When Jennifer, a 30-year old graphic designer from Toronto, was offered a job in Silicon Valley last year, she jumped at the opportunity.
Taxwise, however, her arrival in the U.S. felt like a crash landing. With less than a month to prepare for the big move, Jennifer, who asked to be identified by her first name only, didn’t have time to wrap up all her financial affairs in Canada. Her TFSA sits empty but still open. The sale of her Toronto house has yet to formally close.
With little guidance from her employer, the prospect of having to file both a Canadian and a U.S. return this year is daunting. A couple of free consultations with CPAs yielded contradictory advice, she said. And when she inquired about the cost of hiring a professional tax preparer, she was given a quote of $750, which she said she can’t afford given that her Bay Area rent already eats up more than half of her salary.
Jennifer’s predicament isn’t unusual for young professionals. But Canadian snowbirds, too, can easily get tangled up in the complexities of cross-border taxes and financial planning.
Making mistakes in either your Canadian or foreign tax return can lead to an ugly tax hit and penalties worth tens of thousands of dollars, in some cases. The sums could be large enough to wipe out some Canadians’ savings, so here are some tips to avoid the worst tax traps:
Trap 1: The government needs to know you’re leaving
Decide whether you’re leaving for good
“When you leave Canada you have to decide whether you’re leaving temporarily or whether you’re actually moving permanently,” Mariska Loeppky, director of tax and estate planning at Investors Group told Global News.
That’s an essential first step that many budget-tight Canadians in their 20s and 30s don’t know they have to take.
If you decide you’re gone for good, explained Loeppky, the CRA may charge you a “departure tax” but leave you alone after that, unless you’re still earning income from Canadian sources.
If you decide that your stay abroad is only temporary, there is no departure tax, but you might owe the CRA the difference between your foreign and your Canadian taxes, if the latter are higher. And that’s assuming there is a tax treaty between Canada and whatever country you’re in. If that’s not the case, you may face double taxation.
So how do you make up your mind whether you’re leaving permanently, especially when, as in Jennifer’s case, you’re on a temporary work visa?
In reality, the decision is more about what makes sense from a financial planning point of view rather than making a lifelong commitment to a foreign country.
Editor’s note: The following paragraph has been edited to reflect the fact that bank accounts aren’t considered a proof of residential ties to Canada.
If you say you’re moving permanently, you’ll have to convince the Canadian government this is really the case by severing all or most of your ties to Canada. The CRA will look at whether your home, spouse and dependents are still here. You may also have to cancel your credit cards, and even give up things like your local library card and sportsclub membership, which might also be considered proof of continued residency in Canada, warned Loeppky.
WATCH: Here is what you need to know to get through tax season pain-free.
Once you’ve done that, the CRA will charge you a one-time departure tax based on the value of some of the property you may still have in Canada. RRSPs, TFSAs and your home are among the assets exempt from this, but on almost everything else the CRA will apply a capital gains tax on your property as if you had sold it. For example, if you own a rental property that cost $250,000 but has since appreciated to $350,000, the government will tax you on that $100,000 capital gain at a rate that depends on your income tax bracket.
Telling the government that you’re giving up your residency means indicating your departure date on the first page of the Canadian return you’ll file for the year that you left. You’d normally use the same date as the arrival date on your foreign tax return. Even though you might be moving back and forth a few times before you’re properly settled, “it’s good to draw a line in the sand and say ‘I’m moving on this day,'” said Loeppky.
Jennifer flew to the U.S. to start her new job on Oct. 16 of last year, so she could use that date on her Canadian tax return if she did sever ties, said Ali Khan, a CPA and partner at the Brunton-McCarthy CPA Firm in Boca Raton, Florida.
However, the fact that Jennifer hadn’t yet sold her Toronto home by the end of 2016 may pose a problem, added Khan. “The CRA could argue that because of that she was still a resident of Canada for the full year,” he noted. Khan, who does not know Jennifer’s identity, agreed with Global News to review some of the details of her situation and share some tax tips.
Let your bank know that you’re leaving
You should also notify your bank that you have become a non-resident. Your financial institution will start to automatically charge and remit taxes to the CRA on any non-registered assets and issue forms called NR4 rather than the usual T3 and T5 slips.
Easier re-entry when you sever your ties with Canada
One advantage of making a clear-cut exit out of Canada for tax purposes is that it makes it easier to return. If the government knows you left, it will suspend benefits like the Canada Child Benefit and the GST/HST rebate but will promptly restore them when you come back. On the other hand, if the CRA was never aware of your departure and you suddenly reappear, it will wonder why you haven’t been filing taxes, which may result in considerable benefits delays.
On the other hand, by severing your ties with Canada you’ll likely lose your provincial health coverage. In some provinces, such as Ontario, there is a waiting period of up to three months before coverage is re-instated. You may have to purchase private insurance to cover that gap.
WATCH: 6 easily-overlooked tax credits and deductions
Trap 2: Filing two returns
Your Canadian federal return
If you’re severing your ties with Canada, it’s a good idea to file a return for the year you left even if you do not have a balance owing, just to make the government aware of your departure date. The filing deadlines are the usual ones: April 30 for individuals and June 15 if you own a business.
On your Canadian return you should declare your income from all sources for the period you were in Canada and income from Canada only for the portion of the year after you left. On your T1 federal return, you’ll also have to complete a page titled “Information Relating to Immigrants and to Emigrants.”
Extra forms for Canada
Jennifer will also have to file form T1161, where people leaving Canada must list worldwide assets if their aggregate value is over $25,000. While cash and financial assets like RRSPs and TFSAs are exempt from this requirement, Jennifer would have to report her home on this form, said Khan. In addition, if she had a car or other personal property worth $10,000 or more, she would have to list that, as well, he added. Even items like jewelry should be noted on this form, if their value surpasses the CRA’s threshold.
Failure to file a T1161 will result in a penalty of $100 per day, up to $2,500, Khan warned. The same fine applies for late filing.
To pay the departure tax, you’ll need to include form T1243. In Jennifer’s case, this likely doesn’t apply, since RRSPs, TFSAs and one’s principal residence aren’t subject to the tax. However, if Jennifer had a car, she would need to list it on this form, as well. Cars and most other personal properties don’t generally appreciate over time, so there would be no capital gains on which the tax would apply. But you still have to list those items — that’s the way the taxman rolls.
Determining your residency status in the foreign country
You’ll also need to determine your residency status for the tax year in both Canada and the foreign country. A rough rule of thumb is that you’ll be deemed a resident of Canada and non-resident of the other country if you’ve spent the majority of the year in Canada, and vice-versa if you’ve spent most of the year abroad. However, be sure to review your country’s specific rules for determining residency.
In the U.S. you are considered a resident for tax purposes if you meet the IRS’s Substantial Presence Test, which takes into consideration not only how many days you’ve spent in the country during the tax year but during the previous two years as well.
Jennifer doesn’t appear to meet the test, so she can file U.S. taxes as a so-called Non-Resident Alien, said Khan.
Trap 3: Your RRSPs and TFSAs
Let’s start with the RRSP. The good news is that because this type of registered account has been around for 60 years, it’s generally covered by bilateral tax treaties, and most foreign governments won’t tax any income earned in an RRSP. However, in the U.S. and other foreign jurisdictions RRSP contributions aren’t tax-deductible. Also, you might not be able to manage the investments inside your RRSP from abroad.
Loeppky’s advice is to use up all of your RRSP contribution room before leaving, if you can, and to transfer the funds into long-term investments that require minimal supervision.
That said, Canadians going to the U.S. should be aware that not all U.S. states follow the Canada-U.S. tax treaty and may therefore tax income earned inside an RRSP. California, New Jersey, and Pennsylvania are among these.
One more thing to note: If you’ve used the RRSP Home Buyer’s Plan, you’ll have to repay any balance owing within 60 days of your departure, or the CRA will tax you on it.
The TFSA, which was introduced in 2009, is still the new kid on the block in international tax law and isn’t covered by bilateral treaties. This income earned inside the account is generally taxable. In addition, you aren’t allowed to make TFSA contributions when you’re not a Canadian resident, noted Khan.
In the U.S., there’s also the question of whether TFSAs should be considered trusts, which would imply additional filing obligations. The IRS hasn’t given an official opinion on the matter, and tax advisers often disagree on the best course of action.
You’ll likely have to declare your Canadian registered and non-registered accounts on your foreign tax return and have to fill out extra forms to do so. In the U.S., that would be form 8938. There are thresholds that determine whether you have to declare you accounts depending on how much money is in them. And they vary per form.
There’s more. As governments crack down on tax evasion and terrorism financing, they’re keeping a close eye on foreign accounts, which may result in even more paperwork.
In the U.S., for example, you’ll also have to file the Report of Foreign Bank and Financial Accounts (FBAR), which goes not to the IRS but to a different branch of the U.S. Treasury.
These additional forms are sometimes due on a different date than the general tax deadline and may come with fines of tens of thousands of dollars.
There’s a potential penalty of $10,000 for not filing form 8938 or sending it in late, noted Khan. And you may have to pay an equal amount for unintentionally failing to properly disclose a single account on the FBAR. The fine for purposefully withdrawing information on an FBAR is much higher.
“You’re potentially looking at multiple fines tied to just one mistake,” said Loeppky, who advises Canadians to talk to professional tax preparers familiar with how to report foreign accounts.
“Good advice is priceless,” she noted.
Jennifer won’t have to worry about the extra forms this year if she files her IRS return as a non-resident, said Khan. But she may have to file at least form 8938 and the FBAR in her 2017 U.S. return.
Trap 4: U.S. taxes based on citizenship and residency
One last note: Canadians who move to the U.S. should weigh carefully whether they want to acquire a U.S. green card or passport. That’s because the U.S. taxes its citizens and permanent residents wherever they are in the world. So if you move back to Canada and retain your U.S. citizenship or permanent residency, you’ll still be subject to U.S. tax.
The only other country where you need to worry about this is Eritrea.