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Email this8:56 am
April 6, 2013
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{detailed info about US taxation, foreign earned income exclusion, Canadian mutual funds as PFIC's, FBAR penalties, …}
I think this deserves its own topic. 
I had a look on the IRS site about the US taxation aspects mentioned.
I don't think it will end up being that bad for most dual US-Canada citizens residing in Canada. The accounting/bookkeeping headache will definitely be there. But, US taxes payable may not.
For example, failing to file FBARs (which isn't even a tax form!) gets you an impressive fine. Well, the fine was reduced in 2015 to not exceed "100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination." Previously, the fine was per account, per year for up to 6 years and could be up to 300% of the money balance that you didn't report. BALANCE, not INCOME!
IRS could levy such penalties. However, the IRS has programs to waive such penalties for US citizens living abroad who don't end up owing any US taxes and are not deliberately trying to evade taxes.
It seems that the US government does recognize the reality. Many US citizens living abroad are not tax experts and were just simply not fully aware of their US tax filing obligations.
Nope, the Foreign Earned Income Exclusion is for "earned income". This is income from employment or business income. It does not include pension or annuity income, or interest, dividends and capital gains. The "foreign housing amounts" are related to when your employer provides housing for you.
Back when it didn't matter, we Canadians figured since our taxes are higher than US taxes, we would never owe US taxes. Well, this is only true for earned income. A tax-filing dual citizen in Canada has to pay tax on capital gains from selling a home, RESPs, RDSPs, maybe TFSAs, and I'm sure much more that I'm not aware of. The real killer is when you retire and have only pension and investment income. CPP is finally handled specially by a tax treaty, but not much else.
All that does have to be reported to the IRS. But, it doesn't mean that there is any net US taxes to be paid on them.
The US tax system does have an exemption on the capital gains from the sale of a main home. It is capped at $250,000 and not unlimited as the Canadian one is.
There is also something the Canadian tax system doesn't have: a deduction for interest paid on up to $1 million of total mortgage principal for one's main home and second home.
There is also a foreign income tax credit for Canadian federal and provincial taxes paid on non-excluded income.
Looks like one will end up owing US taxes only when reported income exceeds US personal exemptions and mortgage interest paid. Even then, there will be US taxes payable only when the calculated US federal taxes exceed the Canadian federal and provincial income taxes paid.
These are the US federal tax brackets for 2016 from the IRS web site:
| Taxable Income | 2016 US Federal Tax Rate |
| $0—$9,275 | 10% |
| $9,276—$37,650 | $927.50 plus 15% of the amount over $9,275 |
| $37,651—$91,150 | $5,183.75 plus 25% of the amount over $37,650 |
| $91,151—$190,150 | $18,558.75 plus 28% of the amount over $91,150 |
| $190,151—$ 413,350 | $46,278.75 plus 33% of the amount over $190,150 |
| $413,351—$415,050 | $119,934.75 plus 35% of the amount over $413,350 |
| $415,051 or more | $120,529.75 plus 39.6% of the amount over $415,050 |
Looking at those US tax rates, I don't think it is easy for someone with just pension and investment income to end up every year owing more in US federal taxes than Canadian federal and provincial taxes.
Canadian mutual funds are considered a PFIC and are taxed punitively such that the tax is usually more than the return on your investment. The US investment industry lobbied Congress for this gem, to stop US homelanders from investing outside of the US. Problem is, a tax-paying Accidental American dual-citizen in Canada becomes a 2nd-class Canadian and can't work, live and plan for retirement like other Canadians.
There's doubt about that.
In Certain Canadian mutual funds aren’t PFICs, cross border tax lawyer Max Reed (SKL Tax) writes the following:
… A commonly held view is that these funds are Passive Foreign Investment Companies (PFICs) under US law. This view is based on an unsubstantiated, one sentence conclusion in a non-binding IRS memorandum pertaining to estate tax. The IRS has not taken any official position on the issue. …
…
Prior to 2004, when the laws granting limited liability came into effect, there is a good argument that Canadian mutual fund trusts were partnerships for US tax purposes and thus not PFICs. Although the limited liability status of the investors may have changed with the new laws, because of Treasury Regulation 301.7701-3(a) the US tax classification of those funds does not change.
In short, mutual funds created prior to 2004 may not have been PFICs because their investors had some liability for the debts and obligations of the fund. That liability status may have changed in 2004 when new laws went into effect, thereby dealing with that problem. But the US tax classification does not change. So the funds were likely partnerships for US tax purposes (and so not PFICs) prior to 2004 and as a result remain that way to this day.
…
Lots of good Canadian mutual funds are created as mutual trusts before 2004.
9:37 pm
October 21, 2013
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As an outside observer to this dilemma, it seems clear to me that the situation is full of potential problems for the dual citizen. An ordinary person should not have to wade through so much fine print and still be uncertain as to what exactly are the implications. Also, rules can change t any time, and who knows what the next admin might dream up.
My well-informed friend who deals with this every year is still weighing the possibility of renouncing US. He says that he can't have a TFSA because of US rules, and neither can his kids, unless all renounce, which costs certainly add up. And at best a limited selection of mutual funds are possible. He says none at all, which may be what it amounts to for him.
10:00 am
April 6, 2013
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Loonie said
As an outside observer to this dilemma, it seems clear to me that the situation is full of potential problems for the dual citizen. An ordinary person should not have to wade through so much fine print and still be uncertain as to what exactly are the implications. Also, rules can change t any time, and who knows what the next admin might dream up.
Perhaps dual US-Canada citizens are not considered to be ordinary people, like the rest of us mere-mortals!
My well-informed friend who deals with this every year is still weighing the possibility of renouncing US. He says that he can't have a TFSA because of US rules, and neither can his kids, unless all renounce, which costs certainly add up. And at best a limited selection of mutual funds are possible. He says none at all, which may be what it amounts to for him.
I'm sure your friend and his kids, as dual citizens, can have Canadian TFSA accounts. Looks like the issue is how they are reported to the IRS.
For sure, there's no tax-free sheltering of money earned in the TFSA when they do their US tax returns. But, for US tax purposes, is each TFSA a foreign trust, not a separate entity from the taxpayer, or a separate, but disregarded, entity? There's extensive paperwork for foreign trusts. The paperwork is simpler if the TFSA is a disregarded entity. Even simpler, if the TFSA is not a separate entity.
Classification of the Canadian TFSA for US tax purposes (September 2014) explores the issue and argues that a TFSA is either not a separate entity or a disregarded entity.
Some tax people think a TFSA is a foreign trust in the US tax system. Some think it is a disregarded entity. IRS hasn't ruled on this. Perhaps, even the IRS is not sure as well!
As for Canadian mutual funds, critics of the high-expense Canadian mutual funds would say your friend and his family are not missing out on much.
10:09 am
October 27, 2013
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The 'go to' forum for cross-border tax issues and dual citizens, or US citizens residing in Canada is Serbinski's tax forum https://forums.serbinski.com/ , which is also very helpful about issues around Canadians becoming a tax resident of another country, i.e. non-resident of Canada.
The general guidance for those that have to file US tax returns is to avoid Canadian trusts altogether and TFSAs. There are grey areas in mutual fund trusts and ETFs (also trusts), REITs, LPs, and income trusts like AW.UN. Unless one has masochistic tendencies and wants to wade into the abyss......stay away.
11:16 pm
October 21, 2013
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...and this is why some duals who have no intention of living in the US again are opting for renunciation.
Being a dual and living in Canada is likely to cost them one way or another, whether it's to lawyers, accountants, the IRS, renunciation fees, or inability to take full advantage of rights and privileges accorded to Canadians by virtue of our tax structure or other regulations.
The only way to be rid of it all is to renounce, and it may be the least costly, all things considered.
"Land of the free!"
Please write your comments in the forum.