Are you running a U.S. business about to engage in business transactions with Canada? Or are you a Canadian resident working and earning income in the U.S.? You might be wondering how your cross-border income is to be taxed if you work in Vancouver but are a U.S. citizen – should you pay taxes only in the country where you earn the income or in your residency country as well?
These are all valid questions. Unfortunately, some U.S. and Canadian taxpayers make serious mistakes mostly because of ignoring (or being ignorant to) these important questions. Here are some of the common mistakes you would do well not to make.
Mistake #1: Failing to realize that the U.S. taxes you on your worldwide income
The US is practically the only country in the globe that taxes it’s taxpayers based on citizenship rather than residency. That means that as long as you are a US citizen you have to file a US tax return and possibly pay taxes to Uncle Sam regardless of where you work or where you actually reside. Most other countries, such as Canada, tax their residents on their worldwide income. The difference here is that, if a Canadian citizen stops being a resident of Canada, he will not need to file and pay Canadian taxes. Note that in certain occasions, a nonresident still pays taxes, such as when they earn income in that country or receive rental income from a property situated in that country.
Mistake #2: Not Filing Cross Border Taxes Separately in the U.S. and Canada
If you are a resident of Calgary with income earned in the U.S., you might erroneously believe that you only have to file taxes with the U.S. Internal Revenue Service (IRS). It might seem logical at first that since your income comes from the U.S., you should report it only to the U.S. tax authorities. In reality, the Canada Revenue Agency (CRA) also claims the right to tax the income you earned in the U.S. As previously stated, the CRA has the right to tax the worldwide income of Canadian residents.
The same applies for a U.S. person earning their income in, say, Calgary. They are obligated to disclose or report their foreign income to the IRS. You should contact a lawyer knowledgeable in cross border tax law for more detailed explanations.
Additionally, the government in which you earn your income (be it federal or state/provincial) also has the right to tax that income.
Mistake #3: Not applying for foreign tax credits
We already said that as a resident of either the U.S. or Canada earning your income outside your resident country, you file taxes in your resident country and (usually) in the country where you work. This might look like you are being taxed twice for the same thing. For this particular reason, a number of foreign tax credits are available both for U.S. and Canadian taxpayers.
The purpose of foreign tax credits is to avoid double taxation but there are certain conditions to be met in order to qualify for a particular tax credit. The best thing to do is to consult a tax professional in addition to a cross-border tax lawyer serving U.S. taxpayers working in Calgary or elsewhere in Canada.
Mistake #4: Forgetting about Canada — U.S. Tax Treaty
Some countries have drafted tax treaties so each country can procure taxes from its citizens easily. Canada and the U.S. have had a tax treaty since 1980, with five protocols added to it. As a result, the two countries exchange information upon request, as regulated by the treaty.
The treaty may affect several aspects of tax filing and planning. For example, as a Calgary-born Canadian citizen earning income in the U.S., you would be subject to 30% withholding tax under FDAP. Because of the treaty Canada has with the U.S., the rate is lower. Consult a tax lawyer about the specifics.
Mistake #5: False residency status on the tax return
Depending on your residency status, the tax return forms you will fill out will differ. For example, as a U.S. person, you would prepare returns on a ‘’1040’’ form, whereas, as a non-U.S. resident, you would file a ‘’1040NR’’ form. Different tax forms stand for different taxation structures, which are different for residents and non-residents.
Your tax preparer may simply assume you are a U.S. resident, when in fact you can be a Canadian resident from Calgary working in the U.S. Improper residency status may prove a significant complication and cost you tax exclusion and/or foreign tax credit opportunities.
Mistake #6: Not hiring a tax professional or lawyer specializing in cross-border tax law
Not all tax professionals specialize in (or handle) cross-border tax cases. Insufficient knowledge or practice in handling the cases may lead to severe mistakes. For example, as a U.S. person with foreign income, you are obligated to disclose or report the income on your tax return. Your tax advisor may fail to even ask you about your foreign account or assets, or may simply fail to account for all the foreign assets and income. As a result, the tax return they draw would be incomplete and border on (unintended) tax evasion. Unintended or not, tax evasion is serious and severely punishable.
Cross-border tax law is a complex area of law. As the international market rapidly changes, so does the regulations framework. If you or your company are about to engage in business transactions that cross borders, you will want to know what the cross-border tax implications and legal requirements are.
Contact Brunoro Law, a well-established cross-border and international tax lawyer group – we serve residents of U.S. and Canada that plan on doing or are already doing business in a foreign country. Reach out us to schedule a no-charge 1-hour consultation.