Unlike other countries, US law dictates that American citizens must file tax returns and report their worldwide income every year to the IRS, regardless of where they live and work. This includes Americans citizens, dual American-Canadian citizens and US green card holders.
Personal income tax laws differ greatly between Canada and the United States. One of the primary differences is that Canadian income tax laws are based on residency, while US tax laws are based on citizenship. US citizens have an ongoing obligation to declare and report their worldwide income to the US, regardless of where they reside. US citizens who have permanently departed the US and have become full-time permanent residents of Canada are still required to file US income taxes on an annual basis with the Internal Revenue Service (IRS).
The only way for US citizens to avoid this obligation would be to go through a process to renounce their US citizenship. This however may not be practical or desirable for most people. Therefore, US citizens who resides in Canada are essentially subject to the same US filing requirements as they would if they continued to reside in the US.
This of course means filing a US income tax return, Form 1040 every year, and reporting worldwide income. However, the Tax Treaty between Canada and US has several mechanisms available know as foreign tax credits, to make sure the person does not have to pay double tax. These credits include:
- Foreign earned income exclusion: US citizens may be able to exclude up to $97,600 from their 2013 earned income for US tax purposes by completing Form 2555 (Foreign Earned Income) and attaching it to the 1040 income tax return. To claim this exclusion the person must meet 7 specific criteria which include 3 residency tests: Bona Fide resident of Canada, Physical Present in Canada for at least 330 days during the last 12 months, and whether Canada was the ‘Tax Home’ country.
- Tax Treaty Benefits: In most cases, treaty benefits are not available to US citizens by virtue of Article XXIX, paragraph 2. This provision states that nothing in the treaty can prevent the US from taxing its own citizens, except for those articles listed in paragraph 3. One of these exemptions is the article governing Social Security payments. This means that if a US citizen receives Social Security benefits from the US, these benefits are not taxable in the US, however, they are taxable in Canada. A 15% deduction however can be claimed on the Canadian income tax return on these benefits.
- Foreign Tax Credit or Deduction: A US citizens can avoid double taxation by claiming a foreign tax credit on their US income tax return for taxes required to pay to Canada. To claim the credit, Form 1116 (Foreign Tax Credit) must be completed and attached to the US return. Alternatively, Canadian taxes paid can be claimed as an itemized deduction. Both the deduction and credit are limited to foreign income that is subject to US tax, so neither can be claimed for income excluded on Form 2555.
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