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Wisdom for the American subject to Canadian Taxation


One of the benefits of ageing is the gift of wisdom.  When I was eighteen I knew everything, but now that I am much older I realize how much I do not know, and never did know.  After forty years of tax practice as a CPA I still do not know everything about US income taxes, but I do recognize those areas where my knowledge is not complete, and I know where to go for the answers. That is wisdom.


I have been practicing Canadian income taxes for about twenty years, over ten of those as a Canadian Chartered Accountant .  My knowledge of Canadian taxes is not as complete as my knowledge of US taxes, but what I bring to the table is how those two tax systems interact, and how the conventional tax advice to a Canadian resident could cause problems to the American living in Canada, and how the conventional advice to an American could cause costly problems to one who is subject to Canadian taxes.  Let me give two examples:


Canadian Tax Planning Opportunities


There are two very popular tax planning opportunities that are actively promoted by the Canadian Government and financial institutions—The Tax Free Savings Account (TFSA) and the Registered Education Saving Plan (RESP).  The TFSA account acts in a matter similar to a US Roth IRA, except that it is not a retirement account.  While there is no deduction for contributions to a TFSA, any growth or income earned in the account will be free of Canadian income taxes if the appropriate TFSA rules are followed.  Because of TFSA is not a qualified US plan, and is not covered by the Canada-US Income Tax Treaty, any income earned in the account and any gains realized in the account will be taxable by the US to the American owner of the TFSA.  To make matters worse, in most situations, the TFSA will be subject to the US Foreign Trust reporting regime, the compliance cost of which can easily exceed any benefits of not having the account subject to Canadian taxes.


The RESP will suffer a similar fate as the TFSA to the American owner—current US taxation of the income and realized gains, and Foreign Trust Reporting.  A feature of the RESP is a government grant component. That grant is also taxable by the US to the American owner.  While the government grant is a very attractive feature, the American taxpayer should weigh the US tax and compliance costs against the benefit of the grant.  An informed decision is important.


Choice of Business Entity


The entity of choice in the US for conducting business and rental activities is the Limited Liability Company (LLC).  The LLC has the benefits of limited liability to the owner, ease of formation, simplified governance, and the US income tax treatment, which in most situations, is as a proprietorship or partnership. In the eyes of the Canada Revenue Agency, however, the LLC is considered a corporation for income tax purposes.  This means that income is currently taxed in the US as it is earned, but is only taxed in Canada to the Canadian resident owner when it is paid out as a “dividend.”  This can result is double taxation.  But the situation can be even worse.


A new client, an American living in Canada, was an active owner/participant in a US business venture that was structured as an LLC.  The company lost money and eventually closed.  The business losses resulted in a large US “net operating loss.”  The client’s former US advisor, recognizing the loss, advised the client to take a large IRA distribution that could be free of US tax—a very good piece of tax planning advice for the typical American.


Because the LLC is treated as a corporation in Canada, there were no Canadian tax losses generated by the LLC from the business operations, but a large capital loss when the business dissolved and the client lost her investment.  Capital losses can only deducted against capital gains in Canada.  Because there were no ordinary loss carryovers, the IRA distribution created a large Canadian income tax liability.


There are two lessons in this example—The person subject to Canadian tax should weigh carefully before investing in or operating as a US LLC.  The second lesson is to consider the tax laws and the current tax position in each country before undertaking any significant transaction. It pays to have Wisdom.