The United States tax system is one of the most complex tax codes in the world, and it’s no surprise there are fundamental differences between the U.S. and Canada with regard to taxation.
U.S. citizens have a number of possible income tax scenarios arising from employment in Canada.
Tax Differences Between Canada and the U.S.
Income tax in Canada is assessed upon residents, those who work in Canada while maintaining residential ties, which has a rather broad and flexible definition. The U.S. bases taxation on both residence and citizenship.
This difference leads to a number of situations, but as a bottom line, a U.S. citizen generally files a U.S. tax return every year, regardless of residential arrangements.
Canada and the U.S. have an agreement that exempts a U.S. citizen from being taxed by the U.S. on income earned and taxed in Canada. However, the exemption itself is driven by proper completion of the U.S. 1040 federal tax return.
Failure to timely and accurately complete the U.S. return may lead to double taxation, denial of legitimate expenses, interest charges and penalties on incomplete or inaccurate forms.
U.S. Citizens Residing in Canada
“Generally, as a U.S. citizen living and working in Canada, you are taxed for money earned in Canada, whether from employment with a company operating in Canada, or investment interest from Canadian stocks, bonds or mutual funds,” says Brent Allen, certified financial planner and financial management adviser with Investors Group in London, Ontario.
Canadian residence is very flexible in definition. While there are many factors that may allow a taxpayer to claim Canadian residence for tax purposes, the most basic is how much time the taxpayer spends in Canada.
If it is more than 183 days in a calendar year, the person is likely considered a resident to the Canada Revenue Agency, particularly if the primary residence of that taxpayer is considered to be in Canada. It is important to note that CRA makes residency decisions on a case-by-case basis. If you are unsure of your residency status, contact CRA for assistance.
A Canadian resident must declare income from all world sources on a Canadian tax return.
U.S. Citizens and Residents Working in Canada
Given the length of the shared border between the U.S. and Canada, daily commuters crossing the border to work are common, so it is possible for a U.S. citizen to be a U.S. resident while earning income in Canada.
A non-resident is usually required to pay Canadian tax only on Canadian sources of income; however, under the income tax treaty between Canada and the U.S., a worker may be exempt from Canadian taxation and may apply for exemption on withholding of tax from Canadian sources.
If the taxpayer is working in Canada, but for a U.S. company, and is paid by the U.S. company, employment income is exempt from Canadian taxation as long as the taxpayer is not residing in Canada.
Article XXIV of the Canada-U.S. Income Tax Convention of 1980 spells out rules related to circumstances where both countries may claim the right to tax the same income.
This article spells out the concept that a taxpayer pays income tax to and under the rules of the country of residence, unless the taxpayer has a fixed base in the other country. The fixed base could be an office or residence.
The rule of residence gives basic treaty protection from double taxation to a U.S. citizen working in Canada, though there are elections a taxpayer can make that remove treaty protection, such as when the taxpayer or spouse chooses to be taxed exclusively as a U.S. citizen.
When a U.S. citizen is obligated to pay taxes on the same income under both Canadian and U.S. returns, double taxation usually is eliminated on line 405 of the Canadian return, where the taxpayer can claim the foreign tax credit for taxes paid in the U.S. on income reported on a Canadian return.
References & Resources
- Brent Allen, CFP, FMA; Investors Group, London, Ontario
- Canada Revenue Agency: Line 405 — Federal Foreign Tax Credit