If you make money at home and in the United States, you probably wonder how that affects your income tax. The answer depends on the type of income you receive and whether or not you’ve already paid taxes on it.
Paying Taxes When You Make Money in Canada and the United States
As a Canadian resident, you must pay taxes on your worldwide income. Canada has tax treaties with many countries to ensure that its citizens don’t incur double taxation on the income they earn in other countries. For example, say your bubblegum company sells two cases of gum to the Piedmont Inn in Wisconsin. Although an American company purchased your products and you shipped them to the United States, you just pay taxes like you always do. In practice, though, it’s not quite so simple.
Business income Paid to Canadian Residents
If you provide a product or service to a customer in the United States, you only have to convert the money into Canadian funds to make it part of your business income for tax compliance purposes. The Canada Revenue Agency (CRA) says you need to use the Bank of Canada exchange rate in effect on the day you receive the income to do this.
It’s not so simple, though, when you earn business income while you’re a resident of the United States. When you work as a contractor, you need to file an Internal Revenue Service Form W-8 with your client, and you may have to file both an American and Canadian tax return.
Foreign Employment Income
Handling foreign employment income is fairly simple. Your American employer provides you with a W-2 (the equivalent of a T4 slip), and you convert the money into Canadian funds by using the Bank of Canada exchange rate in effect on the day you received the income. Then, you enter your foreign employment income in Canadian dollars on line 104 of your T1 personal income tax return.
If the company you worked for in the United States withheld taxes, you don’t reduce your foreign income by that amount. Instead, you can possibly claim a foreign tax credit when you calculate your federal and provincial or territorial taxes. Also, look to see if the amount on your W-2 slip reflects contributions to any of the following:
- 401(k), 457 or 403(b) plan
- U.S. Medicare
- Federal Insurance Contributions Act (FICA)
If the company made these contributions for you, you must add these them to your foreign employment income on line 104 on your Canadian return. Keep in mind that you may still be able to deduct them at tax time.
Rental Income From a Property in the United States
Do you own rental property on both sides of the border. It requires some forethought and tax planning to handle rental income in the most beneficial way on your personal tax return. Tax-wise, you’re a Canadian resident for Canadian income tax purposes and a nonresident alien for U.S. tax purposes. Because of this, the person who pays the rent is obliged to withhold and remit 30% of the gross rent to the IRS on your behalf, since you are a nonresident alien. This means that if you want to deduct expenses from your rental income, you need to:
- Provide your renter with a withholding waiver (Form W-8ECI) before you collect any rent. This lets you avoid the 30% withholding, which is otherwise mandatory.
- File a U.S. income tax return to report and pay tax on your net rental income.
What happens if you don’t provide your renter with a withholding waiver? Then your withholding agent (i.e., your renter) must provide you with Form 1042S, which details the amount of gross rental income you received and the amount of non-resident tax withheld. You must file Form 1042 with the IRS concerning your rental income. You can then choose to file a U.S. income tax return, deducting any expenses, to receive a portion of the 30% back as a refund. Alternatively, you can elect not to file a U.S. income tax return, but that means you forego any savings of the 30% withheld.
Here’s the big catch: if you don’t withhold non-resident tax, you must file a U.S. tax return. If you don’t do this within the specified time period, the IRS disallows all deductible expenses and assess penalties for late filing and underpayment of tax.
Planning ahead and knowing how foreign income affects your income tax helps reduce your risks of noncompliance and ensures you don’t leave money on the table, or worse, find yourself owing more than you should. This keeps you in good with tax authorities on both sides of the Canada/United States border. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.