Every four years in America, an unusual event occurs. It takes place on the Wednesday following the first Monday in November. On this day, Americans of all stripes threaten to move to Canada, as a response to their preferred candidate losing the previous day’s presidential election.

Every day, many Americans are moving to Canada for many different reasons. This article is to expand on various tax consequences that will impact them from both countries as part of the move.

Some basic facts about tax in Canada include: Canada taxes all residents on worldwide income—citizenship isn’t relevant. Additionally, outside Quebec, there are no provincial tax returns for individuals; provincial taxes are usually just an additional form on the federal return. Also important is that joint filing is not possible in Canada; all individuals file separately. Finally, it is important to note that tax rates are significantly higher in Canada, with a 53% tax rate in Quebec and Ontario beginning at around $215,000 Cdn or $160,000 USD, based on 2021 exchange rates.

Tax rules that will impact an individual following a move from the U.S. to Canada will depend on the following factors:

1. Whether or not they will retain a U.S. filing obligation upon moving to Canada — U.S. citizens or green card holders
   
   
2. Whether or not the individual is a new resident of Canada, or a returning resident of Canada.

All tax consequences would depend on how the individual will answer the above two questions.

Items to Consider Prior to Leaving for Canada

Five key items to consider prior to moving to Canada include:

1. Should an individual convert a traditional IRA/401K to a Roth IRA/401K?
2. How should we allocate family assets to pay less Canadian tax?
3. Should an individual realize capital gains/sell assets prior to departure?
4. How can one minimize tax on the sale of a primary residence?
5. For small business owners, how do we structure the business if it will continue operations following departure to Canada?

IRA Conversions

In Canada, traditional IRAs are taxed similarly to the U.S., in that all withdrawals are fully taxable. However, with higher Canadian tax rates, it is possible that the tax on these withdrawals can be quite high. Furthermore, Canada will apply the tax treaty rate for periodic pension withdrawals, and only allow a foreign tax credit of 15%, even if the U.S. tax rate is higher, contributing to double taxation. Accordingly, converting to a Roth IRA prior to departure can be a good idea to reduce tax.

Converting the IRA will result in a significant income inclusion right away, but can result in no further tax on that account for the remainder of the life of the account holder. For moderate sized accounts, or for younger individuals, the one-time tax, even at high U.S. rates, will likely be much lower than the eventual tax paid in Canada on traditional IRA withdrawals. To achieve these results, all that is needed is a simple election on the first Canadian return upon arrival in Canada. This conversion must be done prior to coming to Canada as any contribution to a Roth IRA account by a Canadian resident does not receive tax-free status in Canada, including conversions.

Asset Transfers

In Canada, all investment income is based on who is the owner of the asset and there is no joint filing. As such, there would be significant interest for Canadians to transfer assets to a lower- income spouse. In order to prevent these transfers, Canada implemented a system of income attribution to ensure that the giver of the assets will be the one paying the taxes when this occurs. However, there is no attribution for assets transferred by non-residents or transfers prior to obtaining Canadian residency. Furthermore, spousal transfers in the U.S. between two U.S. citizen spouses do not have gift tax, so there would be no change in U.S. tax based on these spousal transfers.

Additional consideration would regard whether individuals will no longer be filing U.S. returns following the move. While gift tax may apply, items transferred to individuals without U.S. filing obligations upon departing the U.S. will result in these items no longer being taxable in the U.S. This would even apply to transfers to minor children who will simply pay tax in Canada at their marginal rate for any income earned on these assets.

Realizing Gains

In Canada, the basis of all assets is either the amount paid for them or the fair value upon immigration to Canada. As such, people moving from the U.S. can have a different basis for each country, complicating the reporting.

As such, it often might make sense to sell all assets prior to moving to Canada. It would allow for the same basis in both countries, allowing individuals to maintain only one set of books and records. This would be correct for cases where both spouses are U.S. citizens and will retain a U.S. filing obligation following the move.

For individuals who will not have a filing obligation following a move, it would make sense to realize all losses, but not sell any items where there is a gain. This will allow the step-up in basis in Canada, and no tax in the U.S. on unsold items unless the individual is subject to expatriation tax rules.

Sales of Primary Residences

Both Canada and the U.S. offer certain tax breaks for sales of primary residences. However, Canada offers an unlimited exclusion on only one home at a time, while the U.S. offers a limited 250K exemption to any home that was the primary residence for two of the past five years. As such, an individual moving to Canada and acquiring a new home in Canada, but keeping one’s American home, can be taxed on the gain in value of the home from move date until sale date, even if there is no American tax on this gain. Alternatively, a long held Canadian home with a large gain, can result in U.S. tax if the gain is larger than the exemption from U.S. tax.

Business Structure Planning

For small business owners, Canada has a completely different business climate than America does. While the U.S. has a large variety of business structures, Canada has a limited few. As such, all American structures that don’t have obvious equivalents, need to be analyzed and classified in Canada based on their characteristics. As a result of this analysis, common U.S. structures such as LLC, LLP & LLLP are taxed differently in Canada. While for U.S. reporting, these entities are generally taxed as partnerships, in Canada they would be treated as corporations. Therefore, for U.S. reporting all income is allocated annually to the members/partners, while in Canada, there is only tax on distributions to the owner. Failure to plan for this can result in double taxation.

Another issue to consider with these structures is the Canadian information reporting. Depending on the share of ownership, Form T1134 might be required. This form is the Canadian equivalent to U.S. form 5471, and is highly complicated to prepare. Furthermore, if the individual has control of the entity, then it would be subject to Foreign Accrual Property Income (FAPI) rules. This is the Canadian equivalent to U.S. subpart F rules.

Four Major Differences in U.S. and Canadian Tax Rules and Classifications

1. Investment income
2. Rental income
3. Alimony
4. Scholarship income

Investment Income

Dividends & capital gains are treated similarly in both countries, but have some significant differences. Per article XXIV(6) of the Canada-U.S. income tax treaty, these items, plus interest are taxed to the country of residence, except for real property sourced in the other country. However, differences are that for dividends, it needs to be remembered that Canada will enforce the treaty and will allow a tax credit of only 15% on this income. Because Capital gains will have different basis in each country, two sets of books and records must be kept.

Rental Income

A key difference between the countries’ rules would be that Canada doesn’t have mandatory depreciation. In fact, it’s very rare that Canadian accountants even claim the depreciation; this is done to reduce recapture taxes on eventual sale. As the U.S. mandates depreciation, it will be necessary to maintain different records for each country as to basis on sale. Additionally, for property held outside the U.S., the depreciation is taken over 30 years, compared with 27.5 inside.

If non-U.S. citizens maintain a U.S. property as a rental following departure, it is necessary to file an 871(d) election with their first 1040NR reporting rental income, in order to claim expenses. Failure to make this election can result in being taxed on the gross rental income.

Alimony

Canada follows the old U.S. rules where amounts paid are taxable to the receiver and deductible to the payor. This can result in a situation where either both sides are non-taxable or both sides are taxable. In a situation where the payor spouse resides in the U.S. and the receiving spouse resides in Canada, tax treaty article XVIII(6) allows the receiver to claim a deduction on the Canadian return to allow the treatment in Canada to mirror the U.S. and not double-tax the payments. However, when both former spouses reside in Canada, the treaty would not apply and there will be double-taxation based on the different rules in each country.

Scholarships

In the U.S., scholarships received in excess of tuition is taxable income. In Canada, scholarships received for full time students are not taxable, while tuition fees are still deductible. As such, U.S. taxpayers studying or residing in Canada may have certain inclusions on their tax returns that would not otherwise be there if they were only Canadian filers.

Cross-border Tax-exempt Accounts

In general, both Canada and the U.S. don’t accept the non-tax designation of financial products put out by the other country. With the limited exception of traditional IRA/401K/similar products in the U.S. and the RRSP/RRIF/LIRA in Canada, all vehicles that are tax free in one country will be taxable in the other.

Information Reporting Forms

Both Canada and the U.S. have significant information reporting forms on their tax returns. For U.S. citizens abroad, your local bank account is a foreign asset as far as the U.S. is concerned and will require annual reporting. From a Canadian perspective, your bank account back in America is a foreign account and will require special reporting. Both countries have sizable penalties for failing to file these forms on time, with the U.S. having penalties of $10,000 per failing for most forms, while Canada has a penalty of $2,500. Some forms to be aware of include:

Canadian Forms

• T1135 – Reporting of all foreign held assets. Similar to Form 8938
• T1134 – Reporting of foreign affiliates or controlled foreign affiliates. A foreign affiliate is a business located outside Canada where the taxpayer has a significant financial interest. Similar to form 5471
• T1141 and T1142 – Reporting of transactions with foreign trusts. Similar to U.S. forms 3520 & 3520A.

U.S. Forms

• FINCEN 114 (FBAR) – Reporting of all foreign accounts in which the individual has a financial interest or signing authority
• Form 8938 – Reporting foreign accounts and specified foreign assets
• Form 5471 – Reporting of ownership of foreign companies
• Form 8865 – Reporting of ownership of foreign partnerships
• Form 8858 – Reporting of ownership of foreign disregarded entities
• Forms 3520 and 3520A – Reporting of ownership and transactions with foreign trusts
• Form 926 – Reporting contributions to a foreign company.

The above is just some basic introductory information regarding tax issues someone might incur when moving from the U.S. to Canada. Keeping aware of these items should help an individual make the move to Canada more successful. However, should someone be considering this type of move, it is crucial to get proper guidance as to the specific situation and not just rely on this article above. 

Nathan Farkas, CPA, is the founder and sole practitioner of Nathan Farkas & Associates, a cross-border accounting firm in Montreal. He has a CPA license in New York, Quebec and Ontario. His office specializes in Cross-border tax (Canada-US) for individuals, in particular, U.S. citizens in Canada, Canadians with U.S. investments, individuals moving between the two countries. He is a member of the NYSSCPA International Taxation Committee and is the former president of the NYSSCPA Adirondack Chapter.