The American Living in Canada: What You Still Owe the IRS and How to Owe Nothing Twice

Short version: U.S. Citizens Living in Canada: What You File Each Year

A US citizen or green card holder who lives in Canada files two sets of returns for life. Canada taxes residents on worldwide income; the US taxes citizens on worldwide income regardless of residence. The treaty and the foreign tax credit mean that most Americans in Canada pay no additional US income tax, because Canadian rates are higher. What they do owe is compliance: an annual 1040 with its foreign-account and foreign-asset schedules, and a set of rules about Canadian accounts that the IRS treats very differently from the CRA.

Key takeaways

• File a US Form 1040 every year reporting worldwide income, with an automatic extension to June 15 for taxpayers abroad and a further extension to October 15 on request.
• Claim the foreign tax credit (Form 1116) for Canadian tax paid; in Canada it almost always beats the foreign earned income exclusion (Form 2555), because Canadian tax exceeds US tax and the excess credit carries forward ten years.
• File the FBAR (FinCEN Form 114) if Canadian accounts exceeded $10,000 in aggregate at any point, and Form 8938 above its thresholds ($200,000 single / $400,000 joint at year-end for taxpayers abroad).
• Canadian mutual funds and Canadian-listed ETFs are PFICs (Form 8621 each); the TFSA is taxable in the US and may be a foreign trust; the RRSP is deferred under the treaty; the RESP is a foreign trust.
• The 3.8% net investment income tax cannot be offset by the foreign tax credit, so Americans in Canada with investment income above the threshold owe it outright.

The annual US return

The 1040 reports Canadian employment income (converted at the annual average or transaction-date rate), Canadian investment income, Canadian pension and CPP income, and everything else. The foreign tax credit on Form 1116 is computed by basket (general, passive) and limited to the US tax on the foreign-source income in each basket. Because Canadian rates on employment income exceed US rates, the general basket usually produces excess credits that carry forward. Passive income can be the reverse: Canadian tax on eligible dividends and capital gains can be lower than US tax, leaving a residual US liability.

The FEIE excludes up to about $130,000 of foreign earned income but wastes the credits that would otherwise carry forward, disqualifies the taxpayer from the refundable child tax credit, and cannot shelter investment income. In Canada, the FTC is the default.

The account traps

• PFICs. Canadian mutual funds and Canadian-domiciled ETFs are passive foreign investment companies. Each requires Form 8621 annually, and the default tax regime is punitive. Hold US-listed ETFs and individual stocks in taxable accounts instead. RRSP holdings are protected by the treaty election.
• TFSA. Not recognized by the US; income is taxable annually, and the IRS may treat the account as a foreign trust requiring Forms 3520 and 3520-A. Most Americans in Canada should not hold one.
• RRSP. Contributions are deductible in Canada. US tax on the growth is deferred under Article XVIII of the treaty; the deferral is automatic for eligible individuals since 2014.
• RESP. A foreign trust for US purposes with Form 3520 filings, and the CESG grant is taxable to the US subscriber. Some families have the non-US spouse subscribe.
• Canadian corporation. A US citizen who owns 10% or more of a Canadian corporation files Form 5471; if US persons own more than 50%, it is a CFC with Subpart F and GILTI exposure.

Reporting

The FBAR is filed with FinCEN, not the IRS, by April 15 with an automatic extension to October 15, and covers every foreign account (including RRSPs, TFSAs, and RESPs) if the aggregate maximum exceeded $10,000. Form 8938 is filed with the 1040 and covers foreign financial assets above the thresholds. Penalties for missing either start at $10,000.

The NIIT

The 3.8% net investment income tax applies to US citizens with modified AGI above $200,000 (single) or $250,000 (joint) and cannot be offset by the foreign tax credit under current IRS interpretation. An American in Canada with substantial investment income owes it in full, on top of Canadian tax.

Catching up

Americans in Canada who have not filed use the IRS Streamlined Foreign Offshore Procedures: three years of returns, six years of FBARs, and a non-willfulness certification, with no penalty for qualifying taxpayers abroad.

Worked example

A US citizen in Toronto earns $180,000 CAD, holds $300,000 in Canadian mutual funds in a taxable account, a $95,000 TFSA, and a $400,000 RRSP.

• Employment income. Canadian tax roughly $60,000; US tax before credit roughly $30,000; FTC eliminates it and about $30,000 of excess credit carries forward.
• Mutual funds. PFICs; Form 8621 for each fund; punitive default treatment. Recommendation: sell and replace with US-listed ETFs.
• TFSA. Income taxable in the US; foreign trust filings. Recommendation: close it.
• RRSP. Deferred under the treaty; reported on the FBAR and Form 8938.
• Filings. 1040, Form 1116, Form 8621 (per fund), Form 3520/3520-A (TFSA), FBAR, Form 8938.

Official sources

"If you are a U.S. citizen or resident alien, the rules for filing income, estate, and gift tax returns and paying estimated tax are generally the same whether you are in the United States or abroad." — Internal Revenue Service, U.S. citizens and resident aliens abroad, https://www.irs.gov/individuals/international-taxpayers/us-citizens-and-resident-aliens-abroad

"You may qualify to exclude your foreign earnings from income up to an amount that is adjusted annually for inflation." — Internal Revenue Service, Foreign Earned Income Exclusion, https://www.irs.gov/individuals/international-taxpayers/foreign-earned-income-exclusion

Practitioner note

Americans in Canada rarely owe US income tax. They owe US compliance, and the cost of getting the account structure wrong (mutual funds, a TFSA, an RESP in the wrong spouse's name) exceeds the Canadian tax saved every year. We set up the Canadian accounts around the US filings, not the other way around.

See also: Planning a move? See the Canada-to-Florida guide and browse every corridor by city, province, and state.

Next step

Fairlight prepares the annual US return with foreign tax credits, the FBAR and Form 8938, and the PFIC and foreign trust filings for Americans in Canada. See cross-border pricing or book a call.