One million or more U.S. citizens live in Canada either as full-time or part-time residents. When they come, Americans usually do so for very positive reasons — whether it be for love, business or career advancement. Or simply because they were born in the U.S. and returned home with their Canadian parents.
But when Americans come to Canada, they bring a passenger — the Internal Revenue Service. And this particular guest can cost thousands of dollars and lots of headaches for U.S. citizens living in Canada.
And it’s not just Americans who may be on the hook. Even if you’re a Canadian citizen, you might have to pay U.S. taxes!
Don’t know they have U.S. citizenship
Believe it or not, many people in Canada are not even aware they’re U.S. citizens. They’re called “accidental Americans.” They have citizenship because they have a parent who is a U.S. citizen, or they were born in the U.S. and soon moved to Canada.
When they find out about their status, they discover what most other Americans living in Canada already know — they have tax and reporting obligations to the U.S. regardless of where they live in the world.
Those obligations start with a requirement to file a U.S. tax return each year. You must also file what’s known as the Report of Foreign Bank and Financial Accounts, or FBAR, if at any point during the year you has more than US$10,000 in foreign bank accounts.
While you have to pay tax only on income from U.S. sources, filing those documents is a hassle and can cost thousands of dollars if you have to hire professionals to do the work for you. On the other hand, failure to comply leads to some very heavy penalties. So you don’t really have a choice.
Some Canadian tax shelters are recognized
By the way, the U.S. does recognize the tax-sheltered status of RRSPs and registered pension plans owned by U.S. citizens living in Canada. But other Canadian tax-sheltered holdings require additional reporting and are subject to tax, among them registered education savings plans and tax-free savings accounts. If you’re a U.S. citizen living in Canada, these vehicles are not for you.
Now, if you’re a Canadian citizen, you may think this is only of academic interest. But hold on. Uncle Sam might have a way to get into your pockets too. That’s because U.S. assets owned by Canadian citizens may be subject to the U.S. estate tax.
What’s an estate tax? It’s a tax on the transfer of money from a deceased person to his or her heirs. Canada doesn’t have one, but the U.S. does and it applies to U.S. situated assets even if they’re owned by non-citizens.
How to determine whether you owe U.S. estate tax
To determine whether your estate would need to pay the tax, you first have to add up your worldwide estate — all your assets including RRSPs, life insurance and real estate. If this exceeds US$5.5 million, you may be subject to the estate tax at the time of your death.
Once you meet this threshold, the tax would apply to the portion of your estate that is U.S. assets, including your U.S. stocks, mutual funds, real estate and business assets. Now, there is a tax credit under the Canada-U.S. tax treaty that allows you to reduce your liability. And if your spouse is still alive, you can transfer your estate to him or her tax free.
But here’s the rub. Even if you don’t owe any taxes, your estate will still probably have to file a special U.S. tax return. That’s because in many cases your estate won’t be able to transfer your U.S. investments to your spouse and other heirs without clearance from the I-R-S.
Some can avoid a huge hassle
It’s another huge hassle and it extends the amount of time and cost it takes to settle an estate. At PWL, we have avoided the problem with some clients who know they are near the end of their lives by selling their U.S. investments.
Another possibility for wealthier clients is to move their investments into a holding company. The company does not die and therefore is not subject to the estate tax. Dealing with Uncle Sam can be expensive, time-consuming and frustrating.
But as I mentioned, the alternative are some very heavy fines. So if you think these situations may apply to you, the best thing you can do is to get advice from experienced professionals.