As a Canadian business owner or corporate executive accumulating wealth, it is likely that U.S. marketable securities are part of your investment assets. In addition, you may be looking to spend some time relaxing in warmer climates. The U.S. is a popular choice for Canadians looking for a vacation destination or to actually own a vacation residence. Any of these three scenarios can subject you, as a Canadian, to U.S. tax.
In some situations, this can be avoided with proper planning. In other cases, it’s best to be prepared for the tax consequences that can arise. In this article we will explore the U.S. tax risks and consequences of spending time in the U.S. or investing in the U.S. and point you in the direction of further information for a deeper dive.
The U.S. tax consequences will be different for an individual who is a U.S. citizen or Green Card holder than for someone who is not. In this article we will address the U.S. tax consequences to a Canadian resident who is not a U.S. citizen or Green Card holder. Under U.S. tax rules, you would be categorized as a “nonresident alien”, but for purposes of this article, we will simply refer to you as a Canadian.
If you are a U.S. citizen or Green Card holder living in Canada, please refer to the BDO Tax Bulletin TAX CONSEQUENCES FOR U.S. CITIZENS AND OTHER U.S. PERSONS LIVING IN CANADA.
Spending time in the U.S.
Ignoring any special circumstances due to the COVID-19 pandemic, there are generally no formal visa requirements for Canadians entering the U.S. for recreational or leisure purposes, provided the length of the stay is no longer than six months. However, if you want to avoid having to make any declarations of tax residency (or disclaimer thereof) to the Internal Revenue Service (IRS), there are income tax rules which make it necessary for you to limit your time in the U.S.
Under the “substantial presence test”, you will be considered a U.S. resident for U.S. domestic tax purposes if the number of days that you spend in the U.S. over the any three consecutive years is more than 183 days, using the following formula (and using 2021 as the current year):
|Number of days in the U.S. in 2021||X|
|Number of days in the U.S. in 2020||Y|
|Number of days in the U.S. in 2019||Z|
|Is the following number >= 183?||X + (1/3 x Y) +(1/6 x Z)|
If this answer is yes and you spend more than 30 days in the U.S. in 2021, then you will be considered a U.S. resident for tax purposes unless you qualify for and file IRS Form 8840, Closer Connection Exception Statement for Aliens on a timely basis.
The BDO Tax Bulletin U.S. TAX ISSUES FOR CANADIANS provides a more in-depth review of this general rule, as well as what constitutes a “day” for these purposes and what to do if you don’t qualify to make this statement. It is important to understand that all days spent in the U.S. are counted, including both workdays and vacation days.
The message here is that it is important for you to keep track of time spent in the U.S. in each calendar year and to make an assessment each year as to if the “closer connection statement” or another U.S. tax filing is required.
Investing in U.S. Marketable Securities
If you invest in U.S. marketable securities, such as stock of a U.S. corporation that trades on a public stock exchange, this will generally not result in adverse U.S. income tax consequence—provided that your investments are made as portfolio investments and any trading does not rise to the level of carrying on a trade or business in the U.S. This means that capital gains realized from the disposition of such stocks will not be subject to U.S. tax. However, as a Canadian you will still be subject to Canadian tax on such gains. If the stocks pay dividends, the dividends will be subject to a withholding tax when they are paid to you. The Canada – U.S. Income Tax Convention (“the Treaty”), generally reduces this tax to 15%. Where the proper amount of tax is withheld at source and you have sufficient income taxed in Canada, the U.S. withholding tax can be claimed as a foreign tax credit on your Canadian tax return and should therefore not result in any overall increased tax burden.
If you have a Tax-Free Savings Account (TFSA) and hold U.S. marketable securities in your TFSA, any capital gains, dividend income, or interest income that you realize on these assets will be tax-free for Canadian tax purposes. However, the U.S. does not recognize the tax-free status of the TFSA, and if dividends are paid on the shares, U.S. withholding tax will still apply. This is a good reason to hold dividend-paying U.S. stocks outside a TFSA, such as in a non-registered account or even in an RRSP. There is a provision in the Treaty that allows an RRSP to receive such dividends without U.S. withholding tax. This makes it less costly to hold U.S. dividend-paying stocks in an RRSP as long as you have alternate assets that you can hold in your TFSA.
Unlike Canada, the U.S. has an estate and gift tax regime. Generally, under this regime, assets held by an individual at death will potentially be subject to estate tax based on the value of such assets at that time, without reference to their original cost. This regime applies to Canadians who own certain U.S. investments, and not just to U.S. residents. Your estate could be subject to paying estate tax if you personally hold U.S. marketable securities at the time of your death, regardless of whether the securities are held in registered account such as an RRSP, RRIF or TFSA, or in a non-registered account. Please see our Tax Bulletin U.S. ESTATE TAX ISSUES FOR CANADIANS for further information.
Investing in a U.S. residence
If you decide to buy a U.S. personal-use property, you will also need to be concerned about U.S. taxes in three situations:
- if the property is rented
- if you sell the property
- if you die owning the property
Often, owners of secondary residences will rent the property for part of the year. While this can make good use of an otherwise idle asset, rent on U.S. real property is subject to a flat 30% tax on the gross rent paid to you. This tax can be mitigated by making a special election and filing a U.S. income tax return to report net rental income or loss and paying tax on any net rental income.
If you sell U.S. real property, you will be taxed on any gain that has been realized. In addition, the purchaser will be required to withhold tax of 15% of the gross proceeds unless steps are taken to either reduce the withholding tax rate based on a signed affidavit from the purchaser (where option applicable), or to file an application with the IRS to reduce the withholding tax to 20% of the net gain. Regardless of the approach taken regarding withholding tax, a U.S. income tax return is still required to be filed to report the actual gain or loss on sale.
Further information on reporting rental income and the process to be followed when a U.S. property is sold can be found in our Tax Bulletin U.S. TAX ISSUES FOR CANADIANS referenced above.
If you die holding the property, U.S. estate tax will apply if your estate is large enough. In 2021, if the value of your total worldwide assets is less than US$11,700,000, your estate likely would not face U.S. estate tax if you were to die. This threshold is effectively doubled to the extent that property is passing to a Canadian spouse who is also a noncitizen of the U.S. However, the maximum value of total estate assets that can be held at death before estate tax applies has varied widely in the past 20 years. In fact, the exemption amount in 2000 was only $1,000,000. The current U.S. administration has expressed the desire to reduce the exemption from current levels, rather than continue the trend of increases. Therefore, planning to minimize estate tax should not simply be based on the current estate tax exemptions. Further details can be found in our Tax Bulletin on U.S. ESTATE TAX ISSUES FOR CANADIANS referenced above.
As your wealth accumulates, and you prepare to expand your investments into U.S. marketable securities or a recreational property, consider that there may be U.S. income and estate tax considerations. Your BDO advisor would be pleased to assist you in planning your investments to minimize or avoid such taxes.
If you have questions regarding how the U.S. personal income tax rules might affect you, please contact our U.S. tax practice leaders in Canada:
Partner, U.S. Personal Tax Practice Leader
Partner, U.S. Personal Tax Practice Leader
The information in this publication is current as of September 20, 2021.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.