Canada is the second-largest trading partner of the United States. Both economies are interconnected and businesses on both sides of borders are subject to the two different income tax rules of both countries. There is a Canada-US tax treaty that provides relief from double taxation.
Caution: US Income tax, both for individuals and businesses, is one of the most complex tax systems in the world. The below post is for information purposes and cannot be considered tax advice at any point in time. You should always consult your income tax accountant who specializes in both Canadian and United States taxes. The purpose of this post is to provide a very high-level overview of income tax reporting for Canadian businesses with US Income.
In order to understand the US Income tax reporting requirement for Canadian businesses, we are going to look into three scenarios and attached reporting requirements. We are going to list down reporting requirements for the different types of business structures often used by Canadians:
- Operating as an unincorporated business, individuals
- Operating as a Canadian Corporation, Canadian Corporations
- Operating through an LLC organized in one of the US States, a US non-resident LLC
1. Canadian businesses selling to US Customers from their Canadian locations
One of the situations where a lot of small businesses get confused is selling online to US customers. When the order comes from the US on its website and is dispatched from Canadian locations, a lot of small businesses get confused. If you are a Canadian business and simply dispatching the order to the US, this is an export by a Canadian business.
- Individuals – No income tax return in the US is required and no US taxes are paid. In Canada, Include the business income on T2125 on T21.
- Corporations – No US income tax return and no US income taxes on income. In Canada, include this income on the T2 Corporation income tax return. Be mindful of completing the internet-based activities schedule if you generate business from the webpage.
- Non-Resident LLC in the US – no US income tax to be paid under the Canada-US treaty if all the beneficial owners are residents of Canada. However, Form 5472 must be filed along with the 1120 Proforma with IRS. In Canada, file T2 for the same LLC. This can get extremely complex quickly. Generally, if you are a Canadian, do not use the U.S. LLC to conduct any business as long as you are a Canadian tax resident. Read more on hybrid entities.
2. US Income tax reporting for sales to US Customers from US Warehouse
If you do not have an office or employee in the United States, however, you are using warehouse services, you have the US effectively connected income, also known as ECI. Please note that if you have a dedicated employee who handles your warehouse only for you, it may create a permanent establishment discussed in the next situation. Any ECI must be reported to the IRS.
One of the most common examples of this situation is having a US Amazon Store which delivers through Fulfillment by Amazon (FBA). Since the warehousing and handling are done by Amazon warehouses in the US, you have an effectively connected income. You have a US income tax reporting requirement now.
- Individuals – File 1040-NR and claim a treaty-based position by filing form 8833. As a result, you will not pay taxes in the US. Your income will be reported and taxed in Canada on T1 when you report business income on T2125.
- Corporations – File form 1120-F and claim a treaty-based position on form 8833. No US income tax is paid. In Canada, report income and pay taxes using a T2 Corporate income tax return.
- Non-Resident LLCs in the US – US LLCs with non-resident members need to file Form 5472, Form 8833, and 1040NR. No income tax is payable in the US. Report the income on T2 in Canada. Be mindful of the LLC problems in Canada before you decide to use LLC.
If you are a U.S. citizen or green card holder, the ECI of a Controlled-foreign corporation is taxed as a branch. However, treaty can override this, if applicable.
3. US Income tax reporting for Canadian businesses having offices and employees in the US
If you are a business with employees or a physical office in the United States, you have a permanent establishment (PE) in the US. In this case, income from the US (ECI) will be taxed there and the foreign tax credit will be available if the income is included in Canadian income tax returns.
- Individuals – File 1040-NR and pay taxes in the US. Report your worldwide income (including US income) in Canada on your T1. The foreign tax credit will be available for the taxes paid in the US.
- Corporations – File form 1120-F and income taxes to be paid in the US on ECI. In Canada, report income and pay taxes using a T2 Corporate income tax return, and the foreign tax credit are available.
- Non-Resident LLC in the US – File 5472, and 1040 NR. ECI is taxed in the US. File T2 in Canada.
When you have a permanent establishment in the US you are required to file state income tax returns and pay state taxes as well.
Caution: US State Income Taxes for Canadian Businesses
The US-Canada Income tax treaty is at the federal level. In Canada, all provinces follow the federal treaty. However, some of the US states do not follow the federal-level treaty. For example, the state of California, a state with the biggest population, taxes California-sourced income even if you have $1 in income from California if you meet non-resident filing thresholds. If you are a single person with no dependents thresholds are as low as US$ 18,241. If you are a business entity nexus threshold is US$601,967 in Sales.
Maroof HS CPA Professional Corporation is a CPA firm registered with CPA Ontario and CPA Alberta in Canada. US income tax services in Canada are provided by a US CPA, and a Canadian Chartered Accountant.
If you are a Canadian business and have US income tax reporting requirements, get in touch with us today.
How to get ITIN from the IRS?
Maroof HS CPA Professional Corporation is an IRS Acceptance Agent in Canada. We can help you with both US Income Tax return preparation as well as forward your application for ITIN (Individual taxpayer identification number). Get in touch with us.