Taxing questions for snowbirds

With the Canadian dollar rising to its highest level in 32 months in February 2011 and the appeal of warm weather, more and more Canadians are considering migrating to the U.S.

Canadian businesses should get used to parity, Toronto-Dominion Bank CEO Edmund Clark told Bloomberg in February 2011. In 2010, the loonie climbed 5.5% against the U.S. dollar and by 16% in 2009.

Many are forecasting that the Canadian dollar should trade around parity through next year, but Canadians also recognize how volatile the dollar can be and how many factors dictate the performance of the loonie. Even though we reached parity in September 2007 for the first time since 1976, many snowbirds remember when the Canadian dollar sank to a five-year record low, US$0.77, on March 9, 2009. Despite the appeal of the warm weather, the value of the Canadian dollar relative to the U.S. dollar is a significant determinant in the numbers of Canadians who head down south each year.

If your clients spend time in the U.S. each year or are contemplating doing so, it’s important to understand the immigration, income tax, healthcare and estate planning considerations while they are in the States.

Overstaying your welcome

Under American immigration rules, Canadians are exempt from getting a visa stamped in their Canadian passport. However, Canadians are actually classified as either a visitor for business (B-1) or pleasure (B-2). (There are other visas available to Canadians, but these would be issued for employment, study or permanent residency in the States.)

Canadians are often confused about how long they can stay in the U.S. on a calendar-year basis. Currently, B-2 visitors are automatically entitled to be in the United States for a maximum of six months (183 days) in the calendar year. Under this visa category, their stay in the U.S. must be temporary, and they must be able to demonstrate a clear intention to depart prior to the end of the authorized period.

American immigration law presumes all persons seeking entry into the U.S. intend to be immigrants and must prove, with clear and convincing evidence, they do not intend to abandon Canada and live permanently in the States. Therefore, if you have Canadian clients that spend a lot of time in the U.S.—even if it is under 183 days per year—an American immigration officer could deny the re-entry into the U.S. or indicate on the Canadian’s passport the length of allowable stay.

A common misconception by some Canadians is that if they return from the U.S. to Canada, the six-month day count restarts again. This is not the case. Canadians who enter as pleasure visitors are only entitled to be in the States for 183 days in a calendar year. If a Canadian overstays their time in the U.S., they risk being denied re-entry and could be subject to American income tax and compliance requirements on their worldwide income and assets. It is a privilege to be able to visit the U.S., not a right—so we discourage Canadians from bending the rules. Bending the rules can also compromise provincial health benefits.

All provinces, except Ontario and Newfoundland, require you to live in your home province for at least six months plus a day in order to qualify for provincial health insurance and Medicare benefits. Ontario allows residents to be out of the country for seven months, and Newfoundland for eight months, without risking the loss of provincial healthcare. For example, if you live in British Columbia but spend one month in Alberta on vacation, you would only be entitled to spend five months in the U.S. without compromising provincial health insurance.

Not only is it important to count days for American immigration and provincial healthcare rules, it is also important to count days for the purposes of U.S. income tax rules.

Under what is referred to as the U.S. Substantial Presence Test (SPT), Canadians could be deemed to be American income tax residents based on the number of days they spend in the U.S. over a three-year period. As a general rule, if the Canadian does not spend more than four months in the U.S. in any tax year over a three-year period, he will not meet the substantial presence test.

If the Canadian meets the SPT, she can file IRS Form 8840 (Closer Connection Exception Statement) by June 15 of the year after meeting this test. By filing this form, she is notifying the IRS her tax home is indeed Canada and that she maintained more significant ties in Canada than in the U.S. during the current year. Failure to file this form could cause the Canadian to be subject to U.S. income tax on her worldwide income as well as additional penalties for failure to comply with the additional income tax compliance requirements of U.S. income tax residents. Therefore, we strongly encourage Canadians to file Form 8840 if they meet the SPT.

Canadian snowbirds might also be required to file U.S. income tax returns under two additional scenarios: when they rent U.S. property, or when they sell U.S. property.

Under American tax rules, Canadians who rent their U.S. property are required to pay tax on their American-source rental income in one of two ways: through the remittance of a 30% withholding tax on the gross rents, or through the filing of a U.S. income tax return on a net-rental basis. Canadians would be entitled to reduce their gross rents through the deduction of ordinary expenses such as property taxes, mortgage interest, insurance, management fees, and utilities. Under American income tax rules, a Canadian would also be required to depreciate the property. This is a mandatory deduction under U.S. income tax rules.

In many cases, after the application of the depreciation deduction, most Canadian taxpayers will generally break even or have a small loss on the rental property. Even though this may be the case, the Canadian is still required to file IRS Form 1040NR along with Schedule E by June 15 of the following year.

Under the recently passed American income tax laws, a Canadian who rents out their U.S. property would be required to file IRS Form 1099. This form reports the U.S. source rents received if the amounts exceeded $600. This Canadian would also be required to file Form T776 with their Canadian return reporting the rental activity in Canadian dollars.

Selling property

When Canadians sell American real property, irrespective of whether they had a gain or loss on the property, they would be required to file an American and, in some cases, a state income tax return. Under the U.S. Foreign Investment in Real Property Tax Act (FIRPTA), a Canadian could be subject to a 10% withholding tax on the gross proceeds at sale. This requirement would be imposed if the proceeds at sale are greater than $300,000, or if the proceeds are less than $300,000 and the buyers will not be using the property as their principal residence.

Given the present state of the U.S. real estate market, most Canadians currently selling their American property are doing so without realizing a capital gain. But even if there is a capital loss, under FIRPTA requirements, a withholding tax might still apply. If this is the case, Canadians are entitled to file IRS Form 8288-B (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests).

If the IRS accepts the application, it will either reduce or eliminate the withholding tax requirement commensurate to what the net tax amount would be. Canadians selling American property should be aware of this option, as failure to file Form 8288-B before closing could cause the withholding tax to be remitted to the IRS. The Canadian would be entitled to recover this tax, but would have to wait for the following year to file a U.S. income tax return to recover the tax.

In order to file a U.S. income tax return, request a reduction in withholding tax on the sale of American property, or eliminate the 30% withholding tax on U.S. gross rents, a Canadian is required to obtain a U.S. Individual Taxpayer Identification Number (ITIN). This number can generally only be obtained under the scenarios indicated above. An ITIN can be obtained with the filing of IRS Form W-7 (Application for IRS Individual Taxpayer Identification Number). This form, along with your Canadian passport, must be certified and submitted by an approved IRS Acceptance Agent. Note that a Canadian notary or attorney is not able to approve this form.

As a Certifying Acceptance Agent, I have filed many of these forms on behalf of Canadian taxpayers under a variety of U.S. tax circumstances. Unfortunately, this can become a rather frustrating process, as the IRS is in no way as efficient as the CRA. In some cases, we have submitted applications for a husband and wife where the wife’s application is approved, and the husband’s denied. There’s no rhyme or reason as to why this is the case. I strongly encourage clients to be patient through this process. One U.S. tax practitioner says her record of resubmitting Form W-7 is seven times before the IRS issued her client an ITIN.

The easiest way to obtain an ITIN is through the filing of IRS Form 1040NR. But note that an ITIN can only be issued for specific tax reasons (renting of U.S. property, reducing or eliminating federal withholding tax on the sale of U.S. property, and withholding tax on gross rents).