The first issue to cover is the US residency rules for tax purposes. There are 2 types of residency that can trap Canadians and put them in the IRS line of fire.

1. Residency through the Substantial Presence Test:

The IRS has a formula to calculate residency for US tax purposes. It is composed of a 3 year rolling average, giving different weights to the number of days in each year. If according to the test, the result is 182 days or less, the individual is not a resident, however, if the result shows 183 days or more, then the individual is considered a US resident for tax purposes and is obligated to file a return.  To see where you wind up, see the substantial presence test calculator on our website (http://www.ustaxesincanada.com/substantial-presence-calculator/).  If someone is considered a resident under this test, which is pretty easy as it requires only 122 days annually in the US, there is a get-out-of-jail-cheap card available to you. This is the closer connection exemption. This exemption requires the filing of form 8840 annually. It is a simple form that essentially asks you to show the Americans that you can’t be considered a resident of the USA because you are really a resident somewhere else. File this form annually by June 15^th and you can avoid any further US filing requirements. Failure to timely file this form can result in your being deemed a US resident for tax purposes for the year in question. Late filed exemption requests are not automatically accepted and can be costly to file.  This isn’t pleasant but it’s a simple form and will result in the elimination of the requirement to file a US tax return other than this specific form. This option is available only to those who spent less than 182 days in the US in that calendar year.

2. Residency through the Canada-US income tax treaty:

This method of avoiding US tax is available to those people who spend 183 days or more in the US in a calendar year. It too will result in the substantial elimination of US tax liability. However, this comes with a huge IRS gotcha. In order to claim this benefit, you are required to file a complete US resident return and claim a treaty exemption. To do this, you will need to prove that you are genuinely a resident of Canada and not a resident of the USA. This might be difficult if you are spending 240 days annually in the USA. However, this will eliminate the tax on income earned outside the USA.

However, income taxes are usually not the problem facing Americans living abroad. The major problem is the myriad information returns that one must file and the treaty does not eliminate this. You will be required to file a complete US tax return for the year with all required attachments and schedules. This will result in needing an FBAR, 3520/3520A for your TFSA, 8891 for your RRSP, 8621 for mutual funds and whatever other forms that may apply to you. The cost of preparing this return can be substantial, plus the penalties for not filing in a timely manner can be terrifying as well.

So how does all this affect you specifically? If you are a snowbird, don’t leave your tax situation to chance. Your winter in Florida might cost you more than you can possibly imagine. The good news is that most of these problems can be avoided with proper planning. Don’t wait until it’s too late. Call us at 1-800-905-0380 or contact us through the website (www.ustaxesincanada.com) and schedule a free consultation with our tax professionals who will advise you as to what the optimal strategies are for you and how to avoid problems in the future.

1)     Tax Free Savings Accounts (TFSA):

For ordinary Canadians these are great vehicles for saving money and avoiding taxes. Unfortunately, the USA doesn’t view them in the same manner. For American purposes these investment vehicles come with 2 problems.

1. All income earned in the TFSA is taxable in the USA. This may result in taxes payable in the USA on the income as there may not be sufficient tax credits available to avoid American taxes.
2. TFSA accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make these investment vehicles unfavorable for an American residing in Canada. However, if the account is closed before December 31, we can file a final return for the trust in 2012 and there will be no hassles subsequently.

2)     Registered Education Savings Plan (RESP):

Similar to a TFSA described above, these vehicles are a great tool for saving for a child’s college education. Unfortunately, this vehicle has similar constraints to the TFSA.

1. In Canada, income earned in the RESP is taxable in the hands of the beneficiary when the money is withdrawn to pay for college. In the USA, the income, including government grants, is taxable annually when it is earned. This can result in double tax with the child paying tax on the income in Canada, and the parent paying tax in the USA.
2. RESP accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make an RESP unfavourable for Americans in Canada. One solution would be to have a non-American spouse or grandparent open the account for the benefit of the child.

3)     Mutual Funds/ETF/REIT

Mutual funds are a standard form of investment. However, if you are an American in Canada, they are taxed in a highly punitive manner. In order to avoid the punitive taxes, a timely election must be made to reduce the penalties. The elections available are:

1. to record the income attributable to oneself in the current year; or,
2. to mark the investment to market which results in the reporting of the unrealized gain on the fund in the current year.

This can easily result in paying taxes on this income in both Canada & the USA as the credits may not be available on a timely basis. However, failure to make any election places you in a situation where the taxes will be punitive. The best solution to the mutual fund problem would be to sell off all Canadian mutual funds by the end of the year and replace them with ordinary stocks and bonds.

These are some key investment vehicles and how they impact Americans in Canada. For further information or specific questions regarding your situation, please send us an email (http://www.ustaxesincanada.com/contact/ ) or make an appointment with our US tax specialists (1-888-877-2505).