Explanation of the US System

The US and Canadian tax systems differ greatly. The biggest difference is that Canada taxes only its residents on worldwide income, while the US taxes all “US persons” on their worldwide income, regardless of where they live.

“US persons” are defined as US citizens, permanent residents/Green Card holders and anyone who passes the “Substantial Presence Test”, a formula based on US law that is used to calculate whether someone has become a US person by virtue of spending a certain number of days per year in the US.

Practically, the rules of the US taxation system mean that US persons who move to Canada and retain their US citizenship or permanent residency status will continue to be taxed by the IRS on their worldwide income. Such individuals will therefore have to make complex US tax filings, and they may owe tax to the IRS on their worldwide income. They are also exposed to the US estate and gift tax regime.

Fortunately, foreign tax credits available through the Canada-US Income Tax Treaty (the “Treaty”) can ease the potential burden of being taxed by both countries on the same income. Frequently, Canadian tax rates exceed US ones. Americans living in Canada can receive foreign tax credits for tax paid to the CRA; these credits can then be used to either reduce or completely offset tax owed to the IRS. However, double taxation cannot always be avoided.

In cases where an individual’s tax residency is unclear, note that the Treaty can be helpful. The Treaty features tiebreaker rules that evaluate an individual’s facts and circumstances to determine which country has a stronger claim to a person’s residence. The Treaty overrides domestic tax rules; for example, American Green Card holders who demonstrate various facts under the Treaty can be deemed tax residents of Canada, if so desired. Retaining a US Green Card while living in Canada as a Canadian tax resident is challenging, however, and may not be ideal.

Indeed, to avoid applying the Treaty factors and to ensure that all US tax obligations are severed, some Americans who move to Canada choose to relinquish their US citizenship or give up their status as US Green Card holders/permanent residents.