Ottawa to Phoenix: Defence Contractors, the Desert Corridor, and Arizona's Flat 2.5%

Arizona's defence contractors in Phoenix and Tucson recruit Ottawa's defence engineers and intelligence professionals, and Ottawa retirees choose the Valley for its climate and its low taxes. The move is a large tax cut: Ontario's combined top rate of about 53.5% becomes about 39.5% in Arizona.

Key takeaways

• Ontario's roughly 53.5% top rate, including the provincial surtax, sets the departure tax. On a $300,000 unrealized gain, about $80,000.
• Arizona's flat 2.5%; no city income tax.
• A Canadian public service pension paid to an Arizona resident is taxed federally with Canadian withholding capped at 15% under the treaty, and by Arizona at 2.5%.
• 13% HST becomes about 8.6% sales tax in Phoenix.
• OHIP ends on permanent departure. Defence roles may require a green card, which sets the US residency start.

The Ontario departure

Departure tax applies to non-registered investments, private company shares, crypto, and foreign property at fair market value on the departure date. Ontario real estate, RRSPs, TFSAs, and registered pensions are excluded. Report on Form T1243, list holdings on Form T1161 if the total exceeds $25,000. The Ontario surtax ends on departure. OHIP ends on permanent departure.

The federal pension

Under Article XVIII of the treaty, Canadian tax on periodic pension payments to a US resident is capped at 15%; file NR301 before the first post-departure payment. The US taxes the pension federally with a foreign tax credit. Arizona taxes the pension at its flat 2.5%. CPP and OAS are taxable only in the US.

Phoenix's side

Arizona's flat 2.5% state income tax, the lowest flat rate of any state that taxes income; no city income tax anywhere in Arizona; sales tax about 8.6% in Phoenix and 7.8% to 8.3% in Scottsdale and the East Valley; property tax among the lowest in the US, near 0.6% effective; no estate tax.

The RRSP in Arizona

Federally deferred under Article XVIII of the treaty and deferred for Arizona because the state starts from federal AGI. Withdrawals face 25% Canadian withholding on lump sums, 15% on periodic RRIF payments within the treaty limit, a US foreign tax credit federally, and Arizona's 2.5%.

Who makes this move

DND and CSE engineers to Raytheon Tucson, Honeywell, and the Phoenix defence contractors, Ottawa cybersecurity staff to the region's security firms, federal program managers to Phoenix's corporate employers, and Ottawa retirees to Scottsdale and the East Valley.

Worked example

A former DND engineer and spouse move to Scottsdale on September 30 with a $40,000-a-year public service pension, $150,000 of unrealized gain in a non-registered account, $500,000 in RRSPs, and a Kanata home sold in the departure year.

• Departure tax. $150,000 gain, $75,000 taxable, at about 53.5%: roughly $40,000.
• Pension. NR301 filed; 15% Canadian withholding; taxed federally with a foreign tax credit and by Arizona at 2.5%.
• RRSP. No tax on departure; federal and Arizona deferral.
• Home. Sold as a resident under the principal residence exemption.
• Scottsdale. Combined top rate about 39.5%. HST 13% becomes sales tax 8.05%. Property tax on a $700,000 home around $4,200.

Official sources

"Pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment." — Canada-United States Tax Convention, Article XVIII(2)(a), https://www.canada.ca/en/department-finance/programs/tax-policy/tax-treaties/country/united-states-america-convention-consolidated-1980-1983-1984-1995-1997.html

"When you leave Canada, you are considered to have sold certain types of property (even if you have not sold them) at their fair market value (FMV) and to have immediately reacquired them for the same amount. This is called a deemed disposition and you may have to report a capital gain (also known as departure tax)." — Canada Revenue Agency, Leaving Canada (emigrants), https://www.canada.ca/en/revenue-agency/services/tax/international-non-residents/individuals-leaving-entering-canada-non-residents/leaving-canada-emigrants.html

New Tax Rate of 2.5% for All Income Levels and Filing Status. — Arizona Department of Revenue, Individual Income Tax Highlights, https://azdor.gov/forms/individual-income-tax-highlights

Practitioner note

Arizona is one of the better states for a Canadian federal pensioner: a flat 2.5% on the pension, low property tax, and no estate tax. The NR301 is the one form that gets missed on the way out.

See also: Weighing Florida instead? See the Canada-to-Florida guide, or the same city's Ottawa to Miami guide.

Next step

Fairlight prepares the Ontario departure return, the pension withholding paperwork, and the first-year federal and Arizona returns for Phoenix clients. See cross-border pricing or book a call.