The 2023 tax season is under way. The IRS just started accepting individual U.S. tax returns. A mere mention of the word “tax” is enough to make Canadians with dual tax filing commitments in Canada and America balk.
U.S. tax return for Canadians is a tricky subject to navigate. It’s crucial that all your documentation is in place so that you can claim your refund quickly and sidestep processing delays.
Before we get ahead of ourselves, let’s boil down to the basics, “Do I have to pay U.S. taxes if I live in Canada?” The answer to that question really depends on whether you have earnings or other income from U.S. sources. For example, you may be working for a Canadian-based employer, but spend some time working in the United States. Or you need to claim applicable Canada-U.S. income tax treaty benefits, including exemption from U.S. tax residency status (in that case, you may not be required to file a U.S. tax return, but a special form may be required to be filed with the IRS to claim a closer connection to Canada).
If you are a Canadian individual or a company that provides services to American customers or engages in trade or business within the United States, you may be required to file a tax return with the Internal Revenue Service (IRS), even if you filed your tax return with the Canada Revenue Agency (CRA).
To address one’s cross-border tax commitments, we recommend that U.S. tax preparation for Canadians is handled by qualified and skilled U.S. tax advisors.
Form 1040NR vs Form 1120-F: Which One is Right For You
To determine what IRS form you may be required to file, you need to understand your tax residency status and whether you are filing individually or for a business entity. Form 1040NR is filed by nonresident alien individuals, while Form 1120-F is filed by non-U.S. corporations that are engaged in a U.S. trade or business and are either subject to U.S. tax or exempt from U.S. tax under the Canada-U.S. income tax treaty (in that case, a treaty-based return is filed with the IRS). There may be state filing requirements and associated state income tax liability, depending on what states your business operates in and whether your business established NEXUS (physical or economic presence) in the particular state..
Form 1040NR (U.S. Nonresident Alien Income Tax Return) is intended for individuals who aren’t U.S. citizens, U.S. resident aliens,or Green card holders, and who either have U.S. source income, including those individuals who are performing services in the United States.
You may not be required to file your U.S. tax return if you only received certain categories of U.S. source income and proper U.S. tax withholding was done.
Form 1120-F (U.S. Income Tax Return of a Foreign Corporation) is intended for foreign (including Canadian) corporations that are engaged in a U.S. trade or business and have income effectively connected with such trade or business. The treaty-based return is filed when a Canadian corporation relies on the applicable Canada-U.S. income tax treaty provisions to be exempt from U.S. tax (for example, Article V, Permanent Establishment).
The United States taxes foreign persons on income effectively connected with one’s U.S. trade or business (taxed at graduated individual income tax rates or a corporate tax rate of 21 percent in case of foreign corporations) or fixed, determinable, annual and periodical (FDAP) income (typically, passive income) (the collection of tax is accomplished by withholding at source – a general 30 percent withholding tax rate applies unless reduced or eliminated by the applicable U.S. income tax treaty). The gain from the disposition of U.S. real property interest is also subject to tax under Foreign Investment in Real Property Tax Act (FIRPTA) provisions.
A Canadian corporation doing business in the United States may not be subject to U.S. tax due to the limited imprint it has in the United States. However, it may be subjec to state income and franchise taxes in a particular state. If your business has U.S. state income or franchise tax filing requirements, your business may be required to still file U.S. federal tax return (protective return) with the IRS because states typically do not accept state income tax returns in the absence of a U.S. federal tax return.
Be mindful of Form 5472 filing requirements. There is a US $25,000 penalty for failure to file Form 5472 or failure to file it on time, when required. You should also carefully evaluate the requirement to file a treaty-based protective return and Form 8833 with the IRS.
Attention, Canadian Corporations! Do You Have a “Permanent Establishment”?
A Canadian corporation may be subject to U.S. tax if it is engaged in a U.S. trade or business and has income effectively connected with that trade or business. The Canada-U.S. income tax treaty may exempt the Canadian corporation from U.S. tax if it is not deemed to have a “U.S. permanent establishment.” Generally, the “U.S. permanent establishment” may be created if the Canadian corporation has an office or a fixed place of business in the United States, has employees or dependent agents with the authority to conclude contracts in the United States on behalf of the Canadian corporation and habitually exercise such authority, or if the Canadian corporation sends Canadian-based employees to work in the United States and certain other conditions are met.
If your Canadian corporation is deemed to have a U.S. permanent establishment, in addition to U.S. federal income tax and state income taxes, it may be subject to the branch profits tax. Note that the Canada-U.S. income tax treaty provides a limited exemption from the branch profits tax of first CAD $500,000 earned by the Canadian corporation.
Can Business Be Conducted in the United States Without a U.S. Permanent Establishment?
Absolutely! However, it depends on the level of activities in the United States. For example, mere solicitation of business may not lead for a Canadian corporation to be deemed engaged in a U.S. trade or business on a federal level (some states, however, may treat such activity as one leading to “nexus” – permanent establishment equivalent on a state level). At the same time, materially negotiating a contract on behalf of Canadian business in the United States may be treated as “conclusion of contract”, while a rubber stamp may not.
Canadian businesses with business operations in the United States would be well advised to perform a permanent establishment analysis to determine if they are subject to U.S. tax. Unfortunately, in many cases little or no due diligence is exercised by business owners in that area. The argument goes like this – my friend has been doing it for 40 years and nothing happened; so, why should I spend any money or effort on the permanent establishment analysis? The answer is simple – if a Canadian business is deemed to have a U.S. permanent establishment in the United States and as such is subject to U.S. tax, the statute of limitations will be open, unless the tax return for the applicable tax year has been filed. In addition, the business may lose the benefit of business expenses and deductions to reduce otherwise applicable U.S. income – such deductions can only be taken when claimed on a timely filed U.S. tax return. Ultimately, the reality of being pulled over and ticketed for speeding by a police officer on a highway remains the same, regardless of the fact that only 1% of drivers receive such a citation. To you, that 1% is 100% of your experience.
In some cases, filing a protective treaty-based tax return may be advisable. Filing such a return would protect the Canadian business in the future if the IRS successfully argues that the business created a permanent establishment after all.
Failure to file U.S. tax returns is usually associated with high penalties. Some penalties may be as high as US $10,000 or US $25,000 per form per year. In addition, the individual or a business may be unable to claim treaty benefits and be subject to a general 30 percent withholding tax.
Is U.S. income taxable in Canada? Canadian individuals and Canadian businesses that operate in the United States through a branch may be able to claim a foreign tax credit on their Canadian tax returns for the U.S. taxes withheld or paid.
Important U.S. Tax Filing Deadlines For You!
For Canadian Corporations Conducting Their Operations WITH a U.S. Permanent Establishment and a U.S. Office or a Fixed Place of Business in the United States
Canadian corporations that have U.S. permanent establishment and have an office or a fixed place of business in the United States, are generally required to file Form 1120-F with the IRS no later than the 15th day of the fourth month after the corporation’s tax year end. For instance, for a calendar year end Canadian corporation, the tax filings for the 2022 tax year are due by April 18, 2022.
IMPORTANT: Don’t forget about state tax returns!
For Canadian Businesses Conducting Their Operations WITHOUT a U.S. Permanent Establishment and no U.S. Office or a Fixed Place of Business in the United States
Canadian corporations that do not have U.S. permanent establishment and have no U.S. office or a fixed place of business in the United States are generally required to file Form 1120-F with the IRS no later than the 15th day of the sixth month after the corporation’s tax year end. For instance, for a calendar year end Canadian corporation, the tax filings for the 2022 tax year are due by June 15, 2023.
IMPORTANT: Don’t forget state tax filings!
For Individuals (Non-U.S. Citizens/Residents/Green Card Holders)
Generally, for the 2022 tax year, Form 1040NR is required to be filed with the IRS by June 15, 2023. For example, if you sold your condo in Florida in 2022 and need to report the sale and claim a refund for U.S. taxes that may have been over withheld, you would be required to file your U.S. tax return by June 15, 2023.
Note that if a Canadian individual earned U.S. wages in 2022, the 2022 tax return’s filing deadline is April 18, 2023.
IMPORTANT: You will need a Taxpayer Identification Number (Individual Taxpayer Identification Number – ITIN) to file your U.S. tax return, unless you have a U.S. Social Security Number (SSN). We can help! As a Certified Acceptance Agent (CAA), we can certify your passport and assist in smooth ITIN application process or renewal of your existing ITIN. Do not leave it till the last minute – start early and don’t procrastinate!
DISCLAIMER: Please note that the information contained in this article is general in nature, is current only as of the date of posting the respective information on the website, and does not (nor is intended to) provide legal or tax advice or an opinion on any matter or issue discussed. You should consult your qualified U.S. tax advisor for any advice on any matters or issues discussed in this article.