SNOWBIRDS: U.S. TAX ISSUES
YOU WON’T BE ABLE TO FLY AWAY FROM*
Samantha Prasad, Associate, Minden
Gross
(*This release is based on an article
published in the TaxLetter, May 2004, MPL
Publishing)
If you are one of the lucky
snowbirds who spend your winters in sunny
Florida, you’re probably already settled back in
at home here in Canada, getting ready for the
summer. But you should be aware of certain U.S.
tax issues that might follow you home back to
Canada. The following is a brief summary of some
of the key tax issues that may affect your warm
sunny lifestyle:
Residency
Although you may consider
yourself a resident of Canada, and you’ve
already duly filed your Canadian tax return as
you do every year, you should be aware that the
U.S. may still consider you a U.S. resident. If
this is the case, you will be taxed in the U.S.
on your worldwide income in much the same manner
as a U.S. citizen. That means you will be
required to file a U.S. tax return and pay U.S.
tax on your income from all sources.
If you are a Canadian
snowbird, you will be resident in the U.S. if
you meet either the lawful permanent resident
(or green card) test, or the "substantial
presence" test. Under the first test, if you
have a green card, you will be treated as a U.S.
resident, regardless of whether you are
physically present in the U.S. The second test,
however, requires a little more analysis.
Under the "substantial
presence" test, you will be considered a U.S.
resident if you spend a substantial portion of
the year in the U.S., calculated as follows:
- you have been in the
U.S. for more than 30 days in the current
year; and
- if the total number of
days you spent in the U.S. during the
current year, plus 1/3 of the days you spent
in the U.S. in the last year, plus 1/6 of
the days you spent in the U.S. in the year
before last equals or exceeds 183 days.
You can, therefore, spend
up to 120 days each year in the U.S. without
crossing this threshold test. In calculating
the number of days, you should be aware that a
partial day in the U.S. counts as a full day,
although you can exclude days that you were in
transit in the U.S. (for less than 24 hours) on
your way to another foreign country. As well,
you may be able to exclude days spent as a
teacher, trainee, student, or professional
athlete competing in certain charitable sporting
events in the U.S.
If you meet the above
substantial presence test, you will be subject
to U.S. tax and filing requirements. This will
be so, even though you may also be a Canadian
resident and pay Canadian taxes.
If you are considered a
U.S. resident you can try to either claim the
"closer connection exception" allowed under the
Internal Revenue Code (the Code) or you claim a
treaty exemption.
To claim the "closer
connection exception", you have to establish
that you have closer connections to Canada, such
as:
- maintaining a
permanent home in Canada (no need to own;
you only need continuous access), as well as
personal belongings
- having family in
Canada
- being employed in
Canada, or carrying on business in Canada
- banking, and holding
investments, in Canada
- voting in Canada
- participating in
social or religious organizations in Canada
You cannot, however, claim
this exception if you spend more than 183 days
in the U.S. in the current year or you have
applied for a green card.
You must also file Form
8840 under the Code to claim the closer
connection exception (you don’t need a U.S. tax
identification number).
If you can’t claim the
closer connection exception, there are
"tie-breaker" rules under the Canada-U.S. tax
treaty. For example, if you have a home
available to you in Canada, you can claim
residence here. If, however, you have a home in
both Canada and the U.S., then you would look to
see where your centre of economic interest lies,
and claim residence in that jurisdiction.
However, you will still be subject to the filing
requirements under the Code (U.S. Tax return,
Form 1040NR).
To claim a treaty
exemption, you have to complete Form 8833 and
attach it to Form 1040NR. You must explain in
the Form 8833 that you are a resident of Canada
and are not subject to regular U.S. income tax
rates on U.S. source income under the Canada-U.S.
tax treaty.
Form 8840 (to claim the
closer connection exception) and the 1040NR with
Form 8833 (to claim a treaty exemption) must be
filed by June 15th of the following year. For
2003, you must file either Form 8840 or the
1040NR and Form 8833 by June 15, 2004. If you
have income subject to U.S. withholding tax such
as employment income, the filing deadline is
April 15th of the following year. You can file
Form 4868 by the due date to get an automatic 4
month extension to file Form 1040R. If you
still need an extension beyond that, you can
file Form 2688 to apply for an additional 2
month extension. Any tax payable, however, must
still be paid by the original due date. No
extension is available for Form 8840. If you
fail to file the above forms in the appropriate
circumstances by the due date, you will be
subject to penalties, which can be as much as
$1,000 for each item of income involved (the
Canada-U.S. tax treaty does not protect you from
these penalties).
Property Ownership
Rental income
Snowbirds who own real
estate in the U.S. and rent it out while they
are back in Canada should be aware that
withholding tax of 30% normally applies to the
gross rent paid. This withholding tax is not
reduced by the Canada-U.S. tax treaty (unlike
withholding taxes on interest and dividends).
You can avoid this withholding tax by
voluntarily filing a U.S. tax return and
electing to pay the tax on the net rental
income. It may be advisable to take advantage
of the net rental income election if you incur
expenses in respect of your U.S. rental
property, such as mortgage interest,
maintenance, insurance, property taxes etc., by
deducting such expenses. This election can
apply for future years and applies to all of
your rental real estate in the U.S. On your
U.S. return (1040NR) you would show the income
and expenses, as well as the amount of tax
withheld. This may also allow you to receive a
refund for any taxes withheld (to the extent the
withholding amount exceeds the tax payable). To
make the net income election you must file a
1040NR, including a statement declaring that you
are making the election. The election should
include the address of the property and your
percentage ownership. As noted above, the
1040NR is due by June 15th of the year following
the calendar year in question (subject to any
extensions). Once the election is made, you
should provide Form 4224 to your tenant and the
30% withholding will not be required.
Sale proceeds
If you sell your U.S. real
estate, a withholding tax of 10% of the gross
sale price is normally payable under the
Foreign Investment in Real Property Tax Act
("FIRPTA"). The tax withheld may be offset
against the U.S. income tax payable on any gain
realized on the sale (or refunded if it exceeds
the income tax liability). The tax under FIRPTA
may be reduced or eliminated in certain
circumstances:
1. There is no
withholding requirement where (a) the purchase
price for the property is under $300,000(U.S.),
and (b) the property is acquired by the
purchaser as a home, with actual plans to reside
in it for at least 50% of the time that the
house is occupied in the first two12 month
periods after purchase.
2. The withholding
tax can be reduced if you obtain a withholding
certificate from the IRS on the basis that the
expected U.S. tax liability on the gain will be
less than 10% of the sale price. The
certificate will indicate the reduced amount of
tax that should be withheld.
On a sale of your real
estate, you will need to provide an Individual
Taxpayer Identity Number ("ITIN") to the
transfer agent. This applies to all
dispositions of real property after November 3,
2003. This is so, even if there is no
withholding tax due. The sale cannot close
without both the vendor and purchaser providing
an ITIN. In addition, the IRS will not issue a
receipt for the withholding tax paid unless both
the vendor and purchaser provide an ITIN. An
ITIN can be obtained by filing Form W-7 with the
IRA. This is at least a 6 week process.
If you sell your real
estate, you will have to file a U.S. tax return
to report the gain (a credit may be claimed for
tax withheld under FIRPTA). This filing
requirement is true even where there is no
withholding tax due. (This is a change from the
previous situation where there was no filing
obligation in the absence of a withholding
requirement.) The capital gains rate in the
U.S. is currently 15%. If you have owned the
property since before September 27, 1980, you
can tax advantage of the Canada-U.S. tax treaty
to reduce the gain. In this case, you will only
have to pay tax on the gain that accrued since
January 1, 1985 (this does not apply to business
properties that are part of a permanent
establishment in the U.S.). To claim this
treaty benefit, you have to make the claim on
your U.S. tax return and include specific
information about the sale.
Any U.S. tax paid on the
sale of the property will generate a foreign tax
credit which you can use to reduce your Canadian
tax on the sale. This tax credit may be limited
if you use your principal residence exemption to
reduce your Canadian gain.
Miscellaneous tax tips
A number of other Canadian
tax rules may be of particular interest to
snowbirds:
- You can claim eligible
medical expenses paid for yourself, your
spouse or a dependent for Canadian tax
purposes, even if you pay them in the U.S.
- Premiums paid to
private insurers in the United States for
medical and health care coverage are
qualified medical expenses for Canadian tax
purposes.
- The principal
residence exemption is available in respect
of residential properties located anywhere
in the world. If you have residential
properties on both sides of the border, you
can elect in respect of the property that
provides the greater benefit.
Gifts to U.S. charities generally are allowed
tax credits for the purposes of computing
Canadian tax to the extent of the 20% limitation
applied to U.S. source income.
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