Canada-US Tax Treaty
Published on April 24, 2024
by Clark Stott
Clark Stott has been with Expat Tax Online since 2015. Being a dual national based in the UK, Clark has unique experience helping US citizens (and Accidental Americans) become tax compliant via the Streamlined Tax Amnesty program. Clark likes to help Americans in the UK keep their tax situations as simple as possible to avoid harsh IRS treatment.
Table of Contents
Why does the tax treaty between the US and Canada exist?
The tax treaty between the US and Canada is designed to prevent the double taxation of income earned in one country by the residents of the other, thus promoting economic cooperation and easing the tax burdens for individuals and businesses operating across borders.
This agreement helps clarify the tax obligations and entitlements for US and Canadian citizens and residents, ensuring they are not taxed by both countries on the same income.
You can take a look at the treaty’s provisions on the official IRS site.
How do I claim US/Canada income tax treaty benefits?
- Applicable Provisions: Familiarize yourself with the treaty provisions that apply to your situation, such as those pertaining to dual residency, earned income, pensions, and investments.
- Complete the Right Forms: To claim treaty benefits on your US tax return, you must file IRS Form 8833, Treaty-Based Return Position Disclosure. This form accompanies your regular tax return and explains the treaty positions you’re taking.
- Documentation and Evidence: Keep detailed records and any necessary documentation from Canada, such as proof of tax residency or statements of income earned in Canada.
- Consult a Tax Professional: Because the US-Canada Tax Treaty covers numerous situations and can be complex, consulting with a tax professional knowledgeable in international tax law is highly recommended.
Do US dual citizens living in Canada pay taxes to the US or Canada?
It depends on your tax residence status. Generally, you are taxed by the US based on your global income. However, both countries allow you to claim a credit for taxes paid to the other country, which can reduce your tax bill with a credit or exemption available on your US tax return.
Why use the IRS Streamlined Tax Amnesty Program?
It’s for American citizens that didn’t know they had to file U.S. tax returns each year, and have therefore fallen behind. Some more than 30 years! With the IRS Streamlined Procedure, say goodbye to overdue tax returns, late fees, and penalties.
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What mechanisms are in place to relieve double taxation under the treaty?
Both the United States and Canada allow individuals to claim Foreign Tax Credits, Foreign-Earned Income Exclusion, and Foreign Housing Exclusion on their tax returns for income taxes paid to the other country.
- Foreign Tax Credits (FTC): The Foreign Tax Credit system allows individuals to credit taxes paid in one country against their tax liability in the other country. This is perhaps the most direct method for preventing double taxation. For example, if a dual citizen pays income tax on employment income to Canada, they can claim a credit for these taxes on their US tax return.Â
- Foreign-Earned Income Exclusion (FEIE): The FEIE is a US tax provision that allows US citizens and resident aliens to exclude a certain amount of foreign-earned income from their US taxable income. For the tax year 2023, this exclusion amount is up to $120,000. This means that if a US citizen living in Canada earns income from Canadian sources, they can exclude up to this amount from US taxation.
- Foreign Housing Exclusion (FHE): In addition to the FEIE, US expats can also claim the Foreign Housing Exclusion or deduction, which allows them to exclude or deduct certain amounts paid for household expenses. The amount of the exclusion or deduction is based on actual foreign housing expenses and varies depending on the location.
If there’s a problem with judging the tax residency, then tie-breaker rules are used to determine a taxpayer’s residency for tax purposes.
How does the treaty address the issue of tax residency?
The treaty includes specific rules to determine a taxpayer’s residency for tax purposes. When an individual is considered a resident of both countries, the treaty resolves this by using several tie-breaker rules:
- Permanent Home: Preference is given to where the individual has a permanent home available.
- Center of Vital Interests: If homes are in both countries, the country with the individual’s economic and personal ties are considered.
- Habitual Abode: If the center of vital interests cannot be determined, the country where the individual spends more time is considered.
- Nationality: If still undecided, the individual’s nationality is taken into account.
- Mutual Agreement Procedure: If there is still no resolution, the authorities of both countries must reach a mutual agreement.
Why do I have to pay US taxes if I live in Canada?
It’s simply because the US taxes its citizens and permanent residents on their worldwide income, irrespective of their place of residence.
How does the US-Canada tax treaty benefit individuals and businesses?
The treaty benefits both individuals and businesses in several ways:
- Avoiding Double Taxation: As previously mentioned, it provides tax credits and exemptions that prevent the same income from being taxed by both countries.
- Reducing Withholding Taxes: The treaty reduces the amount of withholding tax that can be charged on income such as dividends, interest, and royalties paid across borders.
- Providing Certainty: It offers clarity and certainty regarding tax liabilities and procedures, which is invaluable for financial planning and business operations.
- Dispute Resolution: The treaty facilitates a mutual agreement procedure that helps resolve disputes regarding taxation, and assists in the interpretation and application of the treaty provisions.
Does the treaty offer any benefits for retirement savings?
Yes, the treaty offers specific benefits for retirement savings, which are particularly beneficial for dual citizens planning their retirement across borders. Here are a few key points:
- Tax-Deferred Growth: The treaty allows for tax-deferred growth of retirement savings. For instance, if a US citizen contributes to a Canadian Registered Retirement Savings Plan (RRSP), the growth of investments within the RRSP is not taxed by the US until distributions begin. You can take a look at our RRSP article here.
- Deductions for Contributions: Contributions to eligible retirement plans in either country can be deductible on personal tax returns in the resident country. This means US citizens living in Canada can deduct contributions to their RRSPs on their Canadian tax returns, and similarly, Canadians in the US can deduct contributions to their IRA or 401(k) plans.
What is the ‘Savings Clause’ in the US-Canada tax treaty?
The ‘Savings Clause’ is a provision within the US-Canada Tax Treaty that preserves the right of each country to tax its own citizens and residents as if no tax treaty were in effect. This clause is a standard feature in US tax treaties.
- General Rule: The Savings Clause means that if you are a US citizen residing in Canada, the US can still tax you on your worldwide income according to US laws, regardless of what the treaty states.
- Exceptions: There are specific exceptions to the Savings Clause that allow certain provisions of the treaty to apply. These exceptions typically include benefits that relate to pension income, social security payments, and certain other types of income which may still be eligible for treaty benefits despite the Savings Clause.
This clause ensures that US expats cannot use the treaty to entirely avoid US taxation on their global income.
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