Most of my new clients come from the US and have moved up to Canada in the last few years. Not surprisingly, most Americans do not know what to expect for tax filings in their first year of entry to Canada.
In this article I’ll walk through the tax process of entering Canada, filing your first Canadian return, preparing your US return and all the other filings that are potentially required.
For purposes of this article let’s assume a married couple moved to Canada on June 30th of 2022.
What tax returns will I need to file for 2022?
In the year you move to Canada you’ll need the following tax returns
- 1040 US income tax return
- T1 Canadian income tax return (including provincial)
- State return (in most cases)
- Various other forms and financial disclosures
What will each tax return look like?
US 1040 income tax return
It might make sense to start with the US income tax return. Unlike under Canadian tax law, US citizens are taxable based on residency. Therefore, if you move to Canada you’ll be required to file full year US income tax returns even if you are not currently living in the US. As a married couple it often makes sense to file jointly while in Canada. In some cases we will file “married couples separately”, however that is very common as it doesn’t add any benefit.
Because US citizens need to file US tax returns regardless of where you live in the world you’ll file a full year 1040 in the year you enter Canada. Your worldwide income for 2022 will be reported on the 1040, however depending on the type and source of the income it may be ultimately taxed in Canada or the US (more in this below).
T1 Canadian return
Unlike US returns we don’t have joint filing in Canada. Although there is integration between both spouse’s returns, each taxpayer will file a Canadian return separately. Also, as they are enter Canada they will need to report an “entry date” for Canadian tax purposes. This date will be the start of their Canadian tax residency. Essentially any income earned after this date will be taxable in Canada. Your entry date will be reported on the first page of the Canadian return:
Given the taxpayers moved to Canada on June 30th all income earned after that date to the end of December will be reportable on their 2022 Canadian income tax return.
State tax return
Unless you are moving out of a state that has no income tax or filing requirements you’ll need to ensure you file an exit return for your home state. In most cases you’ll file a non-resident state tax return to show the state that you’re no longer a tax resident of the state after you move to Canada.
Generally only income earned from January 1 to your date of exit (date of Canadian entry) will be reportable on the state return. In some cases if you have income such are rental income from the state or real property sales you may be required to report/file on this income in the year you leave or subsequent years. Note however that this income would be reported on a non-resident state return and not a full year resident return.
For example, you might have left California but you maintained ownership of a rental property. Each year you’ll be required to file a California non-resident state return to report the California rental income.
Foreign tax credits
Now that the income for both tax returns has been properly reported you’ll need to ensure that correct foreign tax credits are calculated on each respective return to help mitigate any double tax between Canada and the US.
This topic by itself could be a full article. However, to give you a basic understanding on how the Canada-US tax treaty will help relieve any double tax in the entry year to Canada let me try to explain this in relatively simple terms.
Generally speaking income is “sourced” either Canada or the US based on the treaty. “Sourced” simply means that it will be taxed first by one of the countries, then taxed in the second country. Then the second country will allow for a tax credit against tax to ensure double tax doesn’t occur.
in the example above the following income will be sourced as follows (this is a basic explanation as the treaty does carry quite a bit of nuance):
- Employment income is sourced to the country where the employment income is earned (Article XV)
- Business income will be sourced where the income is earned through a permanent establishment (Article V and VII)
- Rental income and gains on real property sales will be sourced to the country where the real estate is located (Article VI)
- Dividends and pensions will be taxed in the country where they originate and will carry a maximum 15% withholding tax (article X and VXIII)
- Interest will only be taxable in the country you are a resident (Article XI)
- Gains on public securities will be taxable only in the country where you are a resident (Article XIII)
- Social Security, OAS and CPP will only be taxable in the country of residence (Article XVIII)
Foreign asset disclosures
Both Canada and the US both have various foreign assets disclosure forms and requirements that need to be met each year. Each government will want information on assets held outside of each respective country.
US will require FBARs
The Treasury department will require that assuming you meet the filing threshold that form 114 (Foreign Bank Account Reporting – FBAR) will be required for all bank and investment accounts outside of the US. We won’t get into the details of this filing requirement, however you can learn all about FBAR filings here.
Canada will require T1135s
Similar to the US, Canada also has foreign asset reporting requirements albeit at much higher threshold rates. Canadian tax residents that have foreign assets with a cost basis exceeding $100,000 CAD will be required to file form T1135. One interesting thing about the T1135 form is that you would have a first-year filing exemption for those moving to Canada for the first time. Please note that this “first-year” exemption does not apply to those that were residents of Canada previously. You can read more detail on T1135 reporting here.
The FBAR and T1135 requirements are not the only foreign disclosures required as you may have additional forms such as:
- Canadian T1142 filings (disclosures for foreign trusts)
- Canadian T1134 filings (disclosures for foreign companies)
- US 3520 filings (disclosures for foreign trusts
- US 5471 filings (disclosures for foreign companies)
- These are only examples of additional disclosures required as many others may be relevant based on your particular situation.
Other items to consider
The purpose of this article is to discuss the actual tax filings as an American moving to Canada for the first time. Lots of proper planning is required well before someone moves to Canada. To read more about investment and tax planning before moving to Canada please check out our blog articles here.
Some other important items to note:
Business income, SE and CPP tax
In cases where an individual who is self-employed moves to Canada some additional issues should be considered. The US imposes “self-employment tax” on business earnings and Canada imposes “Canada Pension Plan” contribution tax (CPP) on business earnings.
Pursuant to the treaty the a taxpayer will only be taxable on business income in the country where the income is earned or where the taxpayer is earning the business income through a “permanent establishment” (PE). Therefore, regardless of where the business income is coming from (sourced) an individual that moves to Canada will be taxable on their business income in Canada only. Also, under the social security agreement between Canada and the US you’ll only be required to contribute into the social security tax system of the country which you are a resident. So, before you move to Canada you’ll be subject to SE tax and after you’ll be subject to CPP payments on self-employment earnings.
ROTH IRA election
When Americans move to Canada with ROTH IRA accounts they are required to file special elections. I won’t get into the details of the election in this article, however if you’re moving to Canada and have a ROTH IRA please make sure to file the required tax elections.
As you can see from the details above it’s terribly important to properly understand your filings requirements both in Canada and the US in the year you enter Canada. Properly setting up your filings to ensure they are correctly prepared in the first year sets you up for a much easier filing experience in subsequent years. For information on how to file cross-border tax returns including all required forms visit here. Note that although we have covered a great deal on your first year Canadian entry filings additional disclosures and schedules will be required depending your particular situation.
If you’re moving to Canada and need help with your investments or tax returns please touch base with me here and I’ll do my best to help.