US Citizens Living
US citizens move north under a variety of circumstances. Some US citizens living in Canada were born in the US and moved to Canada with their parents as babies, young children, or teenagers. Others come to Canada to attend college or university and stay north of the border to begin their professional lives. Still other US citizens come to Canada as adults, either to relocate for work, because they are marrying a Canadian, or simply because they would like to retire in Canada.
US citizens living in Canada are generally very aware of the many issues involved in being a dual citizen. Indeed, US citizens living in Canada must consider several cross-border planning points to ensure that they live successful financial lives in compliance with both countries’ rules and regulations.
For US citizens living in Canada, cross-border tax considerations are a chief concern. Many Americans are familiar with the fact that the US taxes its citizens on their worldwide income, regardless of residency. Americans living in Canada therefore want to make sure that they are not caught in any cross-border tax traps, particularly if they have US business holdings or a US investment portfolio.
How to handle American retirement accounts, such as 401(k)s and IRAs, in the most tax-advantageous way, is another important consideration. US citizens living in Canada also wonder whether to take advantage of Canadian retirement tools such as the Registered Retirement Savings Plan (“RRSP”) and the Tax-Free Savings Account (“TFSA”).
American citizens living in Canada typically also want to know whether they will be eligible for US Social Security payments, and if so, how Canadian pension programs such as Canada Pension Plan (“CPP”) and Old Age Security (“OAS”) will affect the amount of their Social Security payments.
Other important questions concern how to manage tax filing and reporting obligations in both countries, as well as the pros and cons of relinquishing US citizenship.
Keep reading for more information about these cross-border financial planning topics as they apply to US citizens living in Canada. Please note that the topics covered below require detailed, comprehensive analysis before specific recommendations can be made to an individual client, which is the purpose of creating a cross-border financial plan prior to departure.
- Tax plannning
- Estate Planning
- Retirement Planning
- Investment Planning
- Health Coverage & Insurance
- Tax Filing Requirements
Explanation of US System
As most US citizens living in Canada are aware, 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 citizens on their worldwide income regardless of where they live. US citizens, therefore, have to make complex US tax filings, and they may have to pay 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 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.
To avoid paying US tax and to ensure that all US tax obligations are severed, some US citizens living in Canada choose to relinquish their US citizenship.
Tax Issues for US Business Interests/Corporations
Owning US business interests as a Canadian resident can lead to tax complications, particularly if Americans living in Canada own interests in a Limited Liability Company (“LLC”) and/or an S corporation.
The IRS views LLCs and S corporations as flow-through entities, so they tend to be tax-advantageous business structures for Americans. In the US, profits from these structures are taxed only at the personal level, rather than both the corporate and personal levels.
However, the CRA does not recognize the flow-through nature of LLCs and S corporations, so retaining your interest in such structures as a Canadian tax resident could lead to double taxation.
Tax Traps for Americans Living in Canada
Americans living in Canada can often reduce their IRS tax bill with foreign tax credits that they receive for paying tax to the CRA. Unfortunately, the foreign tax credit system does not work perfectly; Americans living in Canada are often caught in situations where foreign tax credits aren’t available or where IRS reporting requirements are extremely onerous and expensive.
Examples of these “tax traps” abound. Some of the most common ones include the following:
• The different ways the CRA and IRS tax capital gains on the sale of a principal residence.
• The IRS’s treatment of Tax-Free Savings Accounts (“TFSAs”) and Registered Education Savings Plans (“RESPs”) as “foreign trusts”. Foreign trusts require complicated tax filings and produce taxable income in the eyes of the IRS.
• The characterization of Canadian mutual funds and exchange-traded funds (“ETFs”) held in non-registered accounts as “Passive Foreign Investment Companies” (“PFICs”). The IRS taxes PFICs harshly; moreover, PFICs require complex, costly annual tax filings.
• The classification of Canadian holding companies as either PFICs or “Controlled Foreign Corporations” (“CFCs”); CFCs are also treated harshly by the IRS.
• The discrepancy between the way certain whole and universal life insurance policies’ investment components are taxed in Canada and the US.
• Being subject to the US gift and estate tax regime.
• Contending with cross-border tax rules on US rental property income.
• The Canadian tax issues triggered by US revocable trusts.
The above is not an exhaustive list, but it does provide some insight into the more common tax traps that exist for Americans living in Canada.
Fortunately, with proper cross-border financial planning in place, many cross-border tax traps can be eliminated or, at the very least, minimized.
Situs Wills, Trusts, and Power of Attorney Documents
Ideally, estate plans should be made in the jurisdiction where one’s assets are located. Some Americans living in Canada continue to own American assets, such as a home in the Sunbelt. Such individuals should therefore have an American estate plan that covers American assets and a Canadian estate plan for all assets held in Canada. It is also prudent to create power of attorney documents for all jurisdictions in which one retains assets and spends time.
Prior to moving, it is likely that Americans who relocated to Canada later in life drew up an American will, a US revocable trust, and/or incapacity documents, such as powers of attorney for property and health care. Canadian estate planning documents such as a will and/or trust, as well as incapacity documents such as powers of attorney for property and health care, have probably also been drafted if US citizens have lived in Canada for some time.
We assist our clients by reviewing their current estate plans to make sure that they work seamlessly together from a cross-border perspective. We also identify potential plans based on individual clients’ assets; for example, it may be clear that an American living in Canada should prepare a cross-border trust or alter ego trust and revoke their US-situs will to avoid or minimize state-levied probate fees and the time-consuming probate process. Establishing dynasty trusts and/or charitable trusts may also be helpful for Americans living in Canada.
Preparing comprehensive cross-border estate plans provides peace of mind for Americans living in Canada. Establishing power of attorney documents on both sides of the border guarantees that the substitute decision-maker of one’s choice will be able to act in both the US and Canada with respect to not only property, but health care decisions as well. It is also important that one’s estate plan considers domestic laws on both sides of the border to ensure the proper distribution of assets to heirs.
Not only can a cross-border estate plan provide peace of mind in this manner, but it can save money in terms of probate fees (as mentioned) and by considering the US estate and gift tax regime.
US Estate Tax and Gifting
US citizens are exposed to the US gift and estate tax regime even if they live in Canada. Exposure to this regime, which is different than the Canadian system, often requires the execution of tax planning strategies that can be achieved through careful estate and gift tax planning.
One strategy involves planning for exposure to US gift tax. Gift tax applies at graduated rates of up to 40% on gifts of property with some exceptions for gifts made under a certain amount per year. There is also a lifetime gift tax exclusion amount that is adjusted for inflation each year.
When US citizens pass away, federal estate tax is applied to their gross worldwide estate (including some life insurance proceeds) at the same rate as gift tax: up to 40%. (State-levied estate tax may also apply, depending on one’s state of residence.) The federal estate tax exemption is tied to the gift tax exemption such that depleting one’s gift tax exemption during life reduces the portion of a deceased’s gross estate that can be exempt from estate tax upon death.
If estate planning is done effectively, estate tax can be mitigated or even avoided by holding assets in certain vehicles. Rules surrounding the calculation of the value of a deceased’s worldwide estate can be complex, so establishing the correct structures in which to hold assets is important.
Moreover, the unlimited marital deduction that US citizen spouses enjoy, which effectively allows the tax-free transfer of assets from first-to-die to surviving spouse, is not available to non-US citizens. The need to counterbalance this lack of marital credit also necessitates sophisticated cross-border estate planning for high net worth couples consisting of one non-US citizen spouse and one US-citizen spouse.
When we analyze our clients’ current estate plans, our primary intention is to help clients protect their assets from estate tax on both the federal and state-wide levels so their estates will be as robust as possible for future generations inheriting wealth.
Revocable trusts are common estate planning tools for US persons who live in the US. They are effective structures that function like a combination of a will and a power of attorney document.
Unfortunately, US revocable trusts trigger Canadian tax consequences.
The IRS views US revocable trusts as flow-through entities. As such, the IRS taxes income earned by US revocable trusts at the grantor’s personal income tax rate. In contrast, the CRA regards US revocable trusts as separate from the grantor. This discrepancy creates the potential for double taxation.
There are Canadian tax rules that may allow US citizen-Canadian residents to avoid double taxation on their US revocable trusts in the short-term; however, cross-border issues remain.
For instance, once a US person moves to Canada, their US revocable trust may be deemed a Canadian-resident trust that then requires cumbersome reporting to both the CRA and the IRS. Keeping up with this reporting can be costly and time-consuming. Moreover, exposure to the 21-year deemed disposition rule in Canada may trigger double taxation.
US citizens living in Canada who retain a US revocable trust may ultimately choose to revoke their trust to avoid the consequences discussed above. Creating a cross-border trust, or an alter ego/credit shelter trust, to hold US-situs assets might be a preferable cross-border planning solution.
Canadian and US Pension Plans
Canada and the US each have government pension plans that Americans living in Canada may be able to benefit from in retirement. Cross-border tax issues should be considered when assessing how much government pension income Americans living in Canada will be able to collect.
Those who spent a significant amount of their careers working in the US may be eligible for US Social Security payments. Generally, you are eligible to receive US Social Security if you have worked for approximately 10 years in the US.
Americans living and working in Canada will also be eligible for Canada Pension Plan benefits (“CPP”) upon retirement as CPP contributions are mandatory in Canada. Old Age Security (“OAS”) benefits are also available to those Canadian residents who spend at least 20 years living in Canada as adults.
Americans living in Canada often worry about whether they will still be able to receive their US Social Security payments and how much tax the CRA will collect. Fortunately, through the Canada-US Tax Treaty (the “Treaty”), US Social Security Credits are only 85% taxable by the CRA, and the IRS does not tax Social Security benefits of Canadian residents. (Note that the CRA taxes 100% of CPP and OAS benefits, while only 85% of CPP and OAS benefits are taxable by the IRS under the Treaty.)
One cross-border pension limitation that may affect Americans living in Canada is the Windfall Elimination Provision, or “WEP”. The WEP is a US domestic law that allows the US government to claw back Social Security payments of a US person who earns CPP income.
Another potential limitation is the CRA’s OAS clawback rule. The rule is that if a Canadian resident’s earnings exceed a certain threshold amount in yearly income (from sources such as employment, investment, or even CPP income), the government can force the resident to pay back some of their OAS payments. Above a certain maximum threshold, the CRA can stop providing OAS payments entirely.
We work with our clients to balance the competing cross-border pension rules that may exist in Canada and the US and, moreover, to advise on planning opportunities.
US Retirement Accounts, the RRSP, and the TFSA
American citizens living in Canada may have already contributed to one or more US retirement accounts prior to moving, including a Traditional Individual Retirement Arrangement (“IRA”), a Roth IRA, a 401(k), a 403(b), and/or a 457(b).
Each of these retirement accounts comes with its own set of benefits for US residents. But do these accounts have the same benefits for Canadian residents? Often, Americans living in Canada want to know whether they should retain these accounts. The answer varies with each unique situation.
IRAs and 401(k), 403(b), and 457(b) accounts all receive tax-deferral treatment in the US; fortunately, Americans living in Canada continue to enjoy tax-deferral on their IRA, 401(k), 403(b), and 457(b) accounts – as long as they file the proper election with the CRA.
Keeping your US retirement accounts open is generally the simplest method of handling them if you are a US citizen living in Canada. However, when withdrawals are made down the line, they will be subject to higher Canadian tax rates as both the CRA and IRS will tax this income. Foreign tax credits are available from the CRA, but they may not fully offset the cost of US tax. Fortunately, planning solutions exist.
US citizens living in Canada also often wonder about investing in RRSPs. While the Canada-US Tax Treaty provides relief for some of the taxation issues that RRSPs can trigger for US citizens, one major issue is that the IRS does not allow deductions of income for RRSP contributions; however, the CRA does deduct taxable income based on RRSP contributions. RRSP contributions can therefore create a discrepancy in a US citizen’s taxable income where income is higher on the US side than the Canadian side. Foreign tax credits can provide relief, but may not be fully sufficient.
Note that TFSAs are viewed as foreign trusts by the IRS, so they are not ideal savings accounts for US citizens.
Ultimately, determining how to handle a Canadian-resident US citizen’s US and Canadian retirement accounts is a complex process that involves analyzing a client’s total financial picture.
American residents moving to Canada should be aware of the following investment planning and portfolio management issues.
Passive Foreign Investment Companies
As discussed in greater detail under the Tax Planning section, US persons (US citizens, permanent residents/Green Card holders) 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.
Within a Canadian taxable or non-registered account, Canadian mutual funds, exchange-traded funds (“ETFs”), and real estate investment trusts (“REITs”) are classified as passive foreign investment companies (“PFICs”) by the IRS, with extremely punitive tax treatment. If you will be establishing a taxable or non-registered account, you should avoid holding these securities.
Canadian mutual funds, ETFs, and REIT holdings are not subject to the PFIC classification within tax-deferred/retirement/qualified accounts (such as RSPs and RIFs, which are the Canadian equivalents of IRA accounts).
We can help build, maintain, and oversee a holistic and optimized cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon while complementing other aspects of your cross-border financial plan and remaining compliant with Canadian and US tax authorities.
With your move to Canada, it is very likely that your current US-based investment professionals will no longer be able to continue to work with you due to regulatory and compliance restrictions.
For investment professionals, the relevant regulatory bodies in Canada are the Investment Industry Regulatory Organization of Canada (“IIROC”) and the provincial securities commissions. The relevant regulatory body in the US is the Securities and Exchange Commission (“SEC”).
While there are recognition and reciprocity of investment credentials on both sides of the border, investment professionals who are licensed only in one country need to formally apply for registration with the relevant regulatory entity in the other country so that their education, training, and work experience are recognized.
Owing to the additional legal complexity, heightened business risk, and regulatory reporting workload associated with operating in another country, most firms are unwilling to embark on the registration process because of their focus on domestic or regional clients.
We have partnered with best in-class cross-border compliant investment management firms and can help build, transition, and oversee an optimized and compliant cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, while complementing other aspects of your cross-border financial plan. We work with each client to independently determine the most suitable investment portfolio for each particular situation.
US Retirement Accounts (401Ks/403Bs/IRAs)
US persons moving to Canada typically have investments in US retirement accounts. As discussed in greater detail under the regulatory compliance section, once you move to Canada, it is very likely that US-based investment professionals will no longer be able to continue to work with you.
For individual retirement accounts (“IRAs”), the assets can usually remain in the US. However, depending on the custodian, they can either continue to be held with the existing US-based custodian, or they must be transferred to another US-based custodian who can hold assets for non-US residents. In either situation, unless the US-based investment professional is also licensed to work with Canadian residents, they will not be able to manage the portfolio and provide investment guidance and advice to you; rather, the assets will become self-directed.
For employer-sponsored plans such as 401Ks/403Bs, the situation is similar; it is likely that large investment firms handling and managing the plans cannot work with non-US residents. Assets in employer-sponsored plans can be transferred to a rollover IRA with a US-based custodian who can hold assets for non-US residents and then the client can self-direct the investments in the rollover IRA or transfer the assets to a Canadian RSP account.
In such cases, we can help build, transition, and oversee an optimized and compliant cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, while complementing other aspects of your cross-border financial plan. We work with each client to independently determine the most suitable investment portfolio for each particular situation.
Manager Selection and Oversight
Portfolio management is a daunting process for many individuals in general and is compounded by the additional complexities within a cross-border context. Your advisory team should be knowledgeable about investing on both sides of the border; ideally, your team will have a comprehensive understanding of the cross-border tax, financial planning, and regulatory issues that can arise.
Having an investment manager who understands your situation and needs and who works seamlessly with tax experts, lawyers, and financial planners is crucial to your financial well-being.
We favour a multi-manager approach to portfolio management by identifying and selecting top-tier managers for a particular asset class or investment mandate. Our independent oversight helps you determine which managers fit best with your investment objectives and risk tolerance. Moreover, we will coordinate total portfolio reporting, manager monitoring, optimized tax management, and comprehensive cross-border advice to help you avoid tax traps, penalties, and other issues. Where possible, we negotiate preferential pricing on investment management fees for our clients.
As an independent firm and investment fiduciaries, we can help build, transition, and oversee an optimized and compliant cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, while complementing other aspects of your cross-border financial plan.
As Americans living in Canada know, the US health care system is different than the Canadian one. The Canadian system is a free, public system, while the American system is privatized.
US persons generally have three options for obtaining US health insurance: i) via an employer; ii) via private purchase; or iii) via federal government programs such as Medicare, for retirees.
Eligibility for Medicare begins at age 65 for US citizens. If US citizens have also earned enough credits to be eligible for US Social Security payments, then they will not have to pay premiums for Part A Medicare benefits, which cover inpatient care at hospitals.
There are also Part B and Part D Medicare premiums. Part B premiums cover outpatient care, such as doctor visits and lab tests, and Part D premiums cover prescription costs.
US citizens who live in Canada will be eligible for Medicare coverage when they turn 65, although they can choose not to enroll in the program. The decision to enroll in Medicare requires a cost-benefit analysis. Paying thousands of dollars per year for Medicare premiums as a Canadian resident can be challenging, but if Americans living in Canada plan to spend large amounts of time in the US throughout their retirement years, it might be worthwhile to enroll in the program and pay any relevant premiums.
The alternative to maintaining US Medicare coverage is to purchase US travel insurance that covers you when traveling south of the border.
Universal Life Insurance Policies
US citizens living in Canada may have established life insurance policies before they moved north of the border. If those policies still exist, it is important for us to review them to confirm that they reflect our clients’ desired beneficiaries and to ensure that these policies will not create any cross-border tax traps.
One of the most common cross-border tax traps associated with life insurance policies is that certain American whole life and universal life policies may not be tax-exempt in Canada as they are in the US. This discrepancy can trigger a tax liability in Canada, but not in the US.
A similar issue arises when Americans living in Canada purchase Canadian whole life or universal life insurance policies that are not considered tax-exempt by the IRS though they are tax-exempt in the eyes of the CRA. Moreover, Canadian whole life and universal life insurance policies may trigger the egregious Passive Foreign Investment Company (“PFIC”) rules.
We advise our clients on the potential tax liability of their life insurance policies, and we suggest tax-advantageous ways of surrendering policies, if necessary.
We also advise US citizens on the tax filing requirements associated with owning Canadian policies, particularly the requirements of the Foreign Account Tax Compliance Act (“FATCA”), which is the legislation that governs US persons’ reporting requirements for foreign accounts and other financial assets located outside the US.
Life insurance policies also pose potential US estate tax liabilities. There are estate planning solutions that can mitigate tax exposure, however, such as the irrevocable life insurance trust (ILIT).
US citizens and Green Card holders who establish Canadian tax residency do not need to notify the IRS of a change in tax residency status.
Rather, US persons living in Canada as Canadian tax residents will continue to meet their US tax filing obligations by filing US federal tax returns on IRS Form 1040 each year. They will also file state income tax returns if necessary.
US persons resident in Canada are also responsible for filing Canadian tax returns to the CRA, and they will need to pay all applicable tax on both the federal and provincial levels. It is not necessary to notify the CRA of one’s new status as a Canadian tax resident. US persons who move to Canada simply begin filing Canadian tax returns.
Needing to file income tax returns in two countries necessitates organization and careful planning. Since US persons must report foreign bank accounts and financial assets that they retain offshore to the IRS, US tax filings for Canadian tax residents can become complex, with several moving pieces.
Americans who move to Canada will establish bank accounts and financial assets in Canada. As such, they may have to meet FATCA filing requirements. Reportable financial assets under FATCA range from bank accounts to Canadian partnership interests and stocks and securities issued by non-US corporations. US persons with Canadian assets may also have to file FinCEN 114, the Report of Foreign Bank and Financial Accounts, commonly known as the FBAR. Failure to comply with FBAR and FATCA requirements can lead to costly penalties.
Canadian tax residents with certain foreign property holdings, such as some US trusts and bank accounts, are also required to report this foreign property to the CRA.
Given the complexities involved in filing taxes and complying with reporting obligations in both countries, Americans moving to Canada typically require the assistance of cross-border financial planners and accountants.
Relinquishing US Citizenship
Renouncing US citizenship is a difficult, emotional choice, but for some US citizens living in Canada, it feels as if expatriation is the only option. Indeed, expatriation is the only way to completely free oneself of a lifetime of US tax obligations.
Indeed, by renouncing US citizenship, you will gain many freedoms; for example, you will be free to benefit from investing in TFSAs and Canadian mutual funds and ETFs. You will be free of the US estate and gift tax regime, and you will no longer have to comply with the IRS’s often onerous and expensive tax reporting and tax filing obligations.
US citizens considering expatriation need to know that the process may be arduous; it is also expensive. Additionally, certain factors must be proven to the US government before one can expatriate; for example, US citizens living in Canada must be tax-compliant for a certain number of years before expatriating.
High net worth individuals may also have to do extensive financial planning prior to renouncing US citizenship to avoid paying US exit tax.
When considering whether to give up US citizenship, Americans living in Canada should weigh all the pros and cons of expatriation with the help of a cross-border financial planner as well as an experienced legal team specializing in immigration.
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