Did you make money in both Canada and the U.S. last year and are wondering how that will affect your income tax?
The answer depends on what kind of income the money you made is and whether or not you’ve already paid tax on it.
As a Canadian resident, you’re taxed on your world-wide income. And Canada has tax treaties with many countries to ensure that Canadians are not “double-taxed” for the same income that they earn in other countries.
Theoretically, therefore, you just pay tax in Canada for all of your worldwide earnings. In practice, though, it’s not quite so simple. Here’s the lowdown:
The simplest case: business income paid to a resident Canadian
If you have provided a product or service to a customer in the U.S., all you have to do tax-wise is convert the money into Canadian funds (the Canada Revenue Agency (CRA) says that you should use the Bank of Canada exchange rate that was in effect on the day you received the income to do this), and the money becomes part of your business income.
It’s not so simple if you were resident in the U.S. when you made the business income; then, as a contractor, you will have to file a W8 with your client (a tax form for the IRS) and may have to file an American as well as a Canadian tax return.
Foreign employment income
Having foreign employment income is also fairly simple to deal with. Your American employer will provide you with a W-2 (the equivalent of a T4 slip). You will convert the money into Canadian funds (using the Bank of Canada exchange rate that was in effect on the day you received the income to do this) and then enter your foreign employment income in Canadian dollars on line 104 of your T1 personal tax return.
If tax has been withheld, don’t reduce your foreign income by that amount. Instead, you may be able to claim a foreign tax credit when you calculate your federal and provincial or territorial taxes.
Also look to see if the amount on your W-2 slip has been reduced by contributions to a “401(k), 457 or 403(b) plan, US Medicare and Federal Insurance Contributions Act (FICA),” because if so, you have to add these contributions to your foreign employment income on line 104 on your Canadian return. These contributions may be deductible though.
Rental income from a property in the U.S. requires some forethought and tax planning because you want to handle the income in the most beneficial way to your personal tax situation.
Tax-wise, you are a Canadian resident for Canadian income tax purposes and a nonresident alien for U.S. tax purposes. Because of this, the person paying the rent is obliged to withhold and remit 30% of the gross rent to the Internal Revenue Service on behalf of the nonresident alien.
This means that if you want to deduct expenses from your rental income, you are going to have to:
1) provide your renter with a withholding waiver (Form W-8ECI) before you collect any rent so you can avoid the otherwise mandatory 30% withholding.
2) file a U.S. income tax return to report and pay tax on your net rental income.
If you haven’t chosen to eliminate your withholding tax from your rental income, your withholding agent is required to provide you with Form 1042S, detailing the amount of gross rental income received and the amount of non-resident tax withheld. Form 1042 must also be filed with the IRS. You can then choose to file a U.S. income tax return – or choose not to and forego any savings of the 30% withheld.
Here’s the big catch; if you haven’t had non-resident tax withheld, you must file a U.S. tax return. If you don’t do this within the specified time period, the IRS will not only disallow all deductible expenses but will also assess penalties for late filing and underpayment of tax.
A Little Research Can Save a Lot of Grief
This article only deals with three situations that might bring foreign income into your tax scenario – there are others, of course. As you see from the example of having rental income from a property in the U.S., you never want to wait until you’re sitting down to do your taxes to find out how something like having foreign income will affect your income tax. Finding out in advance will help you maximize your tax savings – and stay out of trouble with the tax agencies in both countries.