The 5 Tax Consequences of Your Client Moving to Canada
It's not unusual for Americans to relocate to Canada or for Canadians who have lived in the U.S. for a while to do the same. Knowing how the tax laws in Canada and the United States differ from one another can assist you guide your client through the relocation with far less danger of paying double taxes and incurring penalties.
We'll go over five things to think about when your client relocates to Canada in this article:
#1 - They must submit two separate tax returns.
Tax residency laws in Canada and the United States are significantly dissimilar. While Canadians must file tax returns based on their residency in Canada, Americans must file tax returns depending on their citizenship. An American must file both a U.S. tax return (1040) and a Canadian income tax return after they migrate to Canada (T1).
The majority of the time, your client won't pay double tax even though they will be declaring their worldwide income on both their Canadian and American income tax returns because of provisions in the Canada-U.S. tax treaty that help to reduce the possibility of double tax through calculations of foreign tax credits.
#2 - They'll want to assess their investment portfolio.
Planning your investments is crucial when relocating to Canada from the United States. Given the differences in tax laws, many investments that make sense for U.S. tax residents are simply not tax effective for Canadian purposes. Some noteworthy things are:
In Canada, all interest, even non-taxable interest on muni-bonds, is subject to taxation.
After relocating to Canada, investments retained in the US will require extensive T1135 foreign asset reports, which are incredibly time-consuming and expensive to prepare and file. Moving investments to Canada is typically the best course of action.
To keep ROTH IRA funds tax-deferred for both Canadian and American tax purposes, certain Canadian tax elections must be made.
Americans frequently invest their money in revocable trusts. Because a U.S. revocable trust would be treated as a Canadian trust under Canadian tax law, extensive Canadian trust filings that would not add value would be necessary. Revocable trusts should often be terminated before migrating to Canada.
Because they lack a Canadian investment management license, the majority of U.S. investment advisors are unable to handle investment accounts for Canadian tax residents. Finding a capable Canadian financial advisor who holds both Canadian and U.S. investment licenses is crucial.
#3 - Disclosures of overseas assets will be necessary for both Canadians and Americans.
Both the United States and Canada have particular foreign asset disclosure laws, as was already mentioned. Both nations are interested in learning whether their taxpaying citizens have assets abroad. Foreign disclosure forms are very crucial to comprehend because failure to file them nearly invariably results in severe penalties:
The treasury department must receive Foreign Bank and Financial Account (FBAR) declarations from American tax residents who have assets abroad. If a U.S. taxpayer has $10,000 or more in their combined highest balance of all non-U.S. bank and investment accounts during the year, they must file FBARs (form 114).
In accordance with significantly different standards, Canadian tax residents are also obligated to reveal their non-Canadian assets. Form T1135 is necessary if a Canadian tax resident has assets (bank, investments, real estate, and other) with a cost basis greater than $100,000.
Again, it is crucial to file these foreign disclosure forms since the FBAR has a $10,000 per unreported account penalty and the T1135 form carries a $25 per day penalty with a $2,500 maximum (100 days). The $25 daily fine may not sound like much, but if you don't file this paperwork, you'll probably forget about it for at least 100 days.
#4 - LLCs are ineffective for Canadians.
Interest in limited liability companies is widespread among Americans (LLC). Although the LLC form has several benefits for American taxpayers, it is treated as a corporation and is thus distinct from the taxpayer for Canadian tax purposes. The likelihood that LLC income given to a Canadian resident will be subject to double tax makes this a crucial topic to be aware of.
Let's assume the scenario of an American moving to Canada and becoming the sole owner of an LLC that generates $100,000 in net revenue annually. The $100,000 will be passed through to the taxpayer on their 1040 for U.S. tax purposes (presuming no choice is made to treat the LLC as a corporation). However, for Canadian tax reasons, the revenue is not taxable until it is actually paid out of the LLC as a "dividend," presuming this is active business income. This is troublesome because it's conceivable to pay tax on the same income in two successive years without receiving an offset from a foreign tax credit if the income is not distributed for Canadian purposes in the same year that it is generated.
#5 - There are no possibilities for joint tax filing for Canadians.
Last but not least, the fact that Canadian tax joint filing is not an option sometimes comes as a surprise to many migrating to Canada. Married couples have the option of filing jointly for US tax reasons. If one spouse makes a relatively low salary and the other a high one, this can be a significant advantage. Each taxpayer files a single tax return for Canadian tax purposes, eliminating any benefit associated with joint filings.
The preceding list is by no means comprehensive, and before relocating to Canada, careful consideration should be made to assess a taxpayer's tax and investment status. In addition to lowering the likelihood of double taxation and penalties, competent preparation may also lower potential future tax obligations.