For those of us who thought being an American citizen by birth in Canada was smooth sailing, think again.
Since July 2014, the U.S. Foreign Account Tax Compliance Act has required Canadian financial institutions to report investment account information about anyone considered to be a U.S. citizen to the Canada Revenue Agency, which in turn will share the information with the U.S. Internal Revenue Service under tax treaty rules.
Even those who never lived or worked in the U.S., but were born of a American parent who lived there for a prescribed time, will be on the radar of the IRS and subjected to tax reporting requirements or face the potential wrath of penalties and extra taxes.
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The exceptions to this reporting requirement are accounts less than $50,000 and Canadian accounts such as Registered Retirement Savings Plans and Registered Income Funds.
It’s important for Americans by birth who inadvertently didn’t do what was required to sort it out with the IRS.
The first step might be to use the Streamlined Filing Compliance Program, which allows the non-reporting taxpayer to certify that not filing past tax returns was unintentional.
Canada has many licensed cross border accountants who are prepared to help tackle the paperwork and meet these filing requirements.
Even when compliant, investment planning has its challenges because the IRS treats certain Canadian securities and registered plans differently than the CRA.
American citizens living in Canada should be aware of what the IRS calls a Passive Foreign Investment Corporation (PFIC).
Canadian mutual funds and ex-change-traded funds are treated as PFICs, and they can be a nuisance from a tax filing and tax liability perspective.
Funds are identified as PFICs if:
- They generate 75 percent of their gross income from passive income such as capital gains, dividends, interest and rent.
- At least 50 percent of the fair market value of the assets generate passive income or no income.
The IRS requires holders of these funds to report for each PFIC they own. Even worse, all passive income generated in the PFIC is taxable to the holder for the calendar year, whether it was paid out or not.
Some Canadian mutual fund companies address this by providing investors with proper reporting that lessens the potential tax burden. Call the mutual fund company directly to inquire if it provides this information.
As well, some Canadian public real estate investment trusts and resource and biotechnology stocks may fall under the definition of a PFIC. Talk to the company’s investor relations department before investing.
The IRS also treats flow-through shares differently.
The CRA provides tax incentives to Canadian investors for the risk they bear in buying companies’ flow-through shares, primarily in the mining and oil and gas sectors.
However, American investors who buy this type of Canadian tax shelter would be treated like any other foreign purchaser of shares for U.S. tax purposes because they cannot take a deduction against earned income.
American investors would typically realize a loss on the shares because the value of flow-through shares are often priced at a 20 to 30 percent premium to what they trade at on the respective Canadian exchange.
Fortunately, the primary savings plans in Canada — RRSPs, RRIFS and Locked In Retirement Accounts — are tax deferred in the eyes of the IRS and CRA by tax treaty. Like Canadians, Americans are taxed only when they take distributions.
However, this doesn’t apply to Registered Education Savings Plans, Tax-Free Savings Accounts and Registered Disability Savings Plans.
The IRS views them to be grantor trusts, meaning all forms of income must be reported annually. Even RESP grants must be reported as income.
In most cases U.S. citizens should avoid these plans because of the filing costs and potential tax liability to the IRS. The Canadian spouse can be the subscribers in the case of RESPs.
I often hear of Americans moving to Canada who hold U.S. registered accounts such as Investment Retirement Accounts (IRAs) or defined contribution plans such as 401(k)s.
Their U.S. broker-dealer or plan administrator often has no interest to seek the provincial securities commission exemptions required to manage these accounts for a non-resident.
As well, many Americans and Canadians are inheriting IRAs and are told by the deceased‘s broker-dealer that they are no longer welcome.
But the same tax treaty that provides the tax deferral benefits for holders of Canadian plans such as RRSPs also benefits holders of IRAs and 401(k)s.
It’s hard finding a broker-dealer in Canada who can work with these folks because the firm requires registration with the Securities and Exchange Commission.Only a few firms in Canada have this SEC registration.
Americans treading into Canadian investing waters should consult with a dually licensed cross border investment adviser versed on the tax implications of Canadian securities in taxable and registered accounts.
Ian Morrison is a financial adviser with Raymond James Ltd. and Raymond James (USA) Ltd. The views of the author do not necessarily reflect those of Raymond James. This article is for information only. Raymond James (USA) Ltd. advisers may only conduct business with residents of the states and/or jurisdictions for which they are properly registered. Raymond James (USA) Ltd. is a member of FINRA/SIPC. Raymond James Ltd. is a member of the Canadian Investor Protection Fund.
