EMPLOYEE TAX
Relocating American
employees to Canada Tax and estate planning
Tax and estate planning can present unexpected challenges for US citizens relocating to Canada. Matt C Altro, president and CEO of Canadian firm MCA Cross Border Advisors, advises how planning ahead can help to mitigate them.
A
s American employers continue to expand their operations into Canada – a growing trend in today’s North American marketplace – American employees will be transferred
north of the border with increasing frequency. There are many cross-border tax implications for US citizens
relocating to Canada, which should be addressed prior to an employee’s move. Some of these considerations are analysed below.
Tax distinctions between Canada and the US As discussed in the companion article to this piece, Relocating Canadian Employees to the US: Three Major Tax Considerations, Canadian income tax is based on residency, while the US generally taxes its citizens on their worldwide income, even as non-residents. Americans working in Canada will therefore be taxed by the
Internal Revenue Service (IRS) on worldwide income, regardless of residency; they will also be taxed by the Canada Revenue Agency (CRA) on the employment income earned in Canada. If relocated employees are considered Canadian residents under
Canada’s Income Tax Act, the CRA will also tax the relocated American on his or her worldwide income. US citizens residing in Canada must therefore file tax returns in both countries while remaining compliant with other, often onerous, tax reporting requirements on both sides of the border. Double taxation can also be an issue. There are, however, various
income-tax exclusions available under the Canada-US Tax Treaty, such as foreign tax credits. Since Canadian taxation rates are generally higher than US ones,
tax paid to the CRA will often eliminate the need to pay tax to the IRS. However, foreign tax credits don’t always solve cross-border tax issues for Americans in Canada.
Income-tax traps for US citizens in Canada Issues occur when certain types of income are taxed in one country but not the other. Such income-tax traps include:
• US revocable trusts • Tax-free savings accounts (TFSAs) • Registered education savings plans (RESPs) • Mutual funds and exchange-traded funds (ETFs) • Universal life insurance policies (ULs)
TFSAs and RESPs Conversely, the IRS may impose tax when the CRA does not. For example, US citizens who open TFSAs and RESPs after relocating to Canada may be taxed by the IRS on the income
earned inside those accounts; the IRS does not provide tax breaks for these Canadian tax-advantaged vehicles. Moreover, the IRS imposes reporting requirements on US citizens with TFSAs and RESPs.
Mutual funds and ETFs The IRS also imposes burdensome reporting requirements on US citizens who hold Canadian mutual funds and ETFs, both of which are considered to be passive foreign investment companies (PFICs) by the IRS. In the US, PFICs are subject to severe tax. As such, Canadian
mutual funds and ETFs held outside registered accounts can result in punitive taxation for US citizens in Canada.
ULs Income earned inside a UL is generally tax-deferred, but income that is tax-exempt in a Canadian policy may not meet the test for tax exemption in the US. This taxation mismatch may create a situation where US citizens owe tax on income earned inside a Canadian UL to the IRS.
US revocable trusts A US citizen may already have a US revocable trust in place upon arrival in Canada. US revocable trusts work well in the US: they avoid probate and guardianship proceedings if the creator of the trust dies or becomes incapacitated. Additionally, they have no income-tax consequences in the US However, US revocable trusts are separate taxpayers in Canada,
so if the assets inside the trust are distributed after the relocated employee arrives in Canada, the CRA will tax the trust. Since the trust won’t be taxed in the US, foreign tax credits won’t be available and double taxation will result.
Cross-border planning There are a variety of ways to handle the potential tax implications of an American employee’s cross-border move. Due to the complexity of the issues, working with a cross-border financial planner can be helpful. A cross-border financial planner can serve as a quarterback,
working with other advisers, such as investment advisers, accountants and lawyers, to both minimise the impact of US planning that doesn’t work well for Canadian residents and identify the most beneficial Canadian tax and estate planning opportunities for US citizens living in Canada.
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