There is a lot of paperwork for U.S. citizens in Canada. Here’s some help

As more U.S. citizens living in Canada realize that their tax obligations did not go away when they moved, getting caught up is becoming a priority, especially as the 2011 U.S. tax deadline approaches.

We are recommending people file three years of 1040 Forms to report their income if they do not owe tax, and six years if they do. In most cases, the Canadian tax paid is enough to cover any U.S. obligations. However, tax-free income in Canada may not be exempt under the Internal Revenue Code. This would include gambling or lottery winnings and undistributed earnings inside a Registered Education Savings Plan (RESP) and Tax Free Savings Accounts (TFSAs).

U.S. citizens are required to file a 1040 Form every year they meet the minimum income limitations, which is about $9,500 for a single person, $3,700 for a married person filing separately and about $19,000 for married people filing jointly. This would include all world income. All of your income is taxable in the U.S. but the Canada-U.S. Tax Treaty allows for some benefits to avoid double taxation.  You do receive foreign tax credits for taxes paid in Canada. As a U.S. citizen, you have the responsibility to file, but you are also entitled to some credits, such as the economic stimulus payments and the Making Work Pay credit of $400 per adult for previous tax years. There is also the additional child tax credit which is a refundable $1,000 credit available for each child. But the credits depend on your level of earned income, so not everyone qualifies.

The 1040 tax return also includes a few filing requirements that don’t attract any tax. The first is the 8891 Form for Canadian Registered Retirement Savings Plans (RRSPs); this allows you to defer income from the RRSP until the time you take it out in Canada, so it is taxed in both countries at the same time.

For U.S. citizens living in Canada with Tax Free Savings Accounts (TFSAs) and Registered Education Savings Plans (RESPs), you will need to complete Forms 3520 and 3520A for foreign trusts which you will have to file every year. There is also Form 5471, required for any U.S. person who owns more than 10 per cent of the shares in a foreign corporation or is an officer or director. This form basically creates a U.S. statement for your Canadian corporation to keep track of income you are sheltering in your corporation, until you take it out and pay U.S. tax on it. Failure to file this form could result in a penalty of up to $10,000.

If you are tackling the forms yourself, the IRS estimates the process takes can take more than 30 hours to complete. This includes more than 22 hours to complete the 1040, three hours and 17 minutes to complete the F1116 (foreign tax credit) form and half an hour to assemble the paperwork. In most cases, you are not required to submit documentation with a U.S. return. The exception would be when U.S. tax has been withheld at source and is reported on a U.S. tax slip. Once you have caught up on your tax returns, you should hold on to your records for a minimum of six years.

Remember, there are 100 ways to complete a U.S. return correctly but there is one best way to maximize your tax savings. You need to understand the tax treaty and when the treaty supersedes the Internal Revenue Code. In most cases, it is beneficial to prepare your U.S. and Canadian returns together, so you can figure out the best bottom line between the two.

Cleo Hamel
Senior tax pro and national spokesperson