  In fact, the Treaty allows either taxing authority to ask for your complete tax file from the other country (electronic and otherwise).  This means if you have income in Canada and you don't report it on your US return, your chance of getting caught has increased significantly.  Based on our experience, it appears that real estate transactions, dividends, interest and in particular, government pension payments are exchanged electronically on a regular basis.  Further, the two countries have agreed to allow Canada to use the "long arm of the law" in the US to collect its taxes and vice versa.  This means that the Revenue Agency can use the authority of the IRS in the pursuit of its tax collection in the US.  As you can see, your chances of getting caught evading income or tripping up on a compliance issue are high.  When this happens, nasty notices will begin filling your mailbox.

Foreign Tax Credits - The IRS allows taxes paid to Canada as a foreign tax credit against that same income on the US return to avoid double taxation.  For example, using our scenario above, you would take the C$10 you paid to Canada, convert it at the prevailing exchange rate and use it as a dollar-for-dollar tax credit on the US return.  The Treaty allows you to take the taxes paid to Canada and use them against any tax liability that same income generates on the US return. 

Exempt Certain Income - The Treaty sorts out what income is taxed in which country as well as exempting certain income altogether.  For example, it provides direction on where capital gains are taxed and exempts wages earned in Canada on the US return.

Withholding Taxes - The Treaty specifies the various withholding rates for the various types of income sourced out of that country.  For Canadian source income accruing to those in the US, the current Treaty withholding rates are:

Interest - 10%
Dividends - 15%
Government Interest - 0%
Canada Pension Plan - 0%
Old Age Security - 0%
Company Pension - 15%
Periodic RRIF/LIF Withdrawals - 15%
Rental Income - 25%

 Click here for the consolidated version of the Canada/US Tax Treaty.