Q: I am a U.S. citizen living in Canada, do I have to file U.S. tax returns?
A: Irrespective of your place of residence, U.S. citizens and green cards holders are required to file returns and foreign holdings reporting forms.
You may claim the foreign earned income exclusion ($91,500U.S.-2010) for wages/self-employment income and a credit for Canadian tax allocable to non-U.S. source income, but only to the extent of your U.S. tax liability on this income. For most taxpayers, there should be little or no tax payable, however the bottom line will depend on the composition of your income and filing status.
You may owe tax if you have income from U.S. sources such as investment, rental or personal services performed in the U.S. If you have a U.S. broker, you will receive U.S. reporting slips. As a beneficiary of a U.S. estate or a U.S. partner, you will receive a K-1 reporting form.
Your work in the U.S. is computed by allocating your earned income to business days in the U.S. Most states levy state income tax on rental and personal service income.
Canada may provide a credit for U.S. federal/state tax on U.S. source income.
Foreign reporting forms
If you have a 10% or more interest in a Canadian corporation, the rules become more complex especially if you own an investment company or if you are a beneficiary of a non-U.S. trust. IRS Form 5471 or 3520 may have to be filed.
There are significant penalties for not filing foreign reporting forms such as Form 5471 and Form TDF 90-22.1, (“Report of Foreign Bank and Financial Accounts”, where there is an aggregate balance of $10,000 U.S. in the calendar year). Penalties may be $10,000 U.S. per account per year on the FBAR and $10,000 U.S. per entity on Form 5471 and a reduction of 10% of your foreign taxes available for credit.
Penalties on reporting forms are at the discretion of the IRS. If levied, they may be waived if one can show “reasonable cause”.
What’s the solution?
Administrative practice has been to accept returns for the past 5 years and the current year provided there is no tax payable for a prior year. Interest and penalties will be levied on tax payable. Giving up your U.S. citizenship or long term residency such as your green card, does not alleviate the requirement to file for prior years.
If you have not filed returns for the preceding 5 years that includes the expatriation date, you will be classified as a “covered expatriate” even though you may not be caught by the $2M net worth or 5 -year average $147KU.S. tax liability test. Unrealized gains inherent in certain property held at the time of expatriation exceeding $636KU.S. (2011) will be subject to tax, a rule that is similar to the Canadian deemed disposition rules on ceasing residency.
The statute of limitations does not run out for an unfiled return. Therefore it may be prudent to meet your filing obligations to avoid significant penalties.
You should consult with your professional advisor on all related matters