The U.S. government has made it a priority recently to ensure that American citizens living in other countries file U.S. income tax returns.
This has created frustration and concern for U.S. citizens living in Canada because the penalties for not filing the appropriate returns and forms can be expensive.
Another tax issue for U.S. citizens living in Canada is the many differences between the two countries’ tax legislation.
Tax and estate planning often takes place based on Canadian rules, with little concern given to the effect on the American’s U.S. reporting.
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This can create large U.S. tax bills for transactions that took place in Canada on a tax deferred basis.
Here are some of the more common differences you may want to consider:
Tax Free Savings Accounts are a great tax saving tool for Canadian purposes. The accounts allow people to hold investments and not pay tax on the income that is earned on those investments.
However, while this income may not be taxed in Canada, the United States does not accept the tax free savings tool. Therefore, any income earned through a TFSA is still taxable for U.S. purposes, and as such, may result in additional U.S. taxes.
As a result, the question of whether a TFSA is an appropriate investment tool for U.S. citizens is not as easy as one may think.
Registered Retirement Savings Plans can be a great tool to help defer taxes on income earned now until retirement.
However, without the appropriate filings with the U.S. government, RRSP contributions made by U.S. citizens would not be considered a deduction for U.S. tax purposes and could be subject to tax in the U.S.
Special elections can be made if certain criteria are met to defer this income for tax purposes in the U.S., such as if the RRSP is part of a group plan. However, failure to file the appropriate elections on time can result in unexpected penalties.
When a Canadian sells his principal residence, money earned above the original purchase price is not subject to tax. This is known as the principal residency deduction.
However, the U.S. government does not accept this deduction, and any money made on the sale of a principal residence is subject to taxation in the year it was earned. American citizens who used the principal residency deduction after selling a home with potentially large gains may have unreported income issues with the U.S.
The capital gains deduction is a once in a lifetime exemption that Canadians can use to reduce the taxes that are owing when they sell qualifying assets. This deduction is commonly used when selling farmland, shares of a family farm corporation or an interest in a family farm partnership. You can reduce the gain on the sale by up to $750,000.
However, this deduction is applicable only in Canada. U.S. citizens who have used any of their exemption room may have unreported gains with the U.S. government.
In most cases, these gains can result in significant tax bills and potential interest and penalty charges could be applied if they are assessed.
The U.S. government is developing a reputation for cracking down on some of these issues. The failure of U.S. citizens to file the necessary returns can result in large penalties and interest charges.
American citizens living in Canada should carefully consider their personal tax plans and consult with an adviser to mitigate these tax issues.
