If you’re doing business in the U.S., you may end up paying taxes to the IRS — or face stiff penalties. Even if you’re a Canadian citizen, working for a Canadian subsidiary or branch office, it doesn’t mean you’re in the clear in the eyes of tax officials.
Indeed, it’s a common misperception that the IRS’ rules don’t apply to Canadians. Here are some of the most common tax planning mistakes made by Canadians doing business south of the border — and how to avoid them:
1. The 182 day rule
If you’ve spent more than 182 days in the U.S. over the course of the year, you may be considered a U.S. resident — at least for tax purposes. For those who conduct business in the U.S. on a regular basis, it’s easy to end up “tripping the 182-day wire and all of a sudden they have to disclose everything,” said Peter Megoudis, partner with Deloitte LLP’s Global Employer Services.
2. Substantial presence and closer connection
Maybe you didn’t use up your allotment of 182 days over the course of a year, but you could still be considered a U.S. resident if those days add up over the course of three years. A calculation — called the substantial presence test — is determined based on the number of days spent in the U.S. over a three-year period (which generally works out to more than 120 days per year on average). To claim an exception to the substantial presence test, you must file IRS form 8840 (the Closer Connection Exemption Statement for Aliens) annually. Not filing an 8840 could end up subjecting you to a requirement to file a whole bunch of other forms, to report your Canadian bank or brokerage accounts, trusts, and corporations, and failure to file those forms could expose you to penalties of up to $10,000 per form per year.
3. Spending a short time with a U.S. subsidiary or branch
If you are a Canadian employee of a Canadian company being sent to a U.S. subsidiary or branch office for a short period of time — say, two months or half a year — you may be subject to U.S. income tax, even as a non-resident. People tend to assume that because they have Canadian citizenship, and because they’re working for a Canadian subsidiary or branch office, they don’t need to file any U.S. returns.
4. Transfers to the U.S.
If you are transferred to the U.S. and that subsidiary or branch office is “bearing the cost,” that means you become taxable in the U.S. “The worst thing is, if I’m still maintaining my primary residence in Canada, perhaps because it’s a short term assignment, I still have to pay Canadian taxes and the company withholds Canadian taxes on 100 per cent of my income,” said Megoudis. While you can claim a credit for U.S. taxes with the CCRA, the real problem is cash flow during the year. And while you can apply for a waiver with Canadian tax authorities that authorizes a reduction in Canadian withholdings, you must apply before you are transferred to the U.S.; it’s only effective on payments post-waiver.
5. Social security
Related to that is social security. A Canadian who’s not planning to retire in the U.S. or collect social security probably doesn’t want to pay those taxes — which can be substantially higher than in Canada. So if you’re transferred to the U.S. on a short-term basis, it’s not in your best interest to be hired locally (as a new employee) because you’ll have to pay into the U.S. social security regime. If you work for a Canadian company and are transferred to the U.S. for less than five years, you can continue paying into the Canadian Pension Plan — which can add up to significant savings.
6. Risks for U.S. citizens and green card holders
The IRS is also cracking down on anyone with dual citizenship — even if they happened to be born in the U.S. but have lived in Canada ever since. Any employer who is sending an employee to the U.S. for work purposes should find out if there’s any chance he or she could be considered a U.S. citizen. “There’s a risk that information will start getting disclosed to the IRS and the IRS will come after them,” said Megoudis. “In the past border guards weren’t really asking tax questions, but more and more they are.” There’s a similar risk for Green Card holders. If you’ve moved back to Canada but haven’t surrendered your Green Card, and then try to enter the U.S., from a tax perspective you could be subject to severe tax penalties.
7. Use of a corporation
Canadians tend to set up corporations because corporate tax rates are lower (you park the earnings of the company and don’t pay personal taxes until years later when you take them out as dividends). Many Canadians assume they can just do the same thing in the U.S. The problem is, corporate tax rates are much higher in the U.S., so you don’t get the same tax savings as in Canada. Many Americans set up LLCs instead of corporations. But if you’re a Canadian setting up an LLC, the Canadian government still looks at it as a corporation, “so there could be double taxation in Canada and the U.S. because they treat it a different way,” said Megoudis. “That’s the biggest thing you need to worry about.”
Finding out what you need to do before you go to the U.S. could save you a lot of hassle — not to mention thousands of dollars in potential fines, or even being barred from the U.S.
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Expand in the USA conference
Early bird registration is now open for the two-day conference, Expand in the USA, being held at The International Centre, in Mississauga, Ontario, June 16-17, 2015. (Prices go up on April 25, 2015.) The conference will be focusing on strategic planning and financing for small and medium size Canadian companies looking to achieve significant growth south of the border. See the agenda at: www.expandintheusa.com/agenda.