Taxation of Individuals
Taxation of Self-Employed Persons
Partnerships, Rental Income, Trust and Royalty Income
Taxation of Corporations
(a) Taxation of Individuals
Individuals who are citizens or residents of the U.S. are taxed on their income from all sources, both within and outside of the U.S. Form 1040 (U.S. Individual Income Tax Return) must be filed with the Internal Revenue Service, 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, 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 in 2012, the maximum tax rates for noncorporate taxpayers' net capital gains are 15 percent on adjusted net capital gains (0 percent to the extent the taxpayer is not in the 25-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 2012 regular tax rates on taxable ordinary income are 10 percent through $8,700, 15 percent through $35,350, 25 percent through $85,650, 28 percent through $178,650, 33 percent through $388,350 and 35 percent on amounts over $388,350.
If all taxes due are paid by April 15, an application may be made for an automatic extension of the filing deadline of form 1040 to October 15, and further extensions may be available in certain circumstances. U.S. citizens (or permanent residents) living outside the U.S. (and with no U.S. source employment income) have until June 15 each year to file their returns and pay taxes, without filing an extension.
Employers in the U.S. are required 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 $5,950 for a single individual, $8,700 for head of household, $11,900 for married filing jointly or qualified widow (er) and $5,950 for a married filing separately taxpayer in 2012). 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, by June 15 of the following year.
(b) Taxation of Self Employed Persons
Persons carrying on an unincorporated business as a sole proprietor in the U.S. are subject to income tax on their gross income less allowable deductions attributable to that income, and must file Schedule C with their tax return 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 on the first $110,100 and 2.9% thereafter, 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.
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.
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.
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 (unless extended), and must use variations of form 1120 depending on whether the entity is a Limited Liability Company (LLC), Subchapter S corporation or other entity. Corporations (except flow through entities) pay income tax at graduated rates starting with 15 percent to $50,000 and with a maximum of 35% in 2012 (for taxable income under $18.3 million).
Non U.S. corporations that are controlled by "U.S. persons" must be reported on form 5471 on the personal income tax returns of certain shareholders.
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.
(e) Identification Numbers
Every individual who files a U.S. 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). Effective in 2012, the Certifying Acceptance Agent program has been eliminated, and all new applications must be accompanied by an original certified copy of a passport, issued by the home country passport office. 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 that 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.