Moving to Canada: Basic U.S. Tax Facts

If a U.S. citizen decides to give up their citizenship and move to Canada, they need to be aware of significant tax consequences under U.S. law (IRC § 877A).

Mark-to-Market Tax and Covered Expatriate Rules

Those labeled as "covered expatriates" must pay a mark-to-market tax (IRC § 877A(a)). A covered expatriate is someone who meets certain conditions, such as having a net worth of $2 million USD or more, an average annual net income tax liability over a set amount ($190,000 in 2023) during the past five years, or not certifying compliance with U.S. tax obligations for the last five years (IRC § 877A(g)(1)). The mark-to-market tax treats all your assets as if they were sold at fair market value the day before you renounce citizenship, and any gains are taxed. An exclusion amount of $821,000 for 2023 can reduce the taxable gain (IRS Notice 2023-28).

Planning Tip: If you are classified as a "covered expatriate" under IRC § 877A, all your property is considered sold at fair market value the day before you expatriate. Gains from this deemed sale are taxable, but an exclusion amount (adjusted for inflation) can reduce the taxable gain. For example, the exclusion amount was $600,000 in 2008 and increases each year for inflation.

Exclusions and Deferrals

Covered expatriates can choose to defer paying the tax on the deemed sale by providing adequate security and giving up treaty benefits that prevent tax collection (IRC § 877A(b)). This deferral applies to each asset individually and lasts until the asset is sold or upon the expatriate's death.

Special Rules for Deferred Compensation and Non-Grantor Trusts

Deferred compensation items, like certain retirement accounts, aren't subject to the mark-to-market tax but are taxed under special rules (IRC § 877A(d)). Eligible deferred compensation is subject to a 30% withholding tax on payments to the covered expatriate. Ineligible deferred compensation is treated as received on the day before expatriation, and its present value is included in taxable income. For non-grantor trusts, trustees must withhold 30% of the taxable portion of any distribution to a covered expatriate (IRC § 877A(f)).

Filing Requirements

Expatriates must file Form 8854 to certify they have complied with all federal tax laws for the five years before expatriation (IRC § 6039G). Failing to file results in automatic classification as a covered expatriate, regardless of income or net worth.

Canada-U.S. Tax Treaty Provisions

The Canada-U.S. Tax Treaty helps prevent double taxation. Article XXIV allows Canada to credit U.S. taxes paid on U.S.-source income (Article XXIV(2)). U.S. citizens living in Canada can claim a credit for Canadian taxes paid on U.S.-source income, limited to 15% of the gross income amount (Article XXIV(6)). Gains from the sale of property by former U.S. citizens who become Canadian residents may be taxed by the United States if certain residency conditions are met (Article XIII(5)). Social security benefits paid to a former U.S. citizen residing in Canada are taxable only in Canada (Article XVIII(5)).

Indirect Credit and 10 Percent Voting Stock

Under the treaty, a U.S. company that owns at least 10% of the voting stock of a Canadian company can claim an indirect credit for the Canadian taxes paid by the Canadian company on the profits out of which the dividends are paid. This means the U.S. company is not taxed twice on the dividends it receives from the Canadian company.

Gains from Alienation

Under paragraph 5 of Article XIII of the treaty, gains from the sale (alienation) of property by a U.S. citizen who becomes a resident of Canada are subject to specific rules. If the individual was a resident of the United States for 120 months during any 20-year period and was a resident at any time during the 10 years before the sale, the United States may tax the gain.

U.S. Social Security Income

After renouncing U.S. citizenship, social security benefits paid to a former U.S. citizen residing in Canada are taxable only in Canada, according to Article XVIII of the treaty. This ensures the individual does not face double taxation on these benefits.

Relevant U.S. Internal Revenue Code Sections to Eliminate Double Taxation

Section 901 allows U.S. citizens to claim a foreign tax credit for income taxes paid to other countries (IRC § 901). Section 904 limits this credit to the portion of U.S. tax related to foreign-source income (IRC § 904(a)). Section 905 outlines how to claim the foreign tax credit, including adjustments for changes in foreign tax liability (IRC § 905). Section 911 lets qualified individuals exclude foreign earned income and housing costs from U.S. taxation (IRC § 911). Additionally, Section 904(d)(1)(B) requires calculating the foreign tax credit separately for different types of income, preventing the offset of U.S. taxes on low-taxed income with high-taxed foreign income.

THE INFORMATION PROVIDED IN THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSTITUTE LEGAL ADVICE. FISZMAN TAX LAW RECOMMENDS CONSULTING A QUALIFIED LAWYER FOR ADVICE PERTAINING TO YOUR SPECIFIC SITUATION.