We’ve certainly had significant changes to US tax law over the last few years. These changes have also had a profound impact on the filing of US tax returns for US expats living in Canada.
In this guide I hope to outline in detail the tax filing requirements of US citizens living in Canada. Please note however that those that are moving or retiring to Canada will have additional tax filing requirements and planning items to review in the year they move to Canada. These issues will be outlined in subsequent articles as this guide will review requirements for expats who have already transitioned to Canada, or those that have lived in Canada their entire lives.
Please feel free to comment below with any questions or feedback, and please don’t hesitate to email me at email@example.com or call or text to 250-661-9417 as I would be happy to help answer any questions you may have.
VERY IMPORTANT: Please note that the preparation of cross border tax returns involve a significant amount of technical and professional experience. The potential for very costly filling penalties is extremely high for anyone that attempts to file these type of tax returns without proper experience or guidance from a cross border tax professional. Not only is a deep understanding of both the Canadian and US tax system required but a further understanding and application of the US-Canada Tax treaty required to file such returns.
Also note that the discussions related to tax calculations and forms below are very general in nature and should not be construed as tax advice. Your situation will be specific to you and your circumstances and you will want to review your tax situation with a qualified cross border tax professional.
Now that we got the DISCLAIMER out the way, let’s move on to How to File US Tax Returns in Canada:
US expat citizens are required to continue filing US tax returns even though they are not living as residents in the US. Essentially, regardless of where you live in the world, if you are a US Citizen or US Green Card Holder, you will be required to file US tax returns.
Whether you born in the US or born of US parents and now live in Canada, or have moved from the US to Canada, you will be required to file both Canadian and US tax returns while a resident of Canada.
Note that the discussions related below with respect to filings and required forms are for those that are fully compliant and caught up on their US filings. If you are a US citizen living in Canada that still needs to catch up on your tax returns please review the Streamline tax program for more information on becoming compliant. This will also allow you to receive your economic impact stimulus payment as an expat of the US.
Basic Filing Requirements
Two basic filings will be required of US Citizens living in Canada:
Unless the taxpayer is under the respective income filing thresholds, a US citizen living in Canada will have to file both a Canadian and US income tax return each year.
Due to the recent COVID-19 outbreak Canadian and US tax deadlines have been extended.
Tax filing deadlines for 2020 are as follows:
- Regular Canadian T1 income tax return deadline is now June 1st, 2020
- US 1040 income tax return deadline is now July 15, 2020 with extension available via form 4868
In normal tax filing years US Citizens living abroad are granted a 2 month automatic extension to June 15th. No prescribed form is required to elect for this extension.
Also note that those that have filed their 2018 and 2019 1040 income tax return are also eligible for the new US economic impact stimulus payments. It’s also been confirmed that US expats living outside of the US are eligible for the US stimulus payments.
Foreign Bank Account Reporting
In addition to income reporting, both the US and Canada have specific filing requirements that require taxpayers to disclose foreign income and assets to each respective country:
US FBAR forms (US 114 form) – Form 114, commonly referred to as FBAR forms (Foreign Bank Account Reporting) require US persons to report their non-US banks and investment accounts to the US treasury department. These forms are extremely important for a few reasons. First, they are often missed by US taxpayers. Second, those that fail to report financial accounts on an FBAR could face significant penalties.
FBAR penalties can be up to $10,000 per unreported account or 50% of the value of unreported accounts. Unlike the T1135 outlined below, the FBAR is not filed with your US tax return and is filed separately and electronically with the treasury department. Form 8938 reporting foreign financial accounts is also required, however this form is filed with the 1040 and discussed in more detail below. Taxpayers are required to convert their Canadian holding balances to USD at year-end exchange rates.
T1135 foreign income verification form – This Canadian form is required for those taxpayers that own non-Canadian domiciled assets that have a cost of more than $100,000 CAD. Assets include bank and investment accounts outside of Canada, including real property, but exclude assets such as US IRAs and personal US vacation properties. This form carries a penalty of $25 a day to a maximum of $2,500 if filed late. Something very important to note is that if you have US based non-registered accounts you’ll need to complete a fairly detailed T1135.
For US investments in a Canadian investment accounts you are only required to report totals based on a country by country basis. If these same US investments are held in a US investment account they need to be reported separately. This difference in reporting is significant and could be the difference between thousands in tax preparation fees or countless hours of time to prepare the form yourself. In these cases we tend to advise clients to review the option of transferring their US investments to Canada if possible.
US Tax Forms and Schedules Required for Expats
Please note that there are many other US income tax forms that may apply to a taxpayer’s situation. The forms below however are those that are most common for those American’s living in Canada that need to file US income tax returns:
1040 – This is the main US income tax form that gets filed each year. It contains the name, address, dependents and income of the taxpayer(s). The form summarizes income and tax calculations for the year. You’ll have the option of filing your tax return as single, married filing jointly, married filing separately or head of household.
In most cases, dual citizens living in Canada will file MFJ and US citizens with Canadian non-US citizen spouses would file MFS. In limited circumstances we might elect to have the non-US spouse file jointly, however this is quite rare. We also may use the head of household filing option in limited cases. In order to be eligible for head of household filing status a US citizen filer with a non-US spouse and a US dependent may make this filing status choice.
Schedule 1 through 6 – I won’t spend a lot of time on these schedules as they were introduced in the last few years to help consolidate information lines on the 1040 jacket and other forms. Most of the information on these schedules will come from other forms discussed below.
Schedule A – This schedule calculates all the itemized deductions available to claim. In many cases and considering how a lot of these deductions were eliminated in recent US budget, and the fact that the standard deductions have increased significantly, we tend not to use schedule A for US persons in Canada.
Not only that, but often, regardless of how much we reduce US tax, clients often don’t pay US tax because all US tax calculated on the 1040 is reduce by Canadian tax via foreign tax credits and form 1116 (more on this below).
Schedule B – This schedule outlines investment income of the taxpayer for the year. This form also contains a section often missed by expat tax filers. At the bottom of schedule B includes questions about foreign financial accounts, FBARs and 3520s. These questions are required to be answered.
Schedule C – Profit and loss from business are reported on this schedule. For those that earned self-employment income they will report these activities on schedule C. Note that dual resident taxpayers living in Canada will not be required to pay both Canadian CPP and US self-employment taxes. Under the US-Canada totalization and social security agreement, social securities taxes on self employment income is only payable in the country where the taxpayer is a resident (more on this below). Therefore, US citizens and taxpayer that live in Canada are only subject to Canadian CPP payments and not US self-employment taxes on self-employment income.
Schedule D – Capital Gains and Losses are reported on schedule D. Fairly self-explanatory, capital gains transactions are reported on this schedule including both public and private assets. A big difference between the treatment of capital losses between Canadian and
US income tax rules is that Canadian tax rules do not allow a deduction for capital losses against any income that is not capital gains. On the US side, those filing separately are allowed to deduct $1,500 and those filing MFJ are able to deduct $3,000 of capital losses against other non-capital income respectively.
A common mistake made by those filing their own cross border return or by those with a lack of experience is an incorrect calculation of capital gains for both US and Canadian purposes. Because the reporting of income on the Canadian and US income tax return need to be converted to respective currencies, the gain and loss on both sides of the border will need to be properly calculated at appropriate rates.
We convert income items such as pension, employment and business income on an average rate throughout the year. However, capital gains need to be converted at actual rates. For example:
Let’s say a Canadian resident purchased $10,000 of US stock in previous years when the FX rate was $1.10 USD/CAD. She then sells it in the current year when the stock is worth $11,000 and the FX rate is 1.30 USD/CAD. Her Canadian gain is not $1,000 x the average rate for the year (often the mistake made on tax returns we see prepared by others), but rather it is $3,300 calculated as follows: proceeds of $14,3000 ($11,000 x 1.3) less cost basis of $11,000 (10,000 x 1.10). However, her US gain in this case would simply be $1,00 ($11,000 less $10,000).
The Canadian gain is simply higher because of the change in exchange rate from the time the stock was purchased to when it was sold. It’s important to properly calculate capital gains this way for expats as the movement of currency exchange rates can significantly affect the amount of gain/loss reported on each respective tax return.
Schedule E – This schedule reports a variety of different types of income. In general schedule E reports income and losses from rents, royalties, income from partnerships, S-corps, trusts and estates.
Schedule F – Schedule F reporting income and losses from farming activities. Fairly straight forward.
Schedule SE – US Self employment taxes are calculated on this form. As outlined above, in most cases SE tax is not imposed on self-employment income earned by US citizens living in Canada. As such, no SE taxes would be calculated on this form for Canadians. In these cases a disclosure will be required to included in the return to ensure no SE tax will be owed.
Form 1116 – Form 1116 is one of the most important forms for expat returns. This form allows a US taxpayer living abroad to claim foreign tax credit on taxes paid in Canada. Incorrect preparation of this form can result in material misstatement of taxes and can result in a double taxation. The US-Canada tax treaty is in place to help eliminate double taxation between both countries. Hence the reason why form 1116 is so important to understand when preparing returns for Americans living in Canada.
Essentially, form 1116 allows a US taxpayer to claim a foreign tax credit for income tax paid on income to another country. In this guide we will discuss form 1116 in context of Canada and the US, however in many situations a US taxpayer will have an 1116 claim for foreign taxes from multiple countries.
In general terms form 1116 calculates the amount of foreign income that is taxed on your US tax returns and the corresponding foreign tax (in this case Canadian) on this income.
There are 3 “pools” of income that get calculated on separate 1116 forms:
- General income – pension income, employment, business income, etc.
- Passive income – investment income, dividend income, interest, capital gains, etc.
- Resourced income – this 1116 calculates a foreign tax credit on income that is not taxable in the US pursuant to the treaty. Some examples includes US source interest, US source capital gains and tax on Canadian pension income in excess of 15%
- Global Intangible Low-Rate Income Tax – More on this below
Generally form 1116, in reach respective pool, calculates how much of a foreign tax credit you will get on each “pool” of income. Note however that you will only receive a foreign tax credit for the lesser of the actual tax you paid on foreign income and the amount of US tax paid on the same income.
The nuance of 1116 tax calculations is beyond the scope of this guide, however if you have specific questions on these forms please leave your comments below and I’ll try to answer them as best as I can.
Also note that in addition to the 3 pools outline below, there is also 1116 AMT forms. More on Alternative Minimum Tax forms below.
Form 2350 – This form allows you to request an extension of time to file your tax return. This form is limited to situations where taxpayers file form 2555 and in most cases it is much more efficient to simply file form 4868 to request a further extension. More on deadlines and extensions for US citizens abroad below.
Form 2555 – This form is quite common on cross border tax returns, however in most cases we do not use form 2555 for our Canadian/US clients. This form allows for a deduction, in certain cases, for foreign (non-US) earned income. Unless the client only has employment income we tend to use foreign tax credits and form 1116 to reduce US taxes to nil on Canadian source income versus using form 2555. The reason for this is that if we use form 1116 for earned income so we can carry forward general source foreign tax credits for use in subsequent years.
Note that specific elections need to be made if you decide to stop using form 2555 to exempt foreign income in the US. Also, a simpler version of the form 2555-EZ is also available to those that are eligible.
Form 3520 and 3520-A – These forms, very much known and despised by expats and cross border tax professionals are often required to be filed in particular situations. Often when a American in Canada is a owner or beneficiary of a trust or receives a gift from a non-resident of the US these forms need to be filed.
Recent IRS procedures Rev. Proc. 2020-17 has exempted certain types of accounts that where previously classified as trusts for purposes of 3520 and 3520-A filings. Namely Canadian RESPs.
The assessment and filings of these forms is complex and requires proper advice. It’s important to review possible 3520 filings with your cross border accountant or lawyer.
Form 4506-T – Filing of this form results in a request for a US 1040 transcript. We file this form in order to satisfy reviews of foreign tax credits from CRA. When a US-Canada taxpayer claims a foreign tax credit on their Canadian tax return for taxes paid in the US on CRA often asks the taxpayer, through a pre or post-assessment review, for verification that they paid income tax on reported income. This transcript, once received, satisfies this request from CRA.
Form 4868 – This form allows a taxpayer to request an extension to file a tax return. Note however that US citizens living abroad have an automatic extension of 2 months from the regular US deadline.
Form 5329 – This form calculates any additional tax on IRA plans that are assessed in cases such as early or non-qualified withdrawals. Many of our clients own both Canadian and US retirement plans and in limited cases this form needs to be filed. One interesting item to note is that traditionally penalties imposed on late IRA distributions were not allowable to be claimed as a foreign tax credit in Canada. Due to changes in administrative policies at CRA, now penalties on IRA distributions can be claimed as part of your Canadian foreign tax credit claim.
Form 5471 – The 5471 is extremely important for a few reasons:
- this form is often missed by taxpayers
- if missed or filed late it carries a $10,000 first offense penalty and $25,000 repeat offense penalty
- this form is terribly complicated to complete and requires an in-depth knowledge of both Canadian and US income tax rules
- the recent US US tax changes under the Tax Cuts and Jobs Act of 2017 resulted in significant change to this form including Global Intangible Low-Tax Income regime.
The complexity of the form is well beyond the scope of this article, however I’ll do my best to summaries it here:
Most US Citizen and resident taxpayers that have more than a 10% interest in a private foreign (non-US) company are required to file the 5471. In some cases when the foreign company is inactive the taxpayer is only required to file page one of the form. In the context of this guide most Canadian taxpayers that also file US returns, and are shareholders of a Canadian corporation, must file a 5471.
This form reports the following:
- General information about the corporation and shareholders
- Information about the corporations income statement, balance sheet and equity statement all converted to US dollars
- Information on how the US shareholders were compensated from the company and related loans to shareholders
- Calculation of GILTI income if applicable
- Calculation and tracking of Subpart F income if applicable (more on this below).
- Other forms tracking these calculations:
- Schedule I-1 – GILTI tracking
- Schedule J – Accumulated E&P of CFC
- Schedule M – Transaction of a CFC
- Schedule O – Organizational transactions
- Schedule P – Previously taxed earnings tracking
Very generally speaking, if a US taxpayer owns shares in a private Canadian company they will need to assess the following:
If the company is controlled by a US person or groups of US persons it’s likely considered a “controlled foreign company” for US purposes. If so, the taxpayer will be subject to certain additional tax rules such as Subpart F income rules and GILTI rules. In short, any active business income (GILTI) or inactive income (subpart F) will be subject to US tax regardless of whether it was distributed to the shareholders. In certain cases however we can mitigate any additional US tax owing by properly planning before the tax returns are due or by applying foreign tax credits to the taxpayer’s 1040 to claim a credit for Canadian corporate taxes already paid (this is a very complex area that requires professional assistance).
If a Canadian corporation is not controlled by US persons, but that particular US tax taxpayer does have an interest in the corporation, the 5471 is still required to be filed, just with less forms and calculations.
To add a further note to the 8621 discussion above. If a Canadian corporation is considered a CFC it will not also be considered a PFIC, and therefore will only be required to file form 5471 and not form 8621.
IMPORTANT NOTE: the 5471 discussion above is very general in nature and does not take into account all the complexities of CFCs or PFICs. If you are a US citizen that has an interest in a non-US private company please reach out to a cross-border tax professional for advice.
Form 6251 – This form calculates whether a taxpayer will be subject to Alternative Minimum Tax (AMT). The purpose of AMT is to ensure taxpayer pay a minimum level of tax on their tax returns when in certain years, due to large deductions or low rate income. For example, if a taxpayer’s regular rate of tax on income is 15% and the calculation AMT rate is 20%, the taxpayers additional AMT will be 5%. Essentially their overall (minimum) tax rate would be 20%.
Form 8621 – Not necessarily a common form for domestic American residents, but for any Americans living in the US with Canadian mutual funds this form is likely familiar. Specific US tax rules do not allow US taxpayers from offshoring investments into foreign companies and deferring investment income on these investments. Hence the reasons why form 8621 and Passive Foreign Investment Company (PFIC) rules were developed.
In most cases, if a US taxpayer has ownership of a PFIC, defined as a foreign company that either has 75% of it’s income generated from passive source or it’s made up of more than 50% inactive investment income, this taxpayer will have to file form 8621.
Once again, similar to the discussion regarding CFCs and form 5471, the tax impact of owing PFICs will not be covered in this article. That being said, those that have ownership in Canadian or non-US investment companies should seek specific tax advice for their US filings.
One important thing to note is that, in many cases, Canadian mutual funds meet the strict definition of a PFIC. Therefore Americans living in Canada, that own Canadian mutual funds will be subject to PFIC reporting and form 8621. In many cases however the Canadian fund company provides specific tax forms to the US taxpayer that makes the filing of form 8621 much less onerous.
Schedule 8812 – This schedule allows you to claim the fairly large child tax credit. The credit is up to $2,000 per child, $1,400 of this amount is actually refundable. That being said only Canadian taxpayers with children that are US citizens with valid social security numbers or children that are physically present in the US are eligible for this credit. In cases where your children are eligible for a SSN, you should obtain the SSN in order to obtain this generous credit.
Form 8833 – This is an extremely important forms for US expats. This form is used to claim a treaty deduction or position on a 1040 income tax return. This form also carries a $1,000 penalty is not filed in a timely manner.
Some common examples of 8833 disclosures that US citizens in Canada file are as follows:
- disclosure to exclude payments of self-employment tax on business income
- disclosure to resource certain types of US source income such as interest income and US capital gains
- exclusion of CPP, OAS and US social security payments
Form 8840 – This form is really only filed with 1040NR returns or as a separate form with the IRS. In cases where non-residents of the US spend enough time in the US (under the substantial presence test) they are allowed to file this form to outline to the IRS that they are a more closely related, for tax purposes, to a foreign country. In effect, not requiring the taxpayer from having to file a full 1040 income tax return even through they meet the substantial presence test.
Form 8854 – This form is specifically required for those that have expatriated in the year. This form reports a taxpayers renunciation from the US and related tax consequences.
A discussion of this form is beyond the scope of this articles, however some main points are as follows:
- When a US citizen applies and is eligible for citizenship renunciation the taxpayer needs to file from 8854 for the year they expatriated
- If the expat’s net worth is less than $2,000,000 then the tax impact of expatriation is relatively straight forward (other than the last year of filing requirements).
- If the taxpayer is over $2,000,000 in net worth at the time of expatriation the taxpayer is considered a “covered expatriate” and further tax consequences result.
K1 Form Entries – The K1 form is actually a slip you’ll receive if you are a shareholder of an LLC, partnership, S-Corp, C-Corp or if you are a beneficiary of an estate or trust. Although this is not a form in the 1040 it is a slip that many US citizens in Canada receive that need to assess when they file their US income tax return. A Canadian resident may receive the following types of K1 forms:
- K1 from an S-corp of LLC – This form will allocated income of an S-corp or LLC to a taxpayer. It will note only allocate this income, but outline what type of income is allocated. Note however, that these US style flow-through entities are often not very efficient for Canadian purposes and often result in double taxation. If you or your client receive K1 distributions of any kind please reach out to a competent cross border tax professional for advice on how to deal with these allocation slips
- K1 from US partnership – This form allocates income to a taxpayer from a US partnership
- K1 from trusts and estates – A taxpayer will receive a K1 often from trusts or estate for which they are beneficiaries. Once again, the tax rules related to distributions to taxpayer from foreign trusts and estates are complex and require proper review and planning. Canadians reporting trust and estate distributions from foreign sources should also be filing form T1142 to properly report these distributions (more on this below).
Form 8938 – This form, similar to the FBAR form discussed above reports foreign financial accounts to the IRS on 1040. Some main differences between the FBAR forms and the 8938 forms are as follows:
- The FBAR is filed with the treasury department apart from the actual 1040 income tax return.
- The 8938 is filed along with the 1040 income tax return
- Unlike the FBAR, certain types of foreign pensions are required to be reported on form 8938
- Signing authority over corporate bank and investment accounts are required on the FBAR, but not on the 8938
- The 8938 also has additional information required on the form including whether an account has been closed in the year and how much income is generated in total from foreign accounts
Form 8960 – This form calculated the original Obamacare net investment income tax. This additional tax was introduced a few years ago to help fund the US medical system under Obamacare. Canadians are also subject to this additional income tax. The additional income tax of 3.8% is on income above certain thresholds, $125,000 for those filing single or married filing separately and $250,000 for those filing jointly. Note that this 3.8% tax is only on investment income above these thresholds.
However, this additional tax is not part of “regular income tax” and therefore not able to be reduced by a foreign tax credit via from 1116. Hence, taxpayers with investment income over the thresholds above may face additional US tax that cannot be offset by Canadian taxes.
Form W9 – This form, often requested by investment and banking institutions is simply a request from a US citizen for their US Social Security Number. This form is held by the institution requesting the form and is not sent to the IRS or treasury department.
You’ll notice from the forms above that many of the “deduction” forms are not included. This is because in most cases, regardless of how much you reduce US taxes on a 1040 you have more than enough Canadian taxes to offset this amount. There are certainly cases where we need to use deductions on specific forms or those on schedule A, however these cases are not very common for expats.
The guide above outlines what to forms file on a US 1040 income tax return while a resident in Canada. The filing of Canadian returns for US residents is not outline in great detail. However to help provide some insight I’ve outlined some of the main points and additional forms a US citizen would want to review when filing their Canadian return:
T1 Canadian Income Tax Return Forms for Expats:
T1135 – Similar to the FBAR forms outline above the Canadian tax authorities also want to know about your foreign assets. Form T1135 was discussed above.
T1142 – In situations where Canadian residents receive distributions from foreign trusts or estates they need to fill form T1142 to report both the capital and income portion of the distribution. Because many Americans living in Canada will, at some point in their lifetime, receive distributions from a US estate or trust, we tend to file this form fairly often.
T1161 and T1243 – In cases where a Canadian may leave Canada and become a non-resident of Canada for tax purposes (often by moving to the US), these forms are required to be filed on their Canadian exit return. Generally speaking, when a Canadian becomes a non-resident of Canada most of their worldwide assets (excluding certain assets such as Canadian real estate) are deemed to be disposed as if they were sold. Form T1161 and T1243 report these assets in that particular year.
T2203 – For taxpayers that provide professional services or do business in another province or country this form is required to properly calculated where this income will be taxed.
T2209 – This is a very important form for Americans with Canadian filing requirements. This form allows you (similar to form 1116 above for the US 1040) to claim a foreign tax credit for foreign taxes paid to other countries. For example, an American living in Canada earning US pension income will be taxed in the US first on this income. They will also be taxed in Canada on this income, but they will receive a foreign tax credit on form T2209 for the US taxes already paid or accrued, hence eliminated double tax on this income.
Note that many of the forms above carry high penalties if not filed in a timely manner.
Often, our American clients have taxable income from various states. Whether it’s income from rental properties or part year tax returns for those moving up to Canada. State tax returns are often required in addition to the Canadian and US income tax return.
The discussions above relate to filing requirements of US citizens only. Often Canadians that are not US citizens have to also file a US tax return, namely a 1040NR income tax return for non-residents of the US. Canadians may need to file a non-resident income tax return in the following cases:
- Sale of property in the US
- To report rental income in the US
- To pay tax or claim a refund on under-withheld US source income (often US source pension income)
- Reporting of gambling winnings
In cases where a Canadian or US taxpayer needs to made a revision or correction to their US or Canadian income tax return, form 1040x or form T1adj are available respectively to make these adjustments.
As you can see from the outline and discussion above, the filing of US and Canadian income tax returns for Americans in Canada is almost always complex and multifaceted. Engaging an experienced US-Canadian income tax adviser to assist in these filings is always advised.
Every year we file over 700 US income tax returns for Americans living in Canada. If you need help with your cross border filings, or simply want to chat about services or questions you may have please feel free to reach out via email to firstname.lastname@example.org or via phone or text to 250-661-9417.
I look forward to speaking with you.
Phil Hogan, CPA, CA, CPA (CO)
An archived version of the previously posted guide can be viewed here