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Why some American citizens living in Canada should be concerned

This article was originally published April 18th, 2013 in the Guelph Mercury.  To download the PDF of this article click HERE.  To view this article online click HERE.

I think living as a U.S. citizen outside of the United States is at best difficult and at worst impossible from a taxation perspective.

This is a statement I read on an Internal Revenue Service website: “The IRS is aware that some U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or Reports of Foreign Bank and Financial Accounts. “

American taxpayers are required to file delinquent tax returns, with appropriate related information returns, for the past three years and to file delinquent Foreign Bank and Financial Accounts for the past six years. All submissions will be reviewed. But the intensity of review will vary according to the level of compliance risk presented by the submission. The review could be expedited and the IRS will not assert penalties or pursue follow-up actions or it could spur a more thorough review and possibly a full examination. Tax, interest and penalties, if appropriate, can be imposed in accordance with U.S. federal tax laws based on a review of the submission.

As a U.S. citizen you are taxed in the same way and according to the same rules as U.S. citizens who live in the U.S. It is important to understand that the U.S. tax system is quite different than Canada’s. That’s mainly because retirement planning in Canada is based on the principle of tax deferral through the use of a registered retirement savings plan (RRSP) or via a Tax Free savings Account (TFSA.) The U.S. tax system is designed to attack “tax deferral” and will severely punish you if you invest in these things.

I think the U.S. tax system seems to operate on the principle that if something is “foreign” it should be punished. In my opinion, under no circumstances should a U.S. citizen living in Canada or a Canadian married to a U.S. citizen invest in a TFSA. The reporting costs and potential for penalties for investing in a TFSA are so extreme that you should run. TFSAs are only recognized as trusts. As a trust, form 3520A is supposed to be filed by March 15. Then, a different form 3520 is to be filed when you file your U.S. income tax. Just adding the income to your income tax is not what the IRS wants. The IRS fine for not filing these forms is $10,000 or 35 per cent of the account.

Next, any dual or U.S. citizen living in Canada who has opened a Registered Education savings Plan (RESP) must also file the same forms. A RESP is recognized as a trust and also is taxed by the IRS.

Many will see the difficulties as being too great, too time consuming and too expensive and will renounce their U.S. citizenship. Canada only taxes by residency. The U.S. taxes by birth. Once a citizen always a citizen. You pay tax no matter where you reside. If you want to give up your citizenship you have to pay all taxes you are deemed to owe. This means if you own a business or a home, you have to pay the taxes on unrealized capital gains on them to be free.

Who could have known all this? U.S. citizens and those married or in a common law relationship with a U.S. citizen might want to avoid Canadian investment plans.

The news does get worse if we were to look at Canadian mutual funds and home ownership.

Oh and by the way, beginning Jan. 1, 2014, the Foreign Account Tax Compliance Act will require banks, insurance companies, investment firms and credit unions to collect and report certain information on accounts held by U.S. persons to the IRS.

Kevin Cahill is a Guelph-based financial planner.