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From tax expert Gerry Vittoratos
January 03, 2019
The age-old Canadian tradition for retirees: when it starts getting cold outside, Canadians will “flock” to the warmer shores of the United States. Are there any tax considerations in the United States we need to be aware of when your retired clients stay there periodically? Are there other events that may be subject to US tax?
Resident Alien and the Substantial Presence Test
For US income tax purposes, you will be considered a resident alien if you meet the “substantial presence test”. The test is based on the days you’re physically present in the US. The days are counted as follows [IRC §7701(b)(3)]:
- Must be physically present in the US for at least 31 days in the year AND
- 183 days during the 3-year period that includes the current, prior and 2 years back counting:
• 100% of the days in the current year,
• 1/3 of the days in the prior year,
• 1/6 of the days in the second prior year.
When you do the math, 120 days/year represents the “magic number” for retirees who go back to the US yearly.
However, there are exclusions to this rule. Days that fall within any of the ones listed below are not counted [IRS Publication 519]:
- Days you commute to work in the United States from a residence in Canada or Mexico if you regularly commute from Canada or Mexico.
- Days you are in the United States for less than 24 hours when you are in transit between two places outside the United States.
- Days you are in the United States as a crew member of a foreign vessel.
- Days you are unable to leave the United States because of a medical condition that arose while you are in the United States.
- Days you are in the United States under a NATO visa as a member of a force or civilian component to NATO. However, this exception does not apply to an immediate family member who is present in the United States under a NATO visa. A dependent family member must count every day of presence for purposes of the substantial presence test.
- Days you are an exempt individual.
The medical exclusion is the important one for snowbirds. Days in which you had the intention of leaving but couldn’t due to a medical condition that developed in the US are excluded from the “substantial presence test”. You cannot claim the exclusion if you had the medical condition before arriving in the US. To claim the medical exclusion, Form 8843 must be filed to the IRS.
Closer Connection and Treaty Exclusions
Even if you meet the “substantial presence test”, there are 2 more exclusions you can use. The first is the “closer connection test”. You can be treated as a non-resident alien by the IRS if you:
- Are present in the United States for less than 183 days during the year,
- Maintain a tax home in a foreign country during the year, and
- Have a closer connection during the year to one foreign country in which you have a tax home than to the United States (unless you have a closer connection to two foreign countries, discussed next).
A “tax home” is defined as the place where you permanently or indefinitely work as an employee or a self-employed individual. For determining whether you have a closer connection to Canada, your tax home must also be in existence for the entire current year.
To establish a closer connection to Canada, the IRS considers the following factors:
- The country of residence you designate on forms and documents.
- The types of official forms and documents you file, such as Form W-9, Form W-8BEN, or Form W-8ECI.
- The location of your home, family, belongings, driver’s license, business, etc.
To make the claim for the “closer connection” exclusion, Form 8840 must be filed by June 15.
The other exclusion beyond the “closer connection” one is the “tie-breaking” rule within the Canada-US Tax Treaty. If you stay beyond 183 days in the current year, or you were less than 183 days and did not file a Form 8840 (see above) to claim the “closer connection” exclusion, then the only way out of the resident alien designation is the treaty’s tie-breaking rule. The rule itself is found is subparagraph IV(2) of the treaty.
As per the treaty, the factors to consider for the determination of the tie-breaking rule are, in order:
- The permanent home of the individual,
- The center of vital interests, in other words, the country with the closest personal and economic ties,
- Mutual agreement between both countries.
To benefit from the tie-breaking rules, and be considered a non-resident alien, you must file Form 8833 with the 1040NR, provided you’re not a Green Card holder. As a Green Card holder, you may have to file a 1040 with Form 8833.
Sale of US Real Estate Property
Another event that may subject an individual to US tax is the sale of a vacation home in the US. The first consequence of this transaction is the non-resident withholding tax, or the Foreign Investment in Real Property Tax Act (FIRPTA). The withholding tax is 15% of the proceeds. This withholding tax goes down to 10% if the property was sold for an amount between $300,000 and $1 million, and the purchaser, or a member of his/her own family makes the home their principal residence.
There are 2 exclusions/reductions to this withholding tax:
- If the proceeds are less than $300,000 and the purchaser, or a member of his/her own family makes the home their principal residence,
- Requesting a withholding certificate from the IRS on the expectation that the tax on the transaction will be less than 10% or 15% (see above). Form 8288-B must be completed and sent before the close of the sale. A US ITIN (Individual Taxpayer Identification Number) is required (you can apply for one with the W-7 Form and submit it with Form 8288-B).
This transaction must be reported on the US Non-Resident Income Tax Return (Form 1040NR) or a 1040 for Green Card holders.
When it comes to Canadian taxation on such a transaction, it must be declared on the Canadian return. If any tax was paid on the US side, this amount is eligible for the Foreign Tax Credit. This property can be designated as a principal residence and be exempted from tax, however, once the designation has been made, the years chosen for the US residence cannot be used to designate another property [ITA 54].
In short, asking your client how their vacation went may alert you to tax consequences that were not apparent. There may be further implications…
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