So you are one of the invisible aliens living in Canada – you walk and talk like a Canadian; you enjoy watching hockey, maybe have joined a curling club, and the word “eh” has crept into your vocabulary no matter how much you try to stop it. Maybe you are a permanent resident, maybe you are even a Canadian citizen; however as long as you are a US citizen or possess a US green card, the IRS continues to have an impact on your financial choices.
Most Americans living in Canada file an annual 1040 with the IRS and feel like they have complied with the reporting requirements. Because tax rates in Canada are higher than those in the USA, filing the tax return probably didn’t cost you any additional taxes because the foreign (Canadian based) tax credit offset anything you owed to the IRS. So you’ve done your job, big check on the IRS box, right?
Not quite. Here are a few ways that the IRS and their filing requirements affect your investment strategy in Canada:
- TFSA (Tax Free Savings Accounts) – one of the new and popular tools in Canada which allows you to invest after tax dollars and earn income (whether interest, dividends or capital gains) tax free in Canada. However, the TFSA was introduced after the last US/Canada Tax Treaty was signed; so it was not covered under the treaty. Instead they are treated as “grantor trusts” in the USA, requiring extra reporting and subject to US taxes.
- Foreign (ie., Canadian) Mutual Funds and ETFs are considered Passive Foreign Investment Corporations (PFIC) by the IRS. When held outside of an RRSP, they are subject to a tax and interest regime. This extra regime applies when a distribution or gain is 125% of the average distribution for the prior three years. There are options requiring extra tax filing that may overcome this issue, however the extra paperwork can be onerous and the tax consequences severe depending on the situation. It is typically not in your best interest to invest in foreign (ie., Canadian) mutual funds or ETFs. One way to avoid the issue: invest directly in the stocks and bonds rather than in funds.
- Foreign (ie., Canadian) bank account reporting of your Canadian bank accounts has become increasingly complex. You are required to submit both a FBAR to the US Treasury (if your aggregate value exceeds $10,000), and a Form 8938 to the IRS (if your balance was greater than $200,000 on the last day of the year or greater than $300,000 at anytime during the year).
- Dividend, Interest Income or Capital Gains – Investment income is treated differently between the two countries (eligible dividends vs ineligible dividends; ordinary dividends vs qualified dividends, short-term vs long-term capital gains, tax-free interest income vs taxable income). Your investment strategy needs to consider the tax consequences in both countries to ensure you do not end up with unexpected tax costs.
This is just an introductory review of how the IRS impacts your investment strategy. There are many strategies that can be employed to minimize your taxes in Canada and the USA depending on your circumstances. Please consult with a tax accountant specializing in US taxes to help address your particular needs. And please consult with a financial advisor you trust and who is experienced in the complexities for Americans investing in Canada.
Gail Cosman, after living 8 years in Connecticut, returned to Canada in 2006. Her husband is both an American citizen and a Canadian permanent residence. For the last 7 years they have dealt with the increasingly complex tax and reporting requirements from the USA. They have learned from personal experience the impact the IRS has on investment strategies. Gail works with Americans in Canada to reflect the tax consequences of both US and Canada in their investment strategies.