Ultimate Guide to Cross-Border Tax for Canadians and Americans

Managing taxes is already complex – add international borders to the mix, and it becomes even more challenging. Whether you’re a Canadian investing in the U.S., an American living in Canada, or a snowbird splitting time between both countries, you need to understand how tax laws on both sides of the border affect you.

This article outlines what you need to know about the most common cross-border tax situations, helping you avoid double taxation, reduce compliance risk, and take advantage of every tax-saving opportunity available.

Understanding Tax Residency

Before anything else, it’s essential to know where you’re considered a “tax resident.” In both Canada and the U.S., tax residency isn’t always the same as physical residency. In Canada, you’re considered a tax resident if you maintain significant residential ties, such as owning a home or having a spouse or dependents residing in the country.

In contrast, the U.S. uses the Substantial Presence Test to determine tax residency for foreigners. If you’re present in the U.S. for at least 183 days over a three-year rolling period, you may be deemed a resident alien for tax purposes. Determining your residency status is critical, as it affects where and how you’re taxed on your worldwide income.

Filing Obligations for U.S. Citizens in Canada

U.S. citizens who live and work in Canada are still required to file a U.S. tax return each year, using Form 1040, even if all of their income is earned in Canada. They must also report foreign bank accounts with balances exceeding $10,000 using FBAR (FinCEN Form 114), and may need to file FATCA (Form 8938) to report foreign financial assets.

The U.S.-Canada Tax Treaty helps avoid double taxation, and Form 1116 allows for claiming a foreign tax credit. However, it’s important to note that certain Canadian accounts like TFSAs and RESPs are not recognized as tax-sheltered by the IRS and may require special reporting.

Canadians Working or Moving to the U.S.

Canadians who accept employment in the United States need to be aware of tax obligations in both countries. Typically, you must file a U.S. tax return, either Form 1040 or 1040-NR, and also report that income in Canada. To mitigate double taxation, Canadian residents can claim a foreign tax credit.

Additionally, submitting Form T1213 can help reduce Canadian tax withholdings if you expect to be taxed in the U.S. Coordination with your employer is essential to ensure the appropriate withholdings and contributions are made in both jurisdictions.

U.S. Property Ownership and Rental Income

Canadians who own rental property in the United States are required to file a U.S. tax return to report rental income. This is typically done on Form 1040-NR using Schedule E, which allows for the deduction of expenses such as property management fees, mortgage interest, and maintenance costs.

Without electing to be taxed on a net basis through Form W-8ECI, a 30% withholding tax may apply to gross rental income. Rental income must also be reported on your Canadian tax return, but you can usually claim a foreign tax credit to offset U.S. taxes paid.

Selling U.S. Property as a Canadian

When a Canadian resident sells U.S. real estate, the Foreign Investment in Real Property Tax Act (FIRPTA) requires the buyer to withhold 15% of the gross sale proceeds. However, you can apply to reduce this withholding to reflect your actual tax liability by filing Form 8288-B. The sale must be reported on Form 4797 and Schedule D to determine the capital gain. You also need to report the capital gain on your Canadian tax return and can claim a foreign tax credit to reduce the Canadian tax payable on the same income.

LLC vs. Limited Partnership for U.S. Real Estate Investing

Canadians investing in U.S. real estate are often advised against using a Limited Liability Company (LLC) due to the risk of double taxation. The IRS treats LLCs as pass-through entities, but the Canada Revenue Agency does not, leading to tax on distributions without full foreign tax credit relief. Instead, Canadians can benefit from using a U.S. Limited Partnership (LP), which is typically more tax-efficient as both countries recognize the LP structure similarly, aligning tax treatment and minimizing tax leakage.

Tax Tips for Snowbirds

Canadians who spend a significant amount of time in the United States must understand the Substantial Presence Test, which considers the number of days spent in the U.S. over a three-year period. Exceeding 183 days could result in being classified as a U.S. resident for tax purposes. To avoid this, many Canadians file Form 8840, claiming a closer connection to Canada. It’s also wise to stay under 122 days per year to minimize risk. If your financial accounts exceed U.S. thresholds, you may also need to file an FBAR.

Americans Doing Business or Sending Employees to Canada

U.S. companies that send employees to work in Canada have specific tax obligations. They must register for a Canadian business number, withhold Canadian payroll taxes including income tax, Canada Pension Plan (CPP), and Employment Insurance (EI) contributions, and issue T4 slips to employees.

It’s important to track the number of days employees spend in Canada and ensure payroll compliance. Employees may also need to adjust their U.S. withholdings using Form W-4 to avoid double taxation and cash flow issues.

Reducing Withholding Tax on Cross-Border Income

Tax treaties between Canada and the U.S. allow individuals to reduce the default withholding tax rates on various types of income. Canadians receiving U.S. dividends and interest can submit Form NR301 to reduce withholding rates.

For U.S. property sales, filing Form 8288-B can lower the 15% FIRPTA withholding. In Canada, non-residents can make elections under Section 217 or Section 216 to report income like pensions or rental income on a net basis, potentially reducing overall tax liability.

Getting an ITIN for Cross-Border Tax Compliance

An Individual Taxpayer Identification Number (ITIN) is essential for Canadians who earn U.S. income but do not qualify for a Social Security Number. With an ITIN, you can file U.S. tax returns, claim treaty benefits, reduce withholding taxes, and apply for refunds. To obtain an ITIN, you must complete Form W-7 and provide supporting identification documents. Having an ITIN is crucial for compliance and for receiving the proper tax treatment on U.S.-source income.

Conclusion

Cross-border taxation is complex, but with proper planning and professional guidance, it can be managed effectively. Whether you’re investing in real estate, moving for work, spending time as a snowbird, or retiring abroad, it’s essential to understand your obligations and opportunities in both Canada and the United States. If you need help with your cross-border tax strategy, reach out to Madan CPA for expert assistance tailored to your unique situation.