So you're living in Canada, but are stuck filing a US tax return for whatever reason. And you want to know how to file a US tax return, but don’t know where to start?
Good, you’re in the right place. Below is a brief summary of the various Canadian and US tax return schedules and filings that an expat might encounter during the process.
First things first (because lawyers etc): What is written here is not formal tax advice. I’m not your CPA. It’s possible, or dare I say even probable, that the comments and opinions expressed here contain material errors, are out of date, or that important stuff has been left out. Don’t use this info to make tax decisions. Hire a pro to help you.
Okay, with that you out the way: Don’t assume that because you’re under a certain income level, you don’t have to file a US tax return. There’s certain disclosures that the IRS says must be filed, regardless of your personal income, and there are some nasty, nasty penalties for not doing so.
Given the above, it’s often smart to file your tax returns (US and Canadian) every year to stay clear of any issues with the IRS or CRA. Ironically, by filing some semi-complicated paperwork, you’ll actually make your life simpler.
Important Stuff For Tax Season
For the 2023 Tax Year, keep these deadlines in mind:
- General Canadian filing deadline = April 30, 2024.
- Canadian deadline if self-employed = 17 June 2024.
- US filing deadline = 15 April 2024.
- If you need an extension, file Form 4868
- US expats living in a foreign country get an automatic filing extension to June 15th. (But not an extension of payment. Remember to pay your estimated balance due by April 15th.)
Speaking of extensions…
If you find yourself needing more time beyond the initial deadline for your US taxes, you can use form 4868 to extend the filing date to October 15, 2024. While there's technically an option to extend further to December 15, it's generally best to aim to file by October 15.
Now, on to the tax returns!
PART A: BASICS
Being a US citizen or Green Card holder living in Canada comes with the unique situation of having to file tax returns in two countries. You'll be filing the following:
- A Canadian T1 income tax return.
- The US 1040 income tax return.
“Well thanks, Captain Obvious” I hear you saying. And you’re right. The trick when filing the above returns is to know what supporting Schedules and Forms are included with your 1040/T1 filings. This is sometimes easier said than done, and something that we will get in to more detail on below.
Speaking of supporting docs: in addition to your tax return, you may also encounter some additional, but separate, filings...
ADDITIONAL FILINGS & DISCLOSURES
Taxpayers with foreign ties have potential US and Canadian reporting obligations beyond just tax returns. There’s generally two key reporting schedules, both of which involve the disclosures around foreign assets and income.
US - Foreign Bank Account Reporting (FBAR)
For US persons, the FinCEN Form 114, or FBAR, is crucial. This form, mandated by the US Treasury Department, is for reporting foreign bank and investment accounts. Speaking generally, if you hold Foreign accounts, that when added together, total over $10,000USD, you have to file one of these things.
It's a common oversight but missing this filing can lead to steep penalties—up to $10,000 for each account not reported, or 50% of the account's value, whichever is greater. Unlike the Canadian T1135 (more on that below), the FBAR isn’t part of your tax return. It must be filed separately and electronically directly to the Treasury. (There's a sister form to the FBAR’s, the Form 8938, which is filed alongside your 1040.
Don’t forget: For this reporting, you'll need to convert the value of your Canadian holdings to USD using the year-end exchange rate. (Shameless plug: My office has a DIY working paper on this that we are happy to share with you. Just ask.)
Canada - T1135 Foreign Income Verification
In Canada, taxpayers with certain types of foreign assets totalling more than $100,000 CAD must fill out the T1135 form. This form applies to assets outside of Canada like bank and investment accounts, and real property, but not to US IRAs or personal vacation properties in the US. The penalties for late filing can add up to $25 per day, with a maximum of $2,500CAD.
A detailed T1135 is necessary for US-based non-registered accounts, which can lead to a lot of suck: For investments held in Canadian-based brokerage accounts, you’re only required to report aggregate values by country (Yay!). However, if your investments are held in a US-based account, each individual holding must be reported individually (Very sucky.)
This distinction can significantly impact the complexity of your filing and potentially the cost of tax preparation or the time you spend on it. Transferring US investments to Canadian accounts may simplify this process and may be worth considering.
PART B: US Forms & Schedules – A Brief Summary.
Everything starts with the 1040 Return, the main tax return form used each tax year. This form is where you'll jot down your basic info like your name, address, who's in your family, and how much money you made. It helps you and the IRS see a summary of your income and figure out your taxes for the year. When you file, you can choose how you want to be seen in the tax world: single, married and filing together, married but filing on your own, or as the head of your household.
For those with feet in both Canada and the U.S., here's a quick summary: Dual citizens often file as married filing jointly (MFJ), while U.S. citizens with spouses who aren't U.S. citizens usually file as married filing separately (MFS). There are rare cases where you might decide to file jointly with a non-U.S. spouse, but they are rare. And for those who qualify, filing as head of household could be an option – this requires having a non-U.S. spouse and a dependent who is a U.S. citizen. (Google this up if you want to go down a rabbit hole.)
Schedules 1 through 6 were introduced to streamline the information on the main 1040 form and other related documents. These schedules are filled out based on information from other forms, which we will discuss later.
Schedule A is used to calculate itemized deductions. However, due to recent U.S. tax reforms that eliminated many deductions and increased the standard deduction, Schedule A is less commonly used by U.S. persons in Canada. Often, the U.S. tax calculated on Form 1040 is offset by Canadian tax through foreign tax credits and Form 1116, resulting in no U.S. tax liability.
Schedule B details the taxpayer's investment income for the year and includes important questions about foreign financial accounts, such as FBARs and Form 3520. Expats need to pay particular attention to "Part III" of the schedule.
Schedule C reports profit or loss from business activities. Self-employed individuals report their income here. Dual resident taxpayers in Canada are not subject to both Canadian CPP and U.S. self-employment taxes due to the U.S.-Canada Totalization Agreement. Thus, U.S. citizens residing in Canada only pay Canadian CPP contributions.
Schedule D is for reporting capital gains and losses. The U.S. allows a deduction of $1,500 for individuals filing separately and $3,000 for those filing MFJ against non-capital income. Pro-tip: A common error in cross-border returns is the incorrect calculation of capital gains due to currency conversion. Income such as pensions and employment income is converted using an average exchange rate, while capital gains must be converted using the actual rate at the time of the transaction.
Schedule E reports various types of income, including rental, royalty, partnership, S-corp, trust, and estate income.
Schedule F is for reporting income and losses from farming activities.
Schedule SE calculates U.S. self-employment taxes. As mentioned, U.S. citizens living in Canada typically do not owe self-employment taxes and would not calculate them on this form. A disclosure is required to be included in the tax return (See Form 8833 below) to clarify that no self-employment tax is due.
Form 1116. So, if you're an American living up in Canada, you've probably heard about Form 1116. It's super important for your tax returns because it's the form that lets you tell the IRS, "Hey, I already paid some taxes in Canada, so let's not do this whole tax thing twice."
Now, messing up this form can cause some headaches. You might end up paying more tax than you should, and that's exactly what the US-Canada tax treaty tries to prevent. It's all about keeping things fair and not taxing you twice on the same income.
Basically, Form 1116 is your way of claiming a credit for the income tax you've already forked over to Canada. Functionally, this form looks at how much of your foreign income (in this case, Canadian income) gets taxed on your US tax returns. It then gives you a US-side reduction in your US taxes based on how much Canadian tax you paid on the already-taxed-in-Canada income.
There are three main "buckets" of income that you'll use separate Form 1116s for:
- General income: This is stuff like your pension, work, or business income.
- Passive income: We're talking investment returns, dividends, interest, capital gains, and the like.
- Resourced income: (Pronounced “Re-sourced”) This one's a bit different. It's for US income that the treaty says isn't taxable in the US. Think interest from the US, capital gains, or any US pension and dividend income that's over 15%.
Separately, there's also something called the IRC 951A/Global Intangible Low-Taxed Income (GILTI) rules, but that’s for later.
Form 2350 is utilized by taxpayers to request an extension of time to file their U.S. tax return, specifically when they need to file Form 2555 for foreign earned income exclusion. To be frank, it's generally more practical to file Form 4868 for an extension.
Form 2555 is frequently seen in cross-border tax filings, but it's not commonly used for our clients who are both Canadian and U.S. residents. This form allows for the exclusion of foreign earned income under certain conditions. We prefer to apply foreign tax credits using Form 1116 to eliminate U.S. tax on Canadian-sourced income, especially since it enables the carry-forward of unused general source foreign tax credits to future years. If you choose to stop using Form 2555 to exclude foreign income, specific elections are required.
Forms 3520 and 3520-A (!Danger!) are often mandatory for U.S. expatriates in Canada who are either owners or beneficiaries of a trust or who have received a substantial gift from a non-U.S. resident. Recent IRS guidance under Rev. Proc. 2020-17 has exempted certain accounts, such as Canadian Registered Education Savings Plans (RESPs), from being classified as trusts for the purposes of these forms. The determination and filing of Forms 3520 and 3520-A are intricate. I won't outright say talk to a pro, but also don't be the guy who goes "Hold my beer..." (My comment: These are really annoying forms.)
Form 4506-T is submitted to request a transcript of your U.S. tax return. IRS Transcripts are necessary when responding to the CRA’s inquiries about foreign tax credits claimed on a Canadian tax return for taxes paid in the U.S. The CRA WILL request verification of your US income tax paid on reported income during their pre or post-assessment reviews. The transcript obtained through Form 4506-T fulfills this requirement from the CRA. (ID.me works too - More on that below.)
Form 4868 is used to apply for an automatic extension of time to file a U.S. individual income tax return. While the IRS grants an automatic 2-month extension to U.S. citizens and residents abroad, this does not apply to payments of any tax due. If you owe taxes, you must estimate your tax liability on this form and should pay any amount due by the regular due date to avoid interest and penalties.
Form 5329 is used to report additional taxes on qualified plans (including IRAs) and other tax-favored accounts. U.S. citizens owning both Canadian and U.S. retirement plans may need to file this form if they receive distributions from these plans.
Form 5471 (!Danger!) is required to be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in certain foreign corporations, including Controlled Foreign Corporations (CFCs). In normal-speak: If you’re a US Citizen who owns a Canadian corporation, you’re likely going to have to file this one.
But say you don’t want to, and you’re just going to ignore it? The IRS can impose penalties for failure to file this form: $10,000 per missed filing. (At the time of writing, the Aroeste case might change things, depending on the appeal goes.)
The 5471 is a beast of a filing. If you need one of these drafted, try to make sure you know what you’re doing. CFC’s and PFIC’s are some buzzwords you’ll want to brush up on. Forex conversions too.
Form 6251 is used to calculate the amount of alternative minimum tax (AMT) a taxpayer may owe. The AMT is designed to prevent taxpayers from using certain tax benefits to avoid paying their fair share of taxes. It applies to taxpayers who have certain types of income that receive favourable treatment, or who qualify for certain deductions, under the tax law.
Form 8275 is used to disclose items or positions that are not otherwise adequately disclosed on a tax return to avoid certain penalties. This form is typically used when a taxpayer is taking a position that may result in an adjustment by the IRS, such as claiming a deduction or credit that the IRS may not allow.
Form 8621 is used to report ownership interest in a passive foreign investment company (PFIC), or to elect to treat a foreign corporation as not-a-PFIC. A PFIC is a foreign corporation that meets certain income or asset tests aimed at identifying companies where U.S. shareholders have the potential to defer income through foreign investments.
Fun Fact: PFIC’s are beyond the scope of this post, but you should know that Canadian mutual funds can be caught by PFIC rules. So if you find yourself holding these investments, it’s worth seeing if the fund provides a “PFIC Annual Information Statement.” It'll simplify your life a little bit.
Schedule 8812 is used to calculate the additional child tax credit if a taxpayer has a qualifying child. The key here is that this credit is refundable, meaning it can result in a refund if it's more than the amount of tax owed.
Form 8833 is used to disclose a treaty-based return position, and is often critical in US cross-border filings. It's used when a taxpayer is claiming treaty positions, such as:
- Excluding CPP/OAS/US Social security.
- Make self-employment income non-taxable (Related to Permanent Establishment stuff.)
- Get out of US Self-Employment tax.
- Adjustment of interest or capital gains income.
- Adjustment of income related to artists, athletes, students, trainees, or teachers.
Also, it's a $1,000 penalty for missing this guy.
Form 8840 is used to claim a closer connection to a foreign country and to exclude days of presence in the United States for purposes of the substantial presence test. This form is typically used by nonresident aliens who want to claim the closer connection exception to the substantial presence test.
You can't claim the closer connection exception if:
- you spent 183 days or more in the U.S. in the current year,
- you have a Green Card,
- you missed filing Form 8840 by the due date, and can't come up with a legit reason for late filing to the satisfaction of the IRS.
Form 8854 is essential for individuals who have decided to expatriate, or renounce their U.S. citizenship, within the tax year. This form is used to report the act of renunciation and its associated tax implications. Expatriation is another beast of an area, but here are some points to remember:
- If you're renouncing your U.S. citizenship, you must file Form 8854 for the tax year in which you expatriate.
- If your net worth is under $2 million, the tax consequences of expatriation are relatively straightforward, aside from the final year's filing requirements.
- If you’re a dude with a net worth exceeding $2 million at the time of expatriation = "Covered expatriate". This is bad. You have a bunch of extra tax headaches.
Form 8858 is required for Americans in Canada who operate sole proprietorships or other foreign disregarded entities, to be filed alongside their 1040 tax return.
Form 8938 (!Danger!) is filed with your 1040 tax return to report your foreign financial accounts. Think investment accounts, plus some others. It differs from the FBAR in several ways, including the types of accounts reported, the requirement to disclose account closures, and total income from foreign accounts. There’s a financial threshold for this form, as well as some nuance around non-resident alien stuff.
Form 8960 calculates the Net Investment Income Tax introduced to support the U.S. healthcare system under Obamacare. (You’ll often hear this referred to as the Obama Tax on forums.) This 3.8% tax applies to investment income above certain investment income thresholds ($125,000 Single/$250,000 Joint) and can’t be offset by Canadian taxes through the juggling of foreign tax credits.
Other Misc US Forms
K1 Form Entries are income slips received if you're involved with certain U.S. entities like LLCs, partnerships, S-Corps, C-Corps, or if you're a beneficiary of an estate or trust. These slips are crucial for U.S. citizens in Canada for tax filing purposes. They function similar to a Canadian T5013.
Form W9 is requested by financial institutions for U.S. citizens to provide their Social Security Number. This form is retained by the requesting institution and not sent to the IRS.
The W-8BEN form is essentially a document that foreign individuals or entities use to tell the U.S. tax system, "Hey, I'm not from around here." This form is crucial for anyone outside the U.S. receiving certain types of income from U.S. sources, like interest or dividends. It helps in two big ways: it proves you're not a U.S. taxpayer, and it might qualify you for lower tax rates under tax treaties between the U.S. and your home country. You don't send this form to the IRS; instead, you give it to whoever is paying you, ensuring they withhold the correct amount of tax. So, if you're a foreigner dealing with U.S. income, the W-8BEN form is your key to making sure you're taxed correctly.
Remember, I have to strike a balance between enough detail to help (Helpful) vs. writing a technical novel on this stuff (Not helpful.) If you’re slightly confused, overwhelmed, or annoyed at the content here, it might be a good idea to get some Real Advice.
PART C – CANADIAN TAX RETURN STUFF
Filing Canadian tax returns as a US resident or expat might not be extensively detailed in most resources, but I've gathered some key points and forms that are maybe important for US citizens to consider when preparing their Canadian tax returns.
Form T1135 - This form is basically Canada’s version of the US FBAR requirements, in that Canadian Revenue Agency requires you to disclose information about your foreign assets. It's an essential form for disclosing assets held outside of Canada. (See section above for more detail.)
Form T1142 is for those who have received distributions from foreign trusts or estates. It's particularly relevant for Americans living in Canada who might receive distributions from US estates or trusts at some point. It matters because it helps to report both the capital and income portions of such distributions. (Generally-speaking: Capital –= Tax-free. Income = taxable.)
Forms T1161 and T1243 are for when a Canadian decides to leave Canada and becomes a non-resident for tax purposes, often due to relocating to the US. These forms are filed as part of the Canadian exit tax return. The CRA considers most of your worldwide assets (with some exceptions) to be “Sold” (Section 128.1(4)(b) Deemed Disposition, if you want to google) at the time you leave. These forms are used to report the deemed disposition of assets in that tax year.
Form T2203 is used when services or sales are provided across multiple provincial or international borders. Its primary function is to facilitate the calculation of provincial and territorial taxes for individuals who have earned employment or business income in more than one province or territory within Canada.
Form T2209 plays a crucial role similar to Form 1116 in the US tax system. It enables the claim of a foreign tax credit for taxes paid to other countries. An example would be a Canadian travel nurse working in the US. Initially, this income is reported on a US W2 and taxed in the US. After that, it is subject to Canadian taxation. However, through Form T2209, individuals can claim a foreign tax credit for the taxes already paid or accrued in the US, effectively preventing double taxation on this income. This form ensures that taxpayers are not penalized by dual tax obligations, promoting fairness in the taxation process for cross-border income.
PART D – MISC COMMENTS
Cross-border stuff is weird. In no particular order, here’s some things pay attention to:
- CRA is guaranteed to review your Canadian FTC claim. I don’t know why. It just is. Both in my own practice, and talking to multiple other sources in this filed, everyone is getting FTC claims reviewed, no matter how material the claim is. Get your IRS Transcript in order, because you’ll need it.
- The ID.me system is becoming more and more helpful for Canadian working in the US. (Think TN Visa people.) If you don’t have this set up, you should get it.
- Can you self-file cross-border returns? Yes of course. Tax software these days is pretty good. The issue you’ll run into is that there is no comprehensive cross-border software to make everything work nicely. You functionally have to take Country A’s tax return, and adapt it to the Country B’s tax system, taking into considering how stuff that works in Country A doesn’t apply to Country B. Oh, and they use different currencies.
The End. Oh and one more time for the crowd in the back: What is written here is not formal tax advice. I’m not your CPA. It’s possible, or dare I say even probable, that the comments and opinions expressed here contain material errors, are out of date, or that important stuff has been left out. Don’t use this info to make tax decisions. Hire a pro to help you.