The intrusion of the United States of America into the lives of Canadians is pervasive. And that intrusion extends well beyond the media frenzy generated by the latest incumbent in the White House. While you can escape that frenzy by ignoring the news media, keeping the Internal Revenue Service, the U.S. equivalent of the Canada Revenue Agency, at bay is another matter. You may not be able to avoid the long reach of the IRS, but you can take steps to mitigate its impact.
If you own shares of a U.S. company that pay dividends (almost de rigueur for an adequately diversified investment portfolio), or receive interest income from U.S. sources, U.S. withholding tax may be deducted from income earned before you are paid. The standard tax rate is 30%, but can be reduced to 15% on dividends and eliminated on most interest income, if you provide IRS form W-8BEN to your financial institution (or other withholding agent) to confirm your country of residency and that you are not a U.S. "person" (basically not a U.S. citizen or resident).
The W-8BEN form must be provided every three years, or earlier if any information changes, to maintain the reduced rates. Your investment advisor should be able to provide you with a form.
No U.S. withholding tax is deducted if you own dividend-paying shares of U.S. corporations in your RRSP, RRIF or other registered retirement account, due to a tax treaty between Canada and the U.S. As such, these accounts are an ideal place to hold U.S. dividend-paying stocks to avoid U.S. tax.
This retirement-account tax exemption does not include distributions from U.S. master limited partnerships (MLPs), which are considered business income and subject to a 39.6% U.S. withholding tax. This is not recoverable. MLPs are best held in a non-registered account because some of the tax may be recoverable by claiming a foreign tax credit on your Canadian tax return.
Other registered accounts (TFSAs or RESPs or RDSPs) are also not included in the U.S. withholding-tax exemption for retirement accounts. Tax will be deducted on applicable U.S. income and dividends, and is not recoverable. For U.S. stock exposure in these accounts, you can avoid U.S. withholding by buying a fund that is constructed for tax efficiency, such as Horizons S&P 500 Index (HXS.U). This exchange-traded fund. which does not make any distributions, is designed to deliver the total return of the S&P 500 Index.
The fund company pays the applicable U.S. withholding tax on U.S. investments held indirectly, say in a mutual fund or exchange-traded fund. Justin Bender and Dan Bortolotti of PWL Capital Inc. determined that the hidden withholding tax on select U.S. equity ETFs reduced fund returns by about 0.3%. They concluded that investors could reduce this tax drag by choosing the right fund structure and type of account.
In a registered retirement account, U.S.-listed ETFs for foreign equities are the tax-efficient choice. Canadian-listed ETFs are generally the better choice for foreign equity exposure in TFSA, RESP and taxable accounts.
"Never hold U.S. dividend-paying stocks in a TFSA, RESP or RDSP," says Jamie Golombek, managing director, tax and estate planning at CIBC Wealth Strategies Group. "To avoid double taxation, hold these investments in your RRSP or other registered retirement account."
If you own real estate in the U.S., and rent out the property, the rent is considered U.S. business income, and technically your tenant is required to retain 30% of the gross rent paid as withholding tax, and remit these funds to the IRS. Some tenants may ignore this rule. However, any property manager hired to handle the rental chores will most certainly withhold the required tax. If you file a U.S. tax return, you can claim your business expenses (maintenance, borrowing costs etc.) and pay tax on the net rental income. According to accountants Grant Thornton, if you elect to pay on net income, and provide the necessary information to the withholding agent, the 30% withholding tax is not required. You should provide your Canadian tax preparer with a copy of your U.S. tax return so you can claim a tax credit for U.S. tax paid.
Canadians who are part-time residents of the U.S. (snowbirds take note) should track how long they are physically present State-side. Anyone staying long enough to meet the IRS's substantial-presence test will be deemed a U.S. resident for tax purposes, and subject to many of the same tax rules as a U.S. citizen.
If you meet the substantial-presence test, you may still qualify as a U.S. non-resident if you are in the U.S. less than 183 days in the current year, establish Canada as your tax home and file IRS Form 8840, Closer Connection Exception Statement for Aliens.
If you stay in the U.S. more than 183 days in the current year, then you need to file IRS Form 8833 Treaty-Based Return Position Disclosure to claim that you are a tax resident of Canada under tax treaty tie-breaker rules. In this case, you must remit a U.S. non-resident tax return (IRS Form 1040NR), but should pay less tax than filing as a U.S. resident.
The long arm of the IRS even extends beyond the grave. A U.S. federal estate-tax return must be filed by the estate of a Canadian resident (who is not an American citizen) who owned more than US$60,000 of U.S.-situated assets, such as real estate and U.S. stocks, at time of death. Given the available exemptions, for 2017 no U.S. estate tax will be due on Canadian estates valued at US$5.49 million (world-wide assets) or less.
U.S. estate tax law is a fluid and complex area. Those seeking strategies to avoid this tax should consult a legal or financial professional qualified in this area. There are steps you can take to mitigate the impact of the U.S. IRS on your life. Act now to avoid future regret.
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