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The Biggest Cost Of Being A Dual Canada/U.S. Tax Filer



The reality of being a “DUAL” Canada U.S. tax filer is that you are a “DUEL” tax filer

“It’s not the taxes they take from you. It’s that the U.S. tax system leaves you with few opportunities for financial planning.”

I was recently asked “what exactly are the issues facing “Canada U.S. dual tax filers?” This is my attempt to condense this topic into a short answer. There are a number of “obvious issues facing U.S. citizens living in Canada.” There are a number of issues that are less obvious.

There are (at least) five obvious issues facing “dual Canada U.S. tax filers in Canada”.

At the very least the issues include:

1. The requirement to pay taxes to both the U.S. and Canada

  • Double Taxation: for example, the 3.8% Obamacare surtax on Investment Income
  • U.S. taxation on things that are NOT taxed in Canada (example: sale of principal residence and investment income earned inside Canadian Controlled Private Corporations) and phantom capital gains caused only by exchange rate fluctuations
  • U.S. punishment/deferral penalties (Interest on tax deferral) on Canadian mutual funds – have you ever heard of a PFIC?

In many cases, the “foreign tax credit rules” will mitigate the impact of potential double taxation. That said, it is very common for “dual filers” living in Canada to be required to pay taxes to the United States. Furthermore, double taxation (because of the “savings clause“) is generally NOT eliminated by the Canada U.S. Tax Treaty. U.S. citizens are NOT generally allowed to benefit from the treaty.

2. The reporting requirements

The United States requires its “citizens” to file detailed reports disclosing financial assets. While a “dual filer” living in Canada is required to report very little information to the Government of Canada, the USA requires a massive amount of information about Canadian assets to be reported to the IRS on an annual basis. There are severe penalties for the failure to report on these assets. You may have heard of FBAR, FATCA form 8398, Form 8621, Form 3520 and 3520A and more. Those who have a Canadian Controlled Private Corporation are required to file Form 5471 (a form that requires more disclosure about their Canadian Controlled Private corporation than is required on A CANADIAN tax return!). Note also that there are circumstances where income earned by the company is attributed to the U.S. citizen individual (and must be reported as income on the U.S. return)!

By the way, forms 8621 and Form 5471 have to be filed even if a tax return is not otherwise required!

U.S. citizens have ZERO financial privacy!

3. The direct costs of U.S. tax compliance

U.S. tax returns (including satisfying the “reporting requirements”) can easily exceed 100 pages and can cost thousands of dollars to prepare. Of course, the costs are significantly less for those who have “simple lives” and few assets. U.S. tax returns are NOT simply an extension of a Canadian tax return. Those who complete their U.S. tax returns based ONLY on their Canadian tax returns are making a mistake. U.S. tax returns need to be considered separately and must take into account items that are “taxable or reportable events” in the USA but are not reportable or taxable in Canada.

4. U.S. tax rules that directly impact the marriage between a U.S. citizen and non-citizen

With a bit of advance planning you can “work around” these areas. That said, a “non-U.S. citizen spouse” is considered to be an “alien” and an opportunity for income and assets to slip away from the U.S. tax system. It is common for U.S. citizens living in Canada to use the “married filing separately” category which is extremely punitive. Interestingly, this is a “built in tax” on the marriage between a U.S. citizen and an “alien”.

5. The Opportunity Cost – by far the biggest cost

U.S. citizens resident, are deprived of many of the “normal” financial and retirement planning opportunities available to other Canadians. This is NOT immediately obvious. That said: it is the single biggest cost of being a “dual Canada/U.S.filer”.

Why this so – Let me explain:

Canada is a country with very high tax rates. It’s very hard to “save and get ahead” in a country with a high marginal tax rate that “kicks in” at a relatively low level of income. Canada has a brutally efficient system of tax collection. In addition to paying taxes on income that are (in general) higher than in the United States, Canada has a VAT (which is NOT recognized for purposes of the U.S. “Foreign Tax Credit” rules). Furthermore, Canada does NOT have generous “Social Security Type” programs. Canada Pension Plan and Old Age Security are NOT income replacements but are supplements to income. Therefore, (and financial literacy should be a required skill) it is ESSENTIAL that Canadian residents engage in intelligent, purposeful and effective retirement planning. Much of financial planning is based on the tax consequences of various transactions.

Intelligent, purposeful and effective retirement planning for Canadian residents. At the risk of oversimplification most Canadians employ some or all of the following

Employee pension plans:

Examples include the pension plans offered by teachers, public employees, etc. Fewer and fewer Canadians have access to these kinds of plans. Fewer and fewer Canadians have access to these lucrative arrangements.

Availability to U.S. citizens in Canada: The U.S./Canada tax treaty does allow for favorable treatment of Company pension plans for U.S. citizens in Canada. The U.S. Canada tax treaty is particularly favorable in this regard. In contrast, consider the U.S. Australia tax treaty which does NOT afford similar U.S. tax treatment to Australian pensions.


Individual Tax Deferral Opportunities in Government registered plans

Examples include: RRSP, TFSA, RESP, etc.

Availability to U.S. citizens in Canada:

  • RRSP – yes
  • TFSA – no tax deferral and fully taxable
  • RESP – no tax deferral and fully taxable

The income earned inside the TFSA and RESP will be taxed directly to the U.S. citizen. There may also be additional (expensive) “reporting requirements” with respect to these investments.


The Use of a Canadian Controlled Private Corporation (an opportunity that may be coming to an end FOR ALL PEOPLE with the current Liberal Government)

Availability to U.S. citizens in Canada:

  • Clearly No. The growth of investment income inside the corporation is attributed to the shareholder and subjected to punitive taxation. This destroys the opportunity to use the Canadian Controlled Private Corporation as a retirement planning vehicle.
  • Clearly No. The “reporting requirements” reflected in Form 5471 are tremendously expensive and penalty laden.
  • Clearly No. U.S. citizen shareholders of Canadian Controlled Private Corporations are NOT entitled to the Canadian “lifetime” capital gains exemption on the sale of the shares of the CCPC.
  • Possibly No. Canadian tax planners plan the payment of dividends to shareholders in a way that results in minimization of taxes paid at the Shareholder level. This is the direct result of Canada’s system of giving shareholders tax credits for certain taxes paid by the corporation. The dividends are subject to full U.S. taxation on the U.S. return.
  • Possibly No. In theory dividends from a Canadian Controlled Private Corporation are possibly (depending on your interpretation of the Canada U.S. tax treaty) subject to the 3.8% Obamacare surtax.

There is no “Clearly Yes”. It’s complicated! I have seen very knowledgeable and competent advisors argue over whether U.S. citizens in Canada should make use of Canadian Controlled Private Corporations.


Individual stock and investment portfolios

Generally, this would include individual “debt” (think GICs) and “equity” (think individual stocks).

Availability to U.S. citizens in Canada:

Yes absolutely available. The dividends, interest and capital gains are subject to “normal U.S. taxation”. The U.S. tax owed will be reduced by the tax paid in Canada.


Canadian Pooled stock and investment portfolios

In general, this means “Canadian mutual funds”.

Availability to U.S. citizens in Canada:

No. Canadian Mutual funds are considered to be PFICs under U.S. law and are subject to taxation at rates that can approach 100%.


Principal residence AKA The tax free sale on a principal residence (very popular in larger Canadian cities)

Availability to U.S. citizens in Canada:

Yes and No. U.S. citizens in Canada are required to pay capital gains taxes on the sale of their principal residence. (There is currently a $250,000 USD exclusion).


Conclusion

U.S. citizens in Canada are simply NOT able to take advantage of the retirement and planning opportunities available to their neighbors. The problem of the U.S. tax system for U.S living in Canada should be characterized as:

“It’s not the taxes they take from you. It’s that the U.S. tax system leaves you with few opportunities for financial planning”.

This is the primary reason why for U.S. citizens living in Canada

The Reality of U.S. Citizenship Abroad

My name is John Richardson. I am a Toronto based lawyer – member of the Bar of Ontario. This means that, any counselling session you have with me will be governed by the rules of “lawyer client” privilege. This means that:

“What’s said in my office, stays in my office.”

The U.S. imposes complex rules and life restrictions on its citizens wherever they live. These restrictions are becoming more and more difficult for those U.S. citizens who choose to live outside the United States.

FATCA is the mechanism to enforce those “complex rules and life restrictions” on Americans abroad. As a result, many U.S. citizens abroad are renouncing their U.S. citizenship. Although this is very sad. It is also the reality.

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12 thoughts on “The Biggest Cost Of Being A Dual Canada/U.S. Tax Filer

  1. AnonGirl says:

    Warning for the hidden ‘US persons’ among us: most Canadian banks, credit unions, investment companies, etc will at some point ask you if you were born in the USA. But none of them (so far to best of my knowledge) asks for proof of place of birth. For those Canadians who have never been in the US tax syste, or have been gone for years, it may wise to keep that US place of birth a secret even if it means answering, “NO” to the question: “Are you a US person?” or “Were you born in the USA?”

    It takes a bit of getting use to – the lying part I mean – but one has to do what is necessary to protect oneself against injustices. People who live permanently OUTSIDE USA owe USA big, fat NOTHING. Nor is a US place of birth of a Canadian citizen, living legally in Canada, the business of any Canadian financial institution.

    Protect yourself. Embrace lying about your birth on the plantation as a form of self-protection, that hurts no one. Lying is morally justified when one’s livelihood is being attacked by a foreign government, and even worse, is not protected by the government of the country where one actually lives and pays taxes.

    FATCA, and USA’s insistence on making non-residents, US taxpayers, is probably not going away anytime soon, if ever. Keep your US birthplace a secret and move on with your life.

  2. AnonGirl says:

    Disclaimer: My advice applies to older Canadians (say 30’s up) who are more likely to find it exceedingly complex, and expensive to retrofit their entire financial lives to meld with the US tax system after never having been part of the US tax system (or not having been part of it for years). If you are youngish (i.e. just starting out financially), your tax situation will not YET become a mess to sort out from a US perspective, so it may be wise for you to cough up the outrageous, $2,350 USD renunciation fee, to be free of the master once and for all. For those who are dealing with PFICS, foreign trusts (RESPs, etc), capital gains on house sales, etc, it can be financial suicide (not to mention the accounting headaches) to bend the knee.

    Too bad, there wasn’t a ‘streamlined’ version of renunciation of US citizenship (without all the tax and reporting issues) for people who have never really been a part of American society or who long ago left it. Until then, ssshhhhhh!

  3. Ausam says:

    This is not just a problem in Canada but similarly Australia too.

    To point 4. Tax cost is not the only issue relating to marriage. To protect their non US spouse, many Americans do not share FATCA reportable accounts with their non US spouse. This creates an environment of financial uncertainty and stress particularly if the US citizen spouse is dependent upon the non US spouse. For example, a stay at home mom and US citizens child may experience financial stress if the non US spouse/father withdraws support. This situation forces these mothers into a position of dependence, taking away their ability to manage their own financial affairs or those of the family. This takes a supreme amount of trust in the non US spouse.

    Savings for US citizens children can also trigger FATCA reporting for a non US parent if the parent is a signatory on the account. Thus, discouraging such accounts.

    And, what’s to say that a non US parent will keep a US citizen child compliant when they find the situation a crazy burden.

    • Bell says:

      This is my situation. I’m married to an Australian Defence Force member, and while he serves with U.S. troops overseas I am cut off from all main bank accounts and property, mainly due to FATCA and FBAR. I also have started a small business, and the finances are all handled by my co-founder because my name is also not on the bank account. I will not have Australian citizenship for years.

  4. JB says:

    Frankly, reading all of this makes me sick to my stomach.

    I left the USA in 1998 for love while basically living at the poverty level most of my life.

    Fast forward to today, I’m successful due to years of hard work completely outside the USA. I endure 43% taken out of my paycheck each month and I pay 19% sales tax in the country I live. I also pay a CPA in the country I live to make sure I’m compliant. I’m able to save a bit and I understand the tax system in the country I have lived for years.

    Now the USA forces me and my non US citizen family to pay another and more expensive CPA to file for US tax and also taxes me twice and wants to push me back into poverty, especially when I retire!

    Sorry USA, I’m not going to let you keep me in poverty. I worked too hard to get out of it. Even though I’ll for the rest of my life be seen as an American, I’ll renounce my citizenship and make sure to never set foot in you again, even though my family arrived in 1751 and fought in the revolution against unjust taxation.

    The American government of today should be ashamed of the outright discrimination it allows towards its American emigrants and former “good will ambassadors” around the world.

    The more we learn about this unjust taxation and compliance nightmare, while all the time our pleas are being ignored, we are quickly forced into becoming the “hate ambassadors” around the world.

    The same feeling of injustice that Americans felt before the revolution is there again.

    Yet this time it’s against the US government extracting wealth from other countries around the world where any US citizen is found. Taxation without representation always leads to a revolution.

    Each American that renounces their citizenship is an individual revolution against unjust taxation, penalties and compliance costs! God bless each one of them for being real Americans!

    • CB says:

      Fantastic comment JB; I agree with every word. As you say, we work hard to understand the tax system where we live. I spend a lot of time on my UK tax returns every year to make sure I get them right. Because I have to file US tax returns too, I panic that I will mess up my UK tax return due to overload and confusion, even with the help of an expensive CPA. This is in addition to the panic over filing US returns, which I do not understand having never lived in the US as an adult, and the nausea over reporting my bank balances (!!) to the Financial CRIMES Enforcement Network as if I am a piece of criminal scum. This adds up to several months of panic and distress every year, which is an intolerable way to live. Not to mention hundreds of pounds in compliance costs every year and being unable to save or invest. As they say, all roads lead to renunciation.

      Your sentiment rings so true: ‘Each American that renounces their citizenship is an individual revolution against unjust taxation, penalties and compliance costs! God bless each one of them for being real Americans!’ This needs to be repeated in the US Capitol Building, very loudly, over and over, for every member of Congress until they all get it!

      • A very pertinent part of your comment is:

        “Because I have to file US tax returns too, I panic that I will mess up my UK tax return due to overload and confusion, even with the help of an expensive CPA.”

        You are absolutely correct. The problem of U.S. tax compliance often interferes with your ability to comply easily and on a timely basis with the tax rules of your country of residence. I suspect that those Americans abroad with “small business corporations” feel this stress most acutely.

        Then there is the problem of the Canada Revenue Agency (and likely their equivalent in other countries) demanding proof of U.S. tax payments to claim foreign tax credits against Canadian taxes.

        The bottom line is that those Americans abroad with tax filing obligations in both countries are actually more likely to be have interactions that may lead to audits.

  5. qm says:

    A huge cost either way (attempting to comply or attempting to hide) is to peace of mind. The fear that you have made an enormously expensive error or will be caught as a non-filer never goes away.

  6. Karen says:

    You’re absolutely right, John. The biggest cost of being a US taxpayer residing outside the US is the opportunity cost – the cost of not being able to take advantage of the tax incentives provided by your home country for retirement savings, home ownership, saving for a child’s education, etc. It is so ironic that the only country to tax non-resident citizens has one of the most xenophobic tax codes in existence. Corporations, trusts, managed investments, and other entities that are perfectly legal (even encouraged) where you live are treated punitively by the US and require invasive “information” forms with USD10,000 penalty for omitting a single form that may have no bearing on your actual tax liability.

  7. Linda Northrup says:

    I have finally renounced for exactly these reasons. I would add that filing a US return also requires a great deal of time, even if someone else prepares it; one must collect all the information required. I would cite lack of financial privacy, being treated in a discriminatory manner compared to US citizens at home, and the assumption that one is evading taxes until proven otherwise. Finally, my daughter who was born in Canada and who has never worked or lived inn the US is considered a US citizen, as we learned when crossing the border one day.She was ordered to report herself as a US citizen when crossing. In order to keep her options open until her life settles down, she must also file a US return each year. This is absurd, unfair, and costly. She is unable to take advantage of retirement planning opportunities like the TFSA in Canada for the reasons expressed in the article above.

  8. Thank you all for a wide range of comments illustrating different aspects of the reality of either being a “U.S. tax compliant” citizen abroad or NOT being “U.S. tax compliant” citizen abroad.

    What’s interesting is that the problems of Americans abroad “kick in” at the point that they attempt to live a life in another country in accordance with another country’s tax and retirement planning environments. It really cannot be done. (The reason “digital nomads” don’t suffer is that they are not integrated into the tax systems of other countries.)

    As I have suggested (in other posts – including here at Tax Connections), is that what the U.S. calls “citizenship-based taxation” is really, the United States imposing U.S. taxation on the tax paying residents of other countries. When you describe this situation to others, I encourage you to simply say:

    Hey, did you know that the United States expects certain citizens and residents of other countries to pay taxes to the U.S.?

    That is the only way to get people to understand the absurdity and injustice of this.

    In the meantime, the United States has accomplished, what the United States has accomplished through its unjust, xenophobic and archaic tax policies, is the following three things:

    1. It has made the U.S. “Certificate of Loss of Nationality” (CLN) one of the most sought after and coveted documents in the world.

    2. It has created a situation where “renouncing U.S. citizenship” is the single best investment that people can make in their financial futures. Renunciation is the only investment I know that will pay you dividends every day for the rest of your life.

    3. It has turned 9 million Ambassadors of Good Will for America into the fastest growing and articulate source of anti-Americanism that has ever existed.

    Thanks again for taking the time to comment.

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