1.02 U.S. Income Taxation of Residents
(a) Taxation of Individuals
Individuals who are citizens or residents of the U.S. are taxed by the U.S. government on their income from all sources, both within and outside of the U.S. Each year, Form 1040 (U.S. Individual Income Tax
Return) must be filed with the Internal Revenue Service, a division of the U.S. Department of Treasury, each year by April 15, for the prior calendar year. Unlike taxation in Canada, form 1040 may be filed
either by an individual separately, or by a married couple on a joint basis. Income tax rates are graduated, meaning that higher rates of tax apply to higher incomes, and different rate schedules are used for
returns with different filing status. In this way, income tax rates are adjusted to account for differences in circumstances for persons filing as single, married filing jointly, married filing separately,
qualifying widow(er), or as head of household.
For tax years ending after December 31, 1997, the maximum tax rates for noncorporate taxpayers' net capital gain are 20
percent on adjusted net capital (10 percent to the extent the taxpayer is not in the 28-percent bracket), 25 percent on unrecaptured Section 1250 gain and 28 percent on net capital gain that is not adjusted net
capital gain or unrecaptured Section 1250 gain. For unmarried individuals the 1998 regular tax rates on taxable ordinary income are 15 percent through $26,000, 28 percent through $62,000, 31 percent through
$128,000, 36 percent through $280,000 and 39.6 percent on amounts over $280,000.
If all taxes due are paid by April 15, an application may be made for an extension of the filing deadline of form 1040 to
August 15, and further extensions may be available in certain circumstances. U.S. citizens (or permanent residents) living outside the U.S. have until June 15 each year to file their returns (if they apply for
the appropriate extension and pay their taxes due by April 15).
Entities who employ persons to work in the U.S. are required by law to withhold the prescribed amount of federal and state tax,
including social security, unemployment, and Medicare taxes. The withholding rules apply to all persons employed in the U.S., even if employed by a foreign employer, unless specific provisions exempting
withholding under the Canada -U.S. Income Tax Convention (Treaty) are met and applied for on a timely basis.
Many Canadians believe that mortgage and loan interest and other deductions that are not available in Canada are available in the U.S. Although these and other deductions can be
made in the U.S., persons filing U.S. tax forms must choose whether to itemize these deductions or claim the standard deduction (which was $4,550 for a single individual, $6,650 for head of household, $7,600 for
married filing jointly or qualified widow (er) and $3.800 for a married filing separately taxpayer in 2002). Therefore deductions may not be used if they do not exceed the standard deduction for that
year.
U.S. residents are also required to disclose on U.S. Treasury form 90.22.1 any holdings in foreign bank and securities accounts.
(b) Taxation of Self Employed Persons
Persons carrying on an unincorporated business as a sole proprietor in the U.S. are generally subject to income tax on their gross income less allowable deductions attributable to that income, and must
file Schedule C with their form 1040 or 1040 NR for each business, each year. Complex rules involving the amount of investment "at risk", the degree of "material participation" in the venture, and the nature of
the business are used to determine the extent of and the timing of the deduction of losses from self employment activities.
Self employed persons are also subject to the Self Employment Tax, which amounts to 15.3% of self employment income, and is
imposed in addition to any income taxes payable. The Self Employment Tax is used to fund social security taxes, and is the equivalent of the self employed Canada Pension Plan amount payable in Canada. One
half of self employment tax is deductible from income prior to the calculation of tax liability.
Self employed persons may, depending on their income in any given year, be required to pay quarterly installments of income tax
in advance for the next taxation year. The required installments are normally calculated on the basis of income reported in the current year on form 1040.
  
(c) Partnerships, Rental Income, Trust and Royalty Income
Although partnership income is reported on form 1040 - Schedule E each partnership operating
in the U.S. must file a separate tax return each year on form 1065. The partnership distributes its income, expenses and other items to partners on form K-1 (shown on page 3 of form 1065).
Rental and royalty income are also disclosed on Schedule E. A U.S. resident who files Schedule
E which discloses rental income from sources in Canada or elsewhere must use U.S. rules in the determination of income and expenses, which in many cases can be significantly different from
the rules used in Canada. (Similarly, Canadian rules must be used in reporting rental income on Canadian T1 tax returns, even if that income is from U.S. sources).
Whereas losses from real estate rentals are generally deductible against other income in Canada,
Canadian rules prohibit the claiming of capital cost allowance (depreciation) to create or increase a loss from real estate. In the U.S., losses may be created by claiming depreciation, (and
depreciation calculations are mandatory rather than elective) but the deductibility of the losses may be limited or deferred by the "passive activity loss" rules.
Net income from rental, royalty or other passive (i.e. interest, dividends, investment) activities
may give rise to the requirement to pay quarterly installments of federal (and/or state) tax in advance for the next taxation year.
(d) Taxation of Corporations
Corporations carrying on business in the U.S., whether incorporated in the U.S. or elsewhere, must file a return of income each year within two and one half months after their fiscal year end,
and must use either form 1120, 1120 F, or other forms for Limited Liability Companies, Subchapter S corporations and other entities. Corporations pay income tax at graduated rates
with a maximum of 34% in 2002 (for taxable income under $10 million).
Non U.S. corporations which are controlled by "U.S. persons" must be reported on form 5471
on the personal income tax returns of certain shareholders controlling over 10% of the outstanding shares of the corporation. Form 5471 is used to identify any passive or personal
service income (Subpart F income) earned outside the country of incorporation, and to report that income on the U.S. person's individual return, whether or not it is distributed to him/her in
the year. The purpose of this section is to prevent the avoidance of tax by utilizing foreign corporations.
Corporate tax planning in the United States is considerably different than that in Canada, since
rules are in place to prevent the accumulation of income in excess of $150,000 in a corporation, planning of year end bonuses to reduce corporate income, and accruals of income to related cash basis taxpayers.
In addition to filing income tax returns, corporations are liable to file a variety of forms related to
employee withholdings, vehicle use, and other disclosures, depending on their ownership and the nature of their business.
(e) Identification Numbers
Commencing with the 1996 taxation year, every individual who files a U.S. income tax return must have a valid identification number issued by the Social Security Administration and
acceptable to the IRS. For U.S. residents, citizens, and visa holders entitled to work in the U.S., a Social Security Number (SSN) is required, and is available by completing form SS-5
(Application for a Social Security Card). For spouses, dependents and non-residents who file a U.S. tax return or are claimed as dependents on a U.S. tax return but are not permitted to work
in the U.S., an Individual Taxpayer Identification Number (ITIN) is required, and is available by completing form W-7 (Application for IRS Individual Taxpayer Identification Number). Tax
forms which do not have the appropriate identification numbers will not be accepted by the IRS, and claims for dependents without appropriate numbers will be disallowed.
Partnerships, corporations and self employed persons should apply for an Employer
Identification Number (EIN) by filing form SS-4 (Application for Employer Identification Number).
(f) State Taxes
Many states in the U.S. have independent income tax systems applicable to persons living in or
earning income from within the state or corporations doing business in the state. Although many states who impose an income tax use the federal taxable income as a starting point, rates,
methods of taxation, rules of computation and filing requirements vary from state to state and from entity to entity.
Many states do not recognize foreign tax credits for taxes paid to foreign countries or provinces.
As a result, proper tax planning should be undertaken prior to establishing residence in a state to take into account the implications of state taxation as it is complicated by federal and international taxation.
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