There are many reasons why Canadian tax residents move to the U.S. including economic opportunities, family reunification, education, and lifestyle preferences.
Those who are planning their move to the United States must recognize the key differences between the U.S. and Canadian tax systems. While many of us may find our Canadian tax system overwhelming and burdensome, to much of their surprise, the U.S. takes it to a whole new level of complexity.
This post is for general informative purposes. This is not possible to cover all the possible tax issues involved with emigration to the U.S. Further, heavy penalties at the U.S. side serve as a deterrent for noncompliance. Even if you have a simple tax situation, seeking tax advice from a professional cross-border tax accountant can go a long way to straighten the compliance for you. The contents of this post are not meant to be used as tax advice.
This article focuses on the individuals who emigrated from Canada to the U.S. who are neither the U.S. citizens nor lawful permanent residents.
Tax Residency: Are you a U.S. tax resident?
Tax residency plays a key role in determining the tax consequences in both countries.
Canada taxes its residents on worldwide income.
Canada uses a very subjective approach to determine the tax residency status of its residents. For the departing residents, there is always a risk of being classified as factual residents of Canada. As the tax rates in Canada are higher than those in the U.S., many taxpayers prefer to be treated as U.S. tax residents.
The United States uses a very objective approach where it taxes its Citizens, lawful permanent residents and resident aliens on their worldwide income. While U.S. citizens and lawful permanent residents are not the intended audience of this post, some of the tax issues might be relevant to those who are moving to the U.S. with their brand-new green cards.
For those who do want to avoid being treated as factual residents of Canada so they do not have to pay additional taxes to the CRA (after foreign tax credits), it is very important to become a U.S. resident alien for tax purposes. For those who move to the U.S., there are only two options where they become U.S. tax residents:
U.S. Tax Residency – Green Card Test
The Green Card Test is one of the criteria used by the Internal Revenue Service (IRS) in the United States to determine an individual’s tax residency status. It specifically applies to lawful permanent residents of the U.S., commonly referred to as green card holders.
Under the Green Card Test, you are considered a tax resident of the United States for a particular calendar year if you are a lawful permanent resident of the U.S. at any time during that year. Being a lawful permanent resident means that you have been granted the right to live in the U.S. indefinitely as an immigrant, according to immigration laws, and you hold a green card issued by the U.S. Citizenship and Immigration Services (USCIS).
f you pass the Green Card Test, you are treated as a U.S. tax resident and are subject to U.S. income tax on your worldwide income, similar to U.S. citizens. This includes income earned both within and outside the U.S.
Please note that U.S. green card holders can still calculate their taxes as Nonresident aliens (NRA) if they rely on and disclose their position under Article IV of the tax treaty. These treaty nonresidents are still subject to the reporting requirements, it’s only the tax calculation that’s affected. Filing treaty based position after filing as a U.S. tax resident may result in exit taxes.
Read: Green Card test on the IRS website.
U.S. Tax Residency – Substantial Presence Test
The substantial presence test (SPT) uses a number of days of physical presence in the United States, for any purpose (excluding exempt days), to determine the tax residency.
The Substantial Presence Test involves a two-part calculation:
- 31-Day Rule: The individual must be physically present in the U.S. for at least 31 days during the current year.
- 183-Day Rule: The individual must have been physically present in the U.S. for at least 183 days over the current year and the two preceding years, calculated as follows:
To meet the Substantial Presence Test, the sum of these days as listed below must equal or exceed 183 days.
- All the days you were present in the current year,
- 1/3 of the days you were present in the year before the current year,
- 1/6 of the days you were present two years before the current year
There are specific exclusions, where certain days are excluded from this calculation. You should not count these days while making these calculations as you are not considered to be present in the U.S. for SPT purposes.
- Days you are in the U.S. for less than 24 hours while in transit between two places outside the U.S.
- Certain individuals are not counted for the purpose of the Substantial Presence Test. These include:
- Foreign government-related individuals with diplomatic visas, such as ambassadors, consuls, or members of their household.
- Teachers or trainees on J or Q visas, subject to certain conditions.
- Students on F, J, M, or Q visas who comply with their visa requirements.
- Professional athletes competing in charitable sports events.
- Days you are unable to leave the U.S. because of a medical condition that developed while you were in the U.S.
- If you were present in the U.S. for fewer than 183 days in the current year and can demonstrate a closer connection to a foreign country for the year, you may not be considered a U.S. resident under the Substantial Presence Test.
Keeping a record of the days spent in the U.S. for any purpose is critical! If you do not have this record, you might be able to generate it from the I-94 website.
Read: Substantial Presence Test on the IRS website.
U.S. Residency Start Date
Generally, the U.S. tax residency starts:
- Under Green Card Test: If you were outside the U.S. when the Green Card was approved, the first day you were present in the United States as a lawful permanent resident. If you are already in the U.S. and adjust your status to that of a lawful permanent resident (for instance, from a student visa or work visa to a green card holder), your tax residency starts on the day the USCIS approves your adjustment of status.
- Under Substantial Presence Test (general rule): First day in the year when you were physically present in the U.S. for the year when you met SPT.
- If you met both Green Card and SPT, earlier of the above two.
- If you met U.S. tax residency while also being a Canadian tax resident, the U.S.-Canada tax treaty decides on this. Article IV of the U.S. Canada Tax Treaty provides tie-breaker rules. You may be able to use a different date of change of tax residency using the treaty than the one determined under SPT.
- If you did not meet the substantial presence test in the current year, but met in the next year, you can use the First-Year Choice election where you choose to be treated as a U.S. tax resident alien. This election has a very specific procedure that must be followed.
Read: Residency Starting Dates
Importance of the U.S. Tax Residency Starting Date
When an individual moves from Canada, the date of change of residency (date of emigration), for Canadian tax purposes is determined using the domestic tax law. It is very common for individuals to fall into the category of factual residents of Canada because they did not sever their ties with Canada.
When a factual resident of Canada becomes a tax resident of a treaty country, they become a Non-Resident of Canada!
What if you do not meet the substantial presence test (assuming no Green Card) but you do want to become a Non-Resident of Canada?
Why? Maybe higher taxes in Canada!
Yes, many taxpayers when they move to the U.S. do not want to pay higher taxes in Canada on the U.S.-sourced income. Oftentimes, the taxpayers have certain ties with Canada and remain factual residents of Canada. For them to be a deemed non-residents of Canada, they must become a tax resident of the U.S.
Consider an example where a Canadian individual got an employment opportunity in the U.S. and moved at the beginning of August of 2023, on a TN Visa. If he did not spend enough time in the U.S. prior to this date, he cannot meet SPT. Per the U.S. domestic tax law, he is a nonresident alien. Most likely, he will be a factual resident of Canada as there will be some sort of ties. Factual residents must report their worldwide income to CRA on their T1 including the foreign employment income. Though the taxpayer will claim foreign tax credits, it is quite possible that there will be additional tax payable in Canada as the tax rates are higher. Ignoring other tax consequences of emigration, he may prefer to become a Non-Resident of Canada.
In the above example, the individual cannot use tax treaty tie-breaker rules. Tie-breaker rules can only decide if an individual is considered tax resident of both countries. In this case, he is a nonresident alien per the domestic law of the U.S., so tie-breaker rules do not apply.
If an individual does not meet the substantial presence test in the current year but meets the SPT in the following year, he can make an election under First-year choice. There is a very specific procedure for this, however, in most cases it is doable.
State
First-Year Choice. Use it if you have to!
The First-Year Choice is a provision in U.S. tax law that allows nonresident aliens who do not meet either the Green Card Test or the Substantial Presence Test for a given year to elect to be treated as resident aliens for tax purposes for part of that year.
To qualify for the First-Year Choice, an individual must:
- Be present in the U.S. for at least 31 consecutive days in the year,
- Be present in the U.S. for at least 75% of the number of days beginning with the first day of the 31-day period and ending with the last day of the year, and
- Meet the Substantial Presence Test in the following year.
By making this election, the individual’s residency start date is the first day of the 31-day period. This allows them to be treated as a U.S. resident for part of the year and potentially benefit from certain tax treatments available to residents. To make this election, the individual must attach a statement to their paper-filed tax return for the year they are making the choice. The tax return can only be filed after the SPT is met in the following year.
Continuing from the previous example, the individual can file as a 2023 resident alien by using this election. However, he can only send his tax return on paper after he meets SPT in 2024. Therefore, it is important to pay any amount owing to the IRS before April 15th.
6013(g) Election – Joint filing for Mixed Residencies spouses
The 6013(g) election is a provision under the U.S. tax code that allows a nonresident alien married to a U.S. citizen or resident alien to elect to be treated as a U.S. resident for tax purposes, enabling the couple to file a joint tax return. This election can provide significant tax benefits, such as a higher standard deduction and eligibility for various tax credits that would not be available if filing separately.
To make this election, both spouses must consent to file a joint return and agree to tax their combined worldwide income under U.S. tax laws. Once made, the election remains in effect for all subsequent years unless revoked, offering a strategic tool for managing tax liabilities but also requiring careful consideration of the implications for the nonresident alien’s global income.
More on Nonresident alien spouse to be treated as resident alien for tax purposes.
Is CRA NR73 or IRS Form 8802 needed?
No! You do not have to request a residency determination from CRA or a residency certification from the IRS.
The taxpayers interested in getting a determination from the CRA can submit from NR73. This is an optional form and there is no need for this form to be voluntarily submitted to the CRA. There might be situations when there is a doubt or just for peace of mind, a taxpayer can request such a determination.
The IRS in the U.S., can issue U.S. certification residency if an individual sends form 8802.
If you have consulted a reputable tax cross-border tax professional, you do not have to request a determination either from the IRS or CRA. You should plan and be in control of this date of change of residency as it may affect the departure tax from Canada.
Caution: U.S. Federal & State Tax Residency Mismatch
Not all the U.S. states accept federal tax treaties!
Those moving to the U.S. must plan their date of emigration from Canada keeping in mind the state tax laws in the U.S. Some states do not follow federal tax treaties and that can create a bit of headache for you and your tax preparer.
For example, California – one of the favourite states for Canadians – does not follow federal tax treaties. So if you are planning to use federal treaty tie-breaker rules, California still requires you as a part-year resident if you took residence there. In such a situation, the U.S. treats you as a Nonresident alien but California as a part-year resident. Remember, Nonresident aliens can exclude certain income using treaty provisions, however, may end up paying taxes on worldwide income in the state.
Therefore, it is important to plan ahead keeping in mind state taxes.
Taxation of Income in Emigration Year
If during the year, you became a U.S. tax resident, you will become a deemed Non-Resident of Canada. If you believe your ties and relationships are closer to Canada, you can file a treaty-based return in the U.S.
The below information is for those who became U.S. tax residents and ceased to be Canadian tax residents.
Canadian Tax Reporting
You will become a Non-Resident (NR) of Canada for tax purposes a day before you become a U.S. tax resident.
- File a Canadian ’emigrant’ tax return (same as T1), mentioning the date you ceased to be a Canadian tax resident. The due date for filing such a tax return is the same as the T1. For example, if you ceased to be a resident of Canada in 2023. you will file the tax return before April 30, 2024. You will report everything as any other resident of Canada until that date on this tax return including foreign assets and income reporting.
- You will report your worldwide income to the CRA up to the date of emigration, and only Canadian-sourced income after that date.
- If you have properties that are subject to deemed disposition, you will have departure tax-related implications. More later.
- If you have Canadian rental income you have to file a Sec 216 tax return separately to cover the Non-Resident part of the year.
Some of the above are discussed later in this post.
U.S. Tax Reporting
On the U.S. side in the same way, the year will be divided into two parts: part of the year as a resident alien and part of the year as a nonresident alien.
(The below information may not be as accurate for those with 6013(g) election to avoid any confusion.)
- File a tax return as a dual-status alien on Form 1040. Do not confuse dual-status aliens with dual residents. The term dual-status alien means two residency statuses in the same year for U.S. tax purposes.
- For the part of the tax year you were a Non-Resident alien, you will follow all the rules as applicable to nonresident aliens. You can attach this statement as 1040NR to your tax return.
- For the U.S. residency part, you will report worldwide income and taxes calculated as resident aliens. You will also report specified foreign financial assets.
- All the information returns are required such as 5471, PFICs, 3520, 8865, 8858 or 926 etc. There are rules related to each information return that will decide if you had to file that information return or not.
- FBAR is filed if at any point the balances in the banks or financial accounts crossed USD 10,000, individually or in aggregate.
Planning Challenges, issues & Tips
Canadian Principal Residence
Many individuals own real estate properties that were principal residence at the time of emigration.
They can elect the deemed disposition of the principal residence and shelter the gains up to that point. This will bring the Canadian cost basis equal to the fair market value on the date of emigration. Treaty also allows this step-up of basis for the U.S. tax purposes.
Departure Tax in Canada
Those leaving for the U.S. (or elsewhere) have departure tax on the top of their list.
When leaving Canada, leavers are deemed to have disposed of certain types of property at fair market value and to have immediately reacquired them for the same amount, a concept known as “deemed disposition.” This process can trigger a capital gains tax on the increase in value of the property while the individual was a tax resident of Canada, effectively serving as an exit tax on the unrealized gains of the departing resident’s assets.
Departure tax becomes even more challenging when there are substantial retained earnings tied within Canadian corporations (private).
A detailed discussion on the departure tax is available in this must-read post for emigrants.
Canadian Real Estate
Canadian real estate is not subject to deemed disposition at departure unless elected by the taxpayer.
On the Canadian side, if you are renting that property, the below requirements are applicable (after you move):
- Section 216 tax returns for the rental properties.
- Nonresident withholding tax requirement on the rental payments.
- If you owned the property in partnership or are not a Canadian citizen or PR, an Underused housing tax return must be filed.
- At the time you sell or dispose of the property, a Certificate of compliance is applied with the CRA.
We have an infographic to show the compliance requirement for Non-Residents of Canada, click here.
On the U.S. side,
- The same rental income is reported on Schedule E.
- Foreign tax credits are available against the Canadian taxes paid on that income. As this is a Canadian-sourced income, Canada has the first right to tax it. Therefore, it might be better if Sec 216 tax returns are prepared at the same time as the U.S. tax returns or before.
- If the rental income qualified as a QBU, an information return 8858 may also required to be filed.
Shares of Canadian Private Corporations
If you owned the shares of a Canadian private corporation, there are detailed discussions in this departure tax post.
Once you become a Non-Resident of Canada, your Canadian private corporation loses its CCPC status. If the same corporation is also a Controlled Foreign Corporation (CFC), it might be best to set the new fiscal year as either Nov 30th or Dec 31st to avoid complexities with form 5471 filings, and other income inclusions.
Do not forget to file information return 5471, if you owned at least 10% regardless if the corporation is a CFC or not. When an individual becomes a U.S. tax resident owning shares of a foreign corporation with certain shareholdings, Category 3 is triggered for 5471. Other categories apply if it’s a CFC. Read more about Controlled foreign corporations here.
Registered & Investment Accounts
Canadian registered accounts may not enjoy the same tax deferral in the U.S. as in Canada.
- Retirement accounts such as RRSP and RRIF can automatically qualify for tax deferral in the U.S. However. these assets maybe required to be disclosed on Form 8938 and FinCEN114. Other retirement accounts may also qualify for deferral and there maybe some specific information reporting requirement.
- If you are leaving Canada with unused contribution room for RRSP, consider making contributions before you leave to claim deductions if you have a bigger departure tax bill.
- RESP is not tax deferred in the U.S., however, a recent explanation from the IRS confirmed that it is also not a trust.
- TFSA is not a tax deferred account in the U.S.
- Non-US mutual funds and ETFs may be subject to PFIC rules and reporting requirements.
Notify All Payors about Tax Residency Status
You must notify all the financial institutions, brokerage, investment advisors and others about the update to your tax residency status, both in Canada and the U.S.
Canadian payors can do proper withholding of taxes and issue appropriate information slips at end of the year. Similarly, if the U.S. institutions will start issuing appropriate 1099s etc.
How Can We Help?
It is not possible to cover everything in one post. If you have a unique tax situation, you can leave a generic comment and we can try to update this post in the coming months. If your issue is urgent and pressing, please get in touch with us by requesting a quote.
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