1.05 U.S. Taxation of Residents and Non Residents
Due to the wide range of alternatives available to Canadian residents who conduct business in the U.S., this discussion has been restricted to the provision
of personal services by Canadians in the U.S. only.
Non-residents who are taxable in the U.S. on their U.S. source income must file form 1040 NR by June 15 each year for the prior
calendar year. Married residents of Canada may claim exemptions for a spouse and dependent children who lived with them. Although the maximum tax rate used on the form 1040 NR is the same as that for form
1040, fewer deductions and exemptions are generally available, resulting in a higher overall federal tax cost. Non residents filing form 1040 NR cannot claim the standard deduction, but must itemize deductions.
(a) Canadians Employed in the U.S.
A resident of Canada who is employed by a Canadian company in the U.S falls under the Canada U.S. Income Tax Convention (Treaty) - Article XV - "Dependent
Personal Services", which states:
"Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other
similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment
is so exercised, such remuneration as is derived therefrom may be taxed in that other State."
This has been defined to mean that employment income is exempt from U.S. taxation and withholding unless it is over $10,000 per
year. If it is over $10,000 per year, it is exempt only if:
The individual was in the U.S. less than 183 days in any calendar year, and
The cost is not borne by (deductible by) a U.S. resident employer or an employer with a fixed base in the U.S.
Therefore, to be exempt under the Treaty, an individual must be employed in the U.S. by a Canadian corporation without a
fixed base in the U.S. Employment in the U.S. by U.S. employers, and Canadian employers with a permanent establishment or fixed base in the U.S. is fully taxable in the U.S.
A Canadian employer with a fixed base in the U.S. who hires or transfers Canadian residents to work in the U.S. should ensure
that U.S. withholding taxes are deducted and remitted to the U.S., and that withholdings to Revenue Canada are eliminated, except for those required to fund Canada Pension Plan (under the Totalization
Agreement). Failure to do so can create a cash flow problem for the employee, since they will be taxable in the U.S. and will have to pay U.S. taxes before the Canadian withholdings are recovered through the
operation of the foreign tax credit.
Although persons employed by U.S. resident employers and foreign employers with a U.S. fixed base are subject to tax
withholding at source on U.S. source income, and are liable to file form 1040 NR to disclose that income, the overall tax cost to the individual will not be increased as a result of the operation of the foreign tax
credit available in Canada for the taxes paid to the U.S. or a state.
A person who is exempt from U.S. taxation under the Treaty must still file:
- U.S. 1040 NR Nonresident Alien Individual tax return
- this return would not include any income, but would be filed to preserve the Treaty based exemption from taxation.
- Form 8833 - Disclosure of Treaty Based Position
- disclosing the basis for exclusion of income. This is required by law, with severe penalties for failure to disclose a Treaty based position.
- Form 8840 - Closer Connection Exemption
- to prevent taxation of world income in the United States by virtue of presence in the U.S. - through the establishment of a closer connection to Canada;
- U.S. Form 8233 Exemption from Withholding on Compensation for Independent Personal Services of a Nonresident Alien
Individual - to prevent withholding of income tax at source on employment income from U.S. sources.
- Canadian T-1 Individual Income Tax Return
- including world income and the employment income earned in the United States;
Failure to file may result in a fine, and potential denial of the Treaty exemption.
Persons who fail to file the Treaty based disclosure returns on the presumption that they are not taxable in the U.S. also risk
having tax assessed in the U.S. at a later date when the Canadian return is barred from adjustment as a result of the time statute to include the additional tax under the foreign tax credit provisions in Canada -
thus resulting in potential double taxation. It is therefore extremely important to comply with the letter of the law when it applies to the filing of tax returns, even if the is no apparent immediate tax
liability.
  
(b) Canadian Residents Providing Self Employed Personal Services in the U.S.
A Canadian resident providing personal services in the U.S. as a self employed individual falls
under the Canada U.S. Income Tax Convention (Treaty) -- Article XIV - "Independent Personal Services", which states:
"Income derived by an individual who is a resident of a Contracting State in respect of
independent personal services may be taxed in that State. Such income may also be taxed in the other Contracting State if the individual has or had a fixed base regularly available to
him in that other State but only to the extent that the income is attributable to the fixed base."
Therefore all self employment income is exempt from U.S. taxation, irrespective of amount earned
or time spent in the United States, so long as it is paid to the self employed individual personally as a self employed individual, unless the individual has a fixed base in the United States. The
Canadian individual could be deemed to have a permanent establishment in the U.S. if:
He has an office in the U.S.; or
He uses the services of an agent in the U.S. who has independent authority to enter into contracts on behalf of the individual.
Assuming that the individual is not deemed to have a permanent establishment in the U.S. and the
individual has no other dealings in the U.S., the following filings may be required each year:
U.S. 1040 NR Nonresident Alien Individual tax return - this return would not include any
income, but would be filed to preserve the Treaty based exemption from taxation.
- Form 8833 - Disclosure of Treaty Based Position - disclosing the basis for exclusion of
income. This is required by law, with severe penalties for failure to disclose a Treaty based position.
- Form 8840 - Closer Connection Exemption - to prevent taxation of world income in the
United States by virtue of presence in the U.S. - through the establishment of a closer connection to Canada;
- U.S. Form 8233 Exemption from Withholding on Compensation for Independent
Personal Services of a Nonresident Alien Individual - to prevent withholding of income tax at source on self employment income from U.S. sources.
- Canadian T-1 Individual Income Tax Return - including world income and the self
employment income earned in the United States;
- Canadian form CPT56 - Application for Certification of Coverage of Employment under
the Canada Pension Plan Pursuant to Article V of the Agreement on Social Security between Canada and the United States. - to prevent the requirement to deduct and pay
social security taxes in the United States.
(c) Canadians Providing Personal Services in the U.S. as Independent Contractors Through Their Own Canadian Corporation
A Canadian resident who, in addition to operating a corporation in Canada for the purpose of
rendering personal services, may also use the Canadian corporation to derive income from his personal services in the U.S. Under these circumstances, the individual would fall under Treaty
Article XV (Dependent Personal Services) in connection with his time spent providing services in the U.S. and the Canadian corporation will not be deemed to have a permanent establishment in
the U.S. solely by virtue of the employment of the individual, but could have a permanent establishment if:
Ø It has an office in the U.S.
Ø It uses the services of an agent in the U.S. (with discretion to sign contracts).
Assuming that the corporation is not deemed to have a permanent establishment in the U.S., the
corporation may be exempt under Treaty Article XIV (Independent Personal Services). If the individual has no other dealings in the U.S., the individual employed by his own corporation may
fall under Treaty Article XV (Dependent Personal Services) if the time and income threshold amounts are met (see d(1)). Assuming the individual is not exempt under Treaty the following
filings may be required each year:
a) Personal Filings:
- U.S. 1040 Individual tax return (Including world income if factual or elected residence is
established in the U.S; A separate state return is also required;
- Canadian T-1 Individual Income Tax Return- including world income and a foreign tax credit for taxes on the 1040;
- Form 5471 Information Return of US Persons with Respect to Certain Foreign Corporations:
Any person who is or becomes a U.S. person by virtue of residence, who operates a foreign corporation, must disclose and include in income all passive and personal
services income not derived from the country of incorporation – Subpart F. Income.
Any US person (including someone who becomes a US person during the year) must include in
current taxable personal income on his 1040, his distributive share of Subpart F income earned by a foreign controlled corporation during the year whether distributed or not (subject to some
deductions for qualifying deficits) pursuant to IRC Sec 951. Subpart F income includes income of the foreign corporation which relates to passive activities like rents, interest and dividends (unless
part of active business) illegal payments, bribes, etc., services rendered outside the foreign country, foreign personal holding company income, sales commissions earned for sales outside of the
foreign country, etc. as defined in IRC Sec 952. According to IRC 923, subpart F income does not include active business income from operation of a business in the foreign country.
The thrust is to include in US personal taxable income passive income of US persons which has
been channeled through a foreign country. Therefore, a Canadian who goes to the US to work providing personal services in the US through a Canadian corporation he/she controls, and
becomes a US person by virtue of residence, would be liable to include all net service income in his/her US return which is earned by the Canadian corporation, whether distributed or not. To
further complicate matters under US rules (IRC267), accruals are not permitted to cash basis related parties, and all "bonus" amounts must be paid within the tax year increasing the complexity
of tax planning for corporations operating in the U.S.
b) Corporate Filings:
- U.S. Form 1120-F U.S. Income Tax Return of a Foreign Corporation - as a
protective measure to disclose exemption by virtue of no permanent establishment in the U.S. - including a form 8833 for the corporation.
- U.S. Form W-2 & W-3 – Wage & Tax Statement and Summary Remittances of tax
should be made if the expected stay in the U.S. is over 183 days in the year or if more than $10,000 is paid (otherwise forms 1042 &1042S are filed).
- U.S. Form 5472 - Information Return for 25% Foreign Owned Corporation and Related Party Transactions
- to disclose dealings with the Canadian shareholder.
- Canadian T-2 Corporation Income Tax Return - and a Provincial Corporation Tax Return.
- Canadian form CPT56 - Application for Certification of Coverage of Employment
under the Canada Pension Plan Pursuant to Article V of the Agreement on Social Security between Canada and the United States. - to prevent the requirement to
deduct and pay social security taxes in the United States.
Canadians who operate a small business corporation which would otherwise be eligible for the
"Small Business Deduction" under Para. 125 of the Income Tax Act (Canada) should be cautioned that in order to be eligible for the low corporate rate of tax on Canadian Controlled
Private Corporations, the corporation must be engaged in an active business carried on in Canada. Therefore, income from personal services rendered by the majority shareholder in the U.S. and
paid to the corporation will not be eligible for the lower Canadian corporate rate of tax. Accordingly, and in context of the prohibition from paying year end bonuses in the U.S., proper
tax planning must be carried out during the year to ensure that net taxable income of all such corporations is fully distributed as salary.
(d) Per Diem Expenses While Temporarily Working Away From Home
Canadians who work temporarily in the U.S., and are away from home for business purposes may
be eligible to claim a deduction from U.S. taxes for the costs of lodging, food and travel incident to their engagement. For U.S. purposes, per diem and expense reimbursement plans fall into two categories:
Ø Accountable Plans
- in which the employee accounts for each specific expense and returns the balance. These are not taxable, not includable in a W-2, and not subject to FICA, FUTA, etc.; and
Ø Non Accountable Plans
- which are included on the W-2, but for which the employee can claim itemized deductions subject to the 2% of AGI deduction on Schedule A.
All expense allowances are classified as non accountable plans unless they meet certain specific
criteria. If an expense reimbursement is less than the rate prescribed by the IRS (in tables provided for that purpose) for the area in which the individual works, it will automatically be
classified as an accountable plan reimbursement, and will not be taxable.
For Canadian residents who must also include their U.S. earned income on a Canadian income tax
return, the Income Tax Act (Canada) permits the deduction of reasonable expenses incurred by a corporation or self employed individual to earn income from a source, including the housing of an
employee, but denies the deduction of personal living expenses on individual returns.
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