Americans in Canada can face complex tax situation

Terry McBride for the StarPheonix writes: The April 15 filing deadline for U.S. tax returns is a stressful time for Americans living in Canada. 

Citizenship-based taxation 

The United States imposes taxes based on citizenship. Most other countries, including Canada, have residence-based taxation systems.

About 1 million Canadian residents are "U.S. persons" who are required by U.S. law to file U.S. tax returns as well as Canadian tax returns. The definition of a U.S. person includes those born in the U.S., children of American-born parents and green card holders.

Fortunately, the Canada-U.S. tax treaty has provisions to help ensure that Americans in Canada are not taxed twice on the same income. Because Canadian tax rates are generally higher than U.S. tax rates, an American who files a return in Canada, and pays Canadian taxes on Canadian income, usually owes no U.S. tax.

The problem is not in-come tax. The problems are the punitive IRS penalties and criminal prosecution threats for failure to complete the many required annual information returns.

Renouncing U.S. citizenship

For those who do not plan to return to live in the U.S., these extremely high penalties for not filing annual forms are encouraging U.S. persons in Canada to find out how to relinquish their U.S. citizenship. Websites explain the process, but it is prudent to consult a tax lawyer to avoid becoming subject to U.S. exit tax.

Foreign trusts
Investment income inside TFSAs, RESPs and RDSPs is nicely sheltered from Canadian tax. However, it becomes taxable as foreign trust income in the U.S. when Americans file U.S. tax returns. Furthermore, an American in Canada must report TFSA, RESP and RDSP transactions on annual foreign trust reporting forms 3520 and 3520A each year.

Exchange rate issue

What if you invested $10,000 US in a U.S. stock a decade ago when the currency exchange rate was $1.50? Suppose you sold your U.S. stock for $15,000 US when the Canadian and U.S. dollars were at par. Your Canadian income tax return would show no capital gain. But, if you file a U.S. tax return, you'd report a $5,000 capital gain because the cost and sales proceeds must both be expressed in U.S. dollars.

Report foreign accounts

The IRS wants to know about any "offshore" financial account held that had a balance of $10,000 US or more at any time during the year.

Every June, an American living in Canada must report the balances of these financial accounts on a Foreign Bank Account Reporting (FBAR) form. You must list retirement accounts and ordinary savings accounts that are used for day-to-day spending - even though these accounts have nothing to do with offshore tax evasion.

As a result of these reporting rules, many Americans married to Canadians are taking their names off joint accounts, thus not allowing them to avoid probate costs when one spouse dies.

FATCA

In 2010, the U.S. government passed the U.S. Foreign Account Tax and Compliance Act (FATCA) to force foreign bankers to disclose the names of their American customers.
In 2014 there will be a harsh 30-per-cent penalty charged on all cash flows coming from U.S. sources, if the Canadian financial institution does not give the names of their customers who are "U.S. persons" to the IRS.  Because of FATCA, Americans living abroad must file a new form 8938 with their U.S. income tax returns.

It is no wonder that expatriate Americans around the world are experiencing difficulty in opening bank accounts when they state that they are U.S. persons.