From time to time, many Canadians find themselves considering a permanent move to the United States. Whether it is a business executive seizing an extraordinary career opportunity or a retired entrepreneur simply in search of warmer climates, it is important to understand the tax implications that may result.
The determination of an individual’s residence is a critical step for both Canadian and U.S. tax purposes with many factors to consider. The term “residence” is not defined in the Canadian Income Tax Act so the analysis typically requires reviewing jurisprudence, tax treaties and various interpretations provided by the Canada Revenue Agency (CRA). Generally, residence is determined on the basis of primary ties in Canada, including the location of a permanent home and the location of a spouse and other family members. Secondary ties will also be considered, including the extent of personal property (e.g., furniture, automobiles, etc.) located in Canada and social and economic interests remaining in Canada. Form NR73 – Determination of Residency Status (Leaving Canada) can be used as a guide in this regard.
Though a comprehensive residency analysis is beyond the scope of this article, it is important to understand that the determination of an individual’s country of residence for tax purposes has significant tax consequences and ultimately determines the nature and extent of the tax burden the individual will have in each country.
The discussions below assume that an individual has ceased to be a resident of Canada and has permanently established residence in the U.S.
Canadian deemed disposition on departure
An individual who emigrates from Canada generally will be deemed to have disposed of all property owned at fair market value immediately prior to emigrating. This deemed disposition can result in large unexpected capital gains. Any resulting tax is due by April 30 of the year following the year of departure.
Certain property is excepted from this rule, including:
- Canadian real estate;
- capital property or inventory that is used in a business in Canada;
- certain stock options;
- RRSPs, RRIFs and various other pension plans;
- life insurance policies in Canada; and
- property owned when an individual last became a resident of Canada provided the individual was a resident of Canada for five years or less during the 10 years preceding emigration.
The above types of property generally are excepted as they will continue to be subject to Canadian income tax in one form or another (i.e., upon sale or gift, or will be subject to Canadian withholding tax when amounts are distributed).
If capital gains are triggered on the deemed disposition, individuals have the option to defer payment of the resulting tax by posting acceptable security with the CRA and filing the applicable election form. The additional tax may be deferred until the asset is sold, the taxpayer dies, or the taxpayer re-establishes Canadian residency. Acceptable security includes a bank letter of guarantee, a letter of credit, or a Government of Canada bond. Other types of security like shares of public or private corporations or valuable personal property might also be acceptable, though approval by the CRA is required. Security is deemed to be posted on any tax arising on the first $100,000 of capital gains – in other words, no physical security is required when the total gains do not exceed $100,000.
Additional forms may also be required with the personal tax return for the year of departure, including Form T1161 – List of Properties by an Emigrant of Canada, and Form T1243 – Deemed Disposition of Property by an Emigrant of Canada. Significant penalties may be imposed for non-filing.
Canadian-controlled private corporations (CCPCs)
If an individual owns or controls a CCPC prior to emigration, not only will they be deemed to dispose of the shares at fair market value, potentially resulting in considerable tax, other negative consequences will arise. For example, the corporation will no longer qualify as a CCPC, resulting in lost access to preferential Canadian corporate tax rates and other valuable tax benefits. The company might also be considered a “controlled foreign corporation” or a “passive foreign investment company” for U.S. tax purposes. Either of these classifications can result in significant adverse U.S. tax consequences.
U.S. tax compliance
A resident for U.S. tax purposes must file a U.S. individual income tax return annually, Form 1040 – U.S. Individual Income Tax Return. Should the individual maintain interests in Canadian RRSPs or other tax-deferred Canadian investment vehicles, additional and potentially complex forms must be included in the U.S. personal tax filing. If shareholdings in a private Canadian corporation are maintained, they will add another element of complexity and cost to the annual return.
Any individual considering a permanent relocation to the U.S. should evaluate the financial and tax consequences of the move. Often, the resulting situation becomes increasingly complex and the impending tax and compliance costs play a large role in the ultimate decision. Many tax planning and optimization strategies are available to reduce or eliminate these tax matters, but it is critical that this planning be implemented prior to a change in residence.