If you work with dual citizens of Canada and the United States, it’s important to be aware of the unique financial, tax and estate planning issues these clients face. Given the recent tax changes in the United States, these clients and their advisors will need to be ahead of the curve.
American citizens are deemed to be residents of the U.S. for income, gift and estate tax purposes. A U.S. citizen who is also a resident of Canada would be deemed to be a Canadian tax resident and also subject to tax on their worldwide income. Many presume this type of person would be subject to two levels of tax: on their worldwide income in both Canada and the States.
However, the foreign-earned income exclusion presently exempts US$92,900 of Canadian-source employment income. After the application of the exclusion and the application of foreign tax credits, most American citizens in Canada pay no additional U.S. income tax. However, there are still substantial U.S. income tax filing and compliance issues as well as planning requirements.
Dual citizenship not always convenient
The U.S. government acknowledges dual nationality exists but does not encourage it because of the problems it may cause. For example, dual citizens crossing into the States should not present both passports or indicate they are dual citizens. Doing so will likely delay re-entry. From a U.S. perspective, these people are simply American citizens.
If a U.S. citizen becomes a Canadian citizen, in most cases he does not automatically lose his American citizenship. Use of a Canadian passport or becoming a Canadian citizen does not put into jeopardy an American passport or citizenship status.
Regardless, using a Canadian passport as a U.S. citizen will likely mean a secondary screening. According to the American Embassy in Canada, people can hold both U.S. and Canadian citizenships but must always enter the States as an American.
U.S. citizens who are resident in Canada are required to file IRS Form 1040 annually on their worldwide income. This form is required to be filed by April 15 (April 18, 2011) if an American citizen owes U.S. tax. If no U.S. tax is due on the filing date, an automatic extension to June 15 is available for American citizens resident in Canada.
Despite the fact an extension for filing a U.S. tax return is available to Americans in Canada, it’s important the taxpayer’s Canadian return is coordinated with the U.S. income tax return. We generally recommend a dual-citizen-taxpayer return be prepared by a tax preparer familiar with both Canadian and American tax matters. A preparer with knowledge of both systems will likely source income and deductions properly and understand foreign tax credits, carryovers and additional compliance requirements.
Unfortunately, you can’t escape the clutches of the IRS by renouncing your U.S. citizenship, as this causes further complications (see AE September 2010, “Americans In Canada” ).
Mutual fund earnings
What about U.S. citizens who own Canadian mutual funds? Last year, the IRS changed its view of the U.S. tax treatment of foreign mutual funds. Starting in 1986, many Americans used foreign mutual funds to gain tax deferral on income that wasn’t distributed to them. Thanks to the lobbying efforts of the mutual fund industry, the government enacted a new set of complex rules regarding Passive Foreign Investment Companies. A PFIC exists when 75% or more of its gross income for the taxable year consists of passive income or 50% or more of the average fair market value of its assets consists of assets that produce or are held for the production of passive income.
Passive income includes dividends, interest and its equivalents, passive rents and royalties, annuities, gains from the disposition of stocks and securities and other assets, certain gains from commodity trading, and certain foreign currency exchange gains.
This story continues on the next page.