Cross-border Investment & Tax Planning
Posted 09 Dec 2014 by Melissa Allan
Whether you're a Canadian who resides temporarily in the United States or you're a dual-citizen of both Canada and the U.S., it's important for you to understand how both countries tax certain Canadian investments.
Some clients may have dual-citizenship, are living temporarily in the U.S., or plan to move there eventually. A few quick facts:
- The U.S. is the only country that identifies its taxpayers based on citizenship and not residency;
- There are approximately one million Americans or dual-citizens living in Canada;
- Dual/U.S. citizens have to file both Canadian and U.S. income tax returns annually.
Even if you do not have dual-citizenship, if you are a Canadian who owns U.S. stocks in a non-registered account valued over $100,000 USD there are U.S. tax filing requirements. However, this isn’t required if you own Canadian mutual funds.
Some investment plans to which Canadians and dual-citizens have access are treated different by the Internal Revenue Service (IRS) than the Canada Revenue Agency (CRA):
Tax-Free Savings Accounts (TFSAs)
A non-resident can certainly continue to hold their Tax-Free Savings Accounts in Canada when living in the U.S. However, it's important to realize that these accounts are not recognized in the same way in the U.S. and the income earned each year will be taxed by the U.S. If you're living in Canada as a dual-citizen, this rule applies to you. A TFSA may not be the best investment choice if you're a U.S. citizen. Some financial security advisors may even recommend liquidating your TFSA before leaving Canada and re-investing when you return.
Registered Education Savings Plans (RESPs)
As a non-resident you can hold an RESP and be exempt of Canadian tax each year as these investments remain sheltered in the plan. The annual growth earned each year and the Canada Education Savings Grant is taxed as income to the subscriber (usually the parent) because under the U.S. tax rules it's considered a foreign trust.
Registered Retirement Savings Plans (RRSPs)
As you know, in Canada tax on the growth of RRSP contributions is sheltered until the account owner makes a withdrawal. Upon redemption, both contributions and growth on the contributions are treated as income to the account holder in the calendar year the withdrawal is made. Many U.S. citizens are not reporting their RRSPs on the U.S. tax side of things and RRSP contributions are not tax deductible on a U.S. return. The growth in your RRSP is taxable as income each year in the U.S. Thankfully, you can file a form every year with your U.S. tax return to elect the deferral on the growth (meaning you won’t pay the taxes on growth until a withdrawal is made) which is allowed due to the Canada and U.S. tax treaty.
Under the Foreign Account Tax Compliance Act (FATCA), Canadian financial institutions must disclose information about U.S. citizens with certain Canadian financial accounts. Both financial security advisors and fund companies report U.S. citizens and very hefty penalties are applied to those individuals who have not filed their returns, aka, have not been “identified”. Why? Because Uncle Sam wants to ensure that all U.S. citizens are paying their taxes and they are taking it very seriously. In recent years, since Canada introduced the TFSA, the U.S. has been proactively increasing their penalties for unidentified U.S. citizens.
Perhaps partially due to these changes, many dual-citizens living in Canada are looking to renounce their U.S. citizenship. This sounds simple enough however it's not!
Rick and I attended a fund manager road show a couple of weeks ago and we were told that the state department has increased their fee to renounce U.S. citizenship from $450 to $2,350! However, if you're a high net worth individual, you have to pay an exit tax if your net worth exceeds $2 million or your average annual net income has been over $157,000 for the past five years.
My recommendation, if you are a U.S. citizen/dual resident, I would absolutely enlist a tax preparer who deals with U.S. returns. I've heard many stories of hefty fines that were significantly higher than the initial tax bill would have been. If you're a dual-citizen it's fair to say that your tax situation may be a lot more complicated than it used to be. If you don't file properly, hoping to slip through the cracks, I wouldn’t take any chances as the IRS is making dual-citizens their business.
The Canadian/U.S. tax treaty has been revised many times in the past few years and I wouldn't be surprised if further revisions came down the road.
On a final note, mutual funds are being classified as Passive Foreign Investments Companies (PFICs). I know you’re thinking this isn’t a big deal and doesn’t apply to you but it may! We plan to do another article on PFICs down the road so stay tuned!