If you are an American citizen living in Canada, your tax situation is delicate. Under both countries’ tax laws, you may be obliged to file personal income tax returns for each country. In the end, you won’t be taxed twice, but you need to know the basic rules to ensure that you are compliant.
The Canadian Residency Test
Canada’s tax system for individuals is based on the concept of residency. The rule is that if you are a resident of Canada for a particular tax year, you must declare and pay taxes on all of your worldwide income, no matter where it is earned. To be clear, whether you are a citizen of Canada does not matter.
Residence for tax purposes is a concept based on the taxpayer’s intention. The taxpayer’s intention is demonstrated by day-to-day life and residential ties to the country. Significant residential ties to Canada include owning a home, living day-to-day with a spouse and children, having a full-time job, and enrolment of your children in school. Besides these, secondary ties are relevant and can include a Canadian driver’s licence, membership in clubs or churches, and health insurance.
Also, if you sojourn in Canada more than 183 days in a year, then you are deemed to be a resident under the Income Tax Act.
The U.S. Citizenship Test
Under U.S. rules, if you are an American citizen (or Green Card holder) then you must declare and pay taxes on your worldwide income. The U.S. system differs from the Canadian one in that for U.S. purposes, it does not matter whether a citizen is also a resident of the U.S.
The Canada-U.S. Tax Treaty and Foreign Tax Credit
It’s easy to see how these rules could lead to an absurd result — a U.S. citizen who resides in Canada could be obligated to pay taxes on his worldwide income in both countries. Fortunately, there are two sets of rules to ensure this does not happen.
The Canada-U.S. Tax Treaty contains a series of provisions known as the “tie-breaker rules” to assign a country to people who are in exactly this situation. In general, if you have a permanent home in Canada, then this is where you will pay taxes. If you do not have a permanent home in the country but Canada is your centre of vital interests, you will also be deemed Canadian and will pay your taxes there.
However, you will still need to file tax returns in the United States and ask for a Foreign Tax Credit for the taxes paid in Canada, ensuring that you are compliant with U.S. laws and do not pay taxes in both countries.
Provincial and State Taxes
The rules described above only apply at the federal level, both in Canada and the U.S. Provincial and state taxes operate based on completely different rules. In a nutshell, you pay provincial taxes in the province where you reside on December 31 and will not be required to pay state taxes in the U.S. since individual states do not tax citizens living abroad.