Over their life, many Canadians end up with some U.S. Income. It might be winnings from a casino, it might be the sale of a vacation home, a rental home in Phoenix, or pension income from time spent working in the U.S.
All of these sources of income trigger either the requirement to file a U.S. tax return or the need to file in order to get a refund of taxes withheld.
KMA is able to answer your questions and prepare the tax returns and/or forms needed.
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Common Sources of U.S. Income
Gambling Winnings
While gambling winnings in Canada are generally non-taxable, they are in the U.S. If you have winnings at a U.S. casino, you may end being subject to a U.S. 30% withholding tax. If taxes are withheld, the casino should issue you a form 1042-S that should report your winnings and the taxes withheld.
In order to get some or all of the taxes back, you will need to do the following:
If you do not already have one, obtain a U.S. tax number (called an ITIN), which are valid for a minimum of five years.
Track your losses for the year. Under U.S. tax law, you can offset your losses against your wins. So having a house card that allows you to track your losses is a good idea because it provides the records that the IRS may request to verify the losses.
File a 1040-NR (a U.S. tax return for non-residents). You only need to file a U.S. return when you have reportable income. KMA can prepare this and the W-7 for the ITIN.
Vacation Home Sale
If you sell a vacation home in the U.S., you may be subject to withholding taxes by both the federal and possibly the state government. Generally, a 10% (of the gross sales price) federal withholding tax will be applied. Depending upon the state your property is located in, that state may require a withholding tax as well.
Individuals can apply to reduce the withholding tax, but many times this process is not done in a timely manner and the withholding is deducted.
There is another exception to consider: if the property sells for less than $300,000 and the purchaser signs a statement saying that they intend to use it as a personal use residence at least 50% of the time over the next two years.
Any person who sells a property is required to file a U.S. return (1040-NR). If a couple has both names on title, both of them will have to file a U.S. tax return. In order to file the 1040-NR, you will need the following:
A U.S. tax number (called an ITIN), which are valid for a minimum of five years.
What you originally paid for the property. It is usually a good idea to provide KMA with copies of the original purchase documents as there are closing adjustments that need to be taken into consideration.
If you have done any major repairs or improvements, copies of the invoices. With this information KMA can review determine if these represent additions to your cost basis.
Copies of the sales documents. Your escrow agent should provide these and the U.S. tax forms that report any taxes withheld.
Copy of the 1099-S or 1042-S received that are related to the sale.
We are often asked “Do I really have to file a U.S. tax return?”
Yes, under U.S. law you are required to. But in addition, you should do so for Canadian tax purposes. As a resident of Canada, you are subject to tax on your worldwide income. So if you have a capital gain on the sale of the U.S. vacation property, you are required to report this on your Canadian tax return, and it may also trigger the requirements to file form T1135.
This will not necessarily lead to double taxation as you can claim a tax credit for tax paid to the U.S. But in order to do this, it has to be based upon a U.S. tax return, not just the withholding taxes paid. A common misconception about withholding taxes is that they are the final tax bill. Withholding taxes are only an instalment towards the final tax bill. It is not until the return has been prepared and the final tax bill calculated that you will know what the correct amount for the foreign tax credit will be. You may end with a refund, or owing a bit more.
U.S. Rental Properties
After the U.S. housing crash in 2008, many Canadians bought U.S. real estate as investment. Many continue to do so. As you have income from real property in the U.S., you are required to file a U.S. tax return each year. Depending upon where the property is located, you may have to file a State Tax Return as well.
A couple of common misconceptions about owing real estate in the U.S.:
“It‘s not taxable in Canada since it’s U.S. income.” This is wrong. As a resident of Canada, you are taxed on your worldwide income. In many instances, there are losses in the initial years of ownership, so reporting the rental actually may save you taxes. In addition, you may meet the T1135 foreign income verification statement. This is a form that is required for Canadians with more than $100,000 of investment assets outside of Canada.
“I‘m losing money, so I won’t owe money to the U.S. – why bother reporting?” The truth is that the IRS has the ability to deny deductions (expenses) if a return is filed more than 18 months late. This means that the losses that you incurred will not be allowed to be offset against the gain on the sale of the property. So it is absolutely essential that you file each year in order to preserve the losses so that they can be used in the future.
What We Need to File Your U.S. Tax Return with U.S. Rental Property Income
A U.S. tax number (called an ITIN), which are valid for a minimum of five years.
A summary of rent and expenses for the year. You should receive a 1099-Misc from your rental agent in the US that shows the amount of rent collected in the year. In addition, most rental agencies will provide you a yearly summary of expenses they paid on your behalf. If you have additional expenses that you incurred directly, please provide a list of those.
If you purchased or sold the property in the year, we will need the purchase documents, including the Escrow statement.
If you purchased furniture or other equipment in the year, we will need copies of the invoices.
We will need to know the number of days the property was rented and the number of personal use days.
While there are many similarities between Canada and the U.S. for the calculation of your net rental income, there are a few major differences. The key difference is that depreciation as calculated for tax purposes is a mandatory deduction. In Canada, capital cost allowance (the Canadian equivalent to depreciation) is an optional deduction.
As a result of the depreciation deduction, it is very common for rental property owners to not pay U.S. taxes on a year to year basis.
Another difference between Canada and the U.S. is that if you rented the property for less than 15 days in the year, you are not necessarily required to report the income, regardless of the amount of rent actually collected. This unusual rule was introduced in anticipation of the 2002 Salt Lake City Winter Olympic Games.
Royalties
Over the last few years, a number of Canadians with historic ties to the U.S. have found themselves in possession of oil royalties. This is typically sub-surface rights that have passed from generation to generation and with the recent changes in oil extraction technology, are now finding that there are wells on their property and producing royalties worth a considerable sum.
These royalties are typically subject to a 30% withholding rate. With KMA’s assistance, we have helped a number of clients make the necessary elections and get back some or all of these taxes.
Working in the United States
If you worked as an employee of a U.S. company during the year, and you were not there as a green card holder, you still have to file a U.S. tax return. You should receive a W-2 from your employer, and your 1040-NR is due by April 15th each year. KMA can prepare this return for you. We can review what deductions might be available to you.
Inheritances
Generally speaking, inheritances are tax free. There are situations though, where the executor of the estate, may need to allocate out some of the income that the estate is generating, to beneficiaries. An estate usually generates income when there are assets held during the probate period.
One of the differences between Canadian and U.S. tax laws is the taxation of estates.
Many times in Canada, it is beneficial to leave the income in the estate, and have it pay the taxes. The reason is that the estate gets to use the same marginal tax rate as an individual.
In the U.S. the opposite is true. Generally speaking, the tax rate on estates is at the top marginal tax rate. So in the U.S., it is quite common for executors to allocate out this income to beneficiaries as it will likely result in an overall lower tax bill.
If you are a beneficiary of a U.S. estate, you will be given a K-1 slip from the estate. KMA can prepare your U.S. return. You will need to complete this return before your Canadian return, as the income that is shown on the K-1 is taxable in Canada as well. You need the U.S. return in order to be able to properly claim foreign tax credits on your Canadian return.
Pensions, 401ks, and IRAs
If you worked in the United States for one or more years, it is very likely that you put some money in either IRA or have a company pension. When you receive a payment from one of these retirement vehicles, it is taxable in the United States. In addition, the administrators will withhold at least 15% tax.
When you have these types of income, you should file a U.S. tax return (1040-NR) in order to get the correct amount of taxes paid to the U.S. The Canada Revenue Agency (CRA) will normally only accept the tax calculation from the tax return, not the amount of withholdings.
A common misconception is that if taxes are withheld at source the amount withheld is the final tax bill. That is incorrect. The amount withheld is only considered an instalment towards the final tax bill. It is very likely that the actual tax bill will be different.
KMA can assist you with this filing each year and many of the related questions on U.S. withholding taxes.