You Could Have US Tax Issues

If you spend a significant amount of time in the United States, own rental property in the US, do business in the US, or are a US citizen or "Green Card" holder, then you need to be sure you’re onside with any required US filings. While compliance often does not result in US taxes owing and may simply consist of filing a single form, penalties for non-compliance are severe.

Are you a snowbird? You must keep track of the number of days you spend in the US (including travel days). The US Internal Revenue Service (IRS) will consider you a US resident if you meet the "substantial presence test", which is a formula calculated based on the number of days you were in the US in the current year, the preceding year and the second preceding year. Unlike the 183-day misnomer, if you spend, on average, 4 months per year or more in the US then you may meet the test and be deemed a US resident.

You can avoid being considered a US resident by claiming the "closer connection exception". This requires the filing of US Form 8840 to establish that your ties to Canada are closer than those to the US. Such ties include permanent home, family, personal belongings, banking, and participation in social, religious or professional organizations. If you spent more than 183 days in the US in the current year or if you have applied for a Green Card (permanent resident status in the US) then you cannot claim the closer connection exception.

It is possible to be a resident of both Canada and the US – a dual resident. Under these circumstances, we must turn to the "tie-breaker" rules in the Canada-US Tax Convention (treaty) to determine who has ultimate jurisdiction to tax you (i.e. which country you are, in fact, a resident of). If the rules result in Canadian residency, then a US tax return must be filed to report US-source income, while a Canadian return must be filed to report world-wide income. If the rules result in US residency, then the opposite is necessary. Foreign tax credits are used to the extent possible to provide relief from double taxation.

Perhaps you own US real property that you rent out. It is important to elect, in a timely manner, to be taxed as though the income is effectively connected with a US trade or business. Without the proper election, the tenants are obliged to withhold 30% of the gross rent and remit it to the IRS. By making the appropriate election, you can file a US return reporting gross income and deducting expenses to end up paying tax at the marginal rate on the net income – a far better scenario than 30% of gross income.

If you are a US citizen or Green Card holder residing in Canada you are still required to file a US tax return to report your world-wide income. As a Canadian resident you are also required to file a Canadian tax return to report your world-wide income. Again, foreign tax credits are used to the extent possible to provide relief from double taxation. It is also imperative to file your US return in order to not lose the right to claim a "foreign earned income exclusion" and to make certain elections.

Regardless of your filing status, it is important to file when required and to claim any and all treaty exemptions that are available to you, such as electing to defer taxation of any income or gains accrued in a retirement plan, such as an RRSP.

The US also has Estate Tax issues that should be considered. US estate tax arises on the death of an individual and is applied at graduated rates to the fair market value of the individual’s taxable estate. If you are a non-resident, then the estate tax applies only to the value of property in the US. A US citizen or US resident must pay estate tax on their world-wide estate.

Currently US estate taxes are being phased out – the tax rate is being reduced while the exemption amounts are being increased. By 2010, there will be no estate tax; however that may change. Under US legislation, there is a "sunset clause" which essentially means these changes will not apply after December 31, 2010. So, unless further steps are taken, the repeal of the estate tax will last for only one year – 2010. In 2011, the system will revert back to the rules that applied before this phase-out started.

In general, US forms and returns are due April 15 (vs. April 30 in Canada). For US citizens residing outside the US, there is an automatic two-month extension. For non-citizens, it may be possible to request a filing extension. For everyone, regardless of extensions, any tax owing is still due April 15 and subject to interest if not paid on time.

The bottom line is that many people don’t realize they have filing obligations with the US. You may be at risk for severe penalties and lose the ability to rely on tax benefits and treaty protection.

Caren MacLeod
Scott Rankin & Gardiner
www.srgg.com