Note from Coleman Wealth: We work with a network of Canada’s best cross border experts, and are fortunate to have connected with Kevyn Nightingale, a partner with MNP LLP leading the Expatriate Taxation practice. Kevyn has worked with a number of our clients who have cross border legal issues and is known as a thought leader in this complex area of law. We thank Kevyn for allowing us to republish one of his blog posts from December, 2014. To contact Kevyn, please email us at email@example.com and we can facilitate an introduction
By now, it is well-known in Canada that U.S. citizens must file U.S. tax returns, no matter where they live. However, the U.S. also taxes people based on residency ‘ the same concept that is used by most of the world’s advanced nations.
The U.S. has some peculiar residency rules and it is surprisingly easy to run afoul of them. Mistakes can be very costly. For clarity, we’re talking about income-tax residency here; the gift and estate taxes use different rules.
Impact of U.S. residency ‘ tax and filing
Residents must file tax returns annually and a host of information returns. Even if there is no U.S. tax, the filing process is usually onerous, intrusive and expensive.
A resident files form 1040, reporting worldwide income (yes, this duplicates the Canadian reporting). The income tax rules are similar to Canada’s. The U.S. offers certain exclusions and foreign tax credits to people abroad, so usually there is no actual tax. However, since the rules aren’t the same, it’s possible to have U.S. tax, even after paying the higher Canadian tax.
There are two ways a person can be resident:
1) A green card holder (also known as a lawful permanent resident, under immigration law) is deemed to be a resident, no matter where he or she lives.
Many people think that once the card expires, the status also expires. In order for a green card to cease to be valid, it must be voluntarily relinquished or retracted by a court. As a result, there are quite a few Canadians who think their status has expired, but are mistaken.
2) A person who spends a lot of time in the U.S. is also a resident. This determination is called the Substantial Presence Test and is the test most Canadian snowbirds need to be concerned about.
Substantial Presence Test (SPT)
Under domestic law, an individual who spends at least 31 days physically present in the U.S. in a year and meets this formula, is considered a resident:
Days in the U.S. in the current year +
1/3 days in the U.S. in the prior year +
1/6 days in the U.S. in the 2nd prior year
Any portion of a day is a day.
A person who spends 122 days per year in the United States for three years running will meet this test for year three.
Governments are tracking days
In the past, the IRS largely relied on individuals’ representations of their time in the United States. While it has always been possible for the IRS to glean the necessary information from border-crossing records, it was not practicable to do so on a mass basis.
The U.S. government is now tracking the number of days Canadians (among others) spend south of our border. Any individual can find out the government’s record of their number of days on the Department of Homeland Security’s website.
Exempt individuals Some days in the U.S. don’t count: Those for someone on foreign government-related business, a teacher or trainee, a student or a professional athlete competing in a charitable sports event.
The important exclusion here for snowbirds is for someone whose medical condition prevents them from leaving the country.
Form 8843 must be filed on a timely basis. This phrase, in most cases, means by June 15 of the following year. The due date can be extended, but late filing almost always means the form will not be accepted and the days will not be excluded.
Closer Connection Exception (CCE)
A Canadian who meets the SPT may be able to avoid U.S. residency by filing form 8840. To do this, one must meet several criteria:
1) Have a ‘tax home’ (usually the place one works) and a closer connection to Canada, based on their facts and circumstances;
2) Be physically present in the U.S. for under 183 days in the current year; and,
3) File form 8840 to indicate this connection on a timely basis.
An individual who meets the SPT, but does not file this form is deemed to be a U.S. resident under U.S. domestic law.
Again, late filing means the form will not be accepted and the individual will not be eligible for the CCE.
Treaty residency ‘ a last resort
Just about every snowbird will have a tax home in and closer connection to Canada. But it’s not uncommon to see people exceed the 183-day threshold (even if that causes them to be offside for immigration purposes as well). And many people are unaware of form 8840, so they can’t use the CCE.
It is still possible, even for these people, to avoid residency by filing a U.S. return with a treaty disclosure. The treaty contains tiebreaker rules, allowing a snowbird to be taxed as a resident of only Canada.
The tiebreaker tests are applied in order. If one rule breaks the tie, then the subsequent tests are ignored. If a test results in a tie, the subsequent one is examined. An individual is a resident of the one country where they have:
1) A permanent home available to him / her;
2) A closer connection (similar to the Canadian domestic law residency test); 3) An habitual abode; or,
The treaty overrides domestic law. Assuming Canadian residency, the individual files form 1040NR (not form 1040), along with form 8833. There is a $1,000 penalty for failing to file this form. If the individual has no U.S.-source income, there will be no U.S. tax.
Supplementary filing required anyway
A person who uses the treaty to be taxed as a U.S. non-resident is still considered a resident for most filing purposes. The IRS doesn’t have easy access to the same information about potential foreign (say, Canadian) payors of income, so it demands the individual taxpayers provide the data. For example:
Foreign Bank Accounts (FinCen 114)
Specified Foreign Financial Assets (8938) News flash: The IRS has withdrawn this requirement for 2014 and subsequent returns
Foreign Corporations (5471)
Foreign Partnerships (8865)
Foreign Trusts (3520/A)
These forms require disclosure of quite a bit of information many people would rather keep private. It goes without saying that preparation of these forms is time-consuming and therefore expensive.
Bottom line ‘ watch how many days you spend in the United States!
To learn more about taxation considerations for snowbirds, contact Kevyn Nightingale, CPA, CA, CPA (IL) at firstname.lastname@example.org or 416.515.3881