As the nickname implies, “snowbirds” are Canadians who spend a considerable amount of time in the U.S. (often to escape our winters).
If you are a snowbird, there are a number of U.S. tax issues that you should be aware of because the last thing you want is to find yourself inadvertently liable for U.S. income tax or subject to U.S. penalties for failing to satisfy U.S. filing requirements.
Does the U.S. consider you a U.S. resident?
Despite the fact that you might consider yourself to be resident in Canada (for example, because you pay Canadian income taxes), if the number of days you spend in the U.S. exceeds certain thresholds, you may be considered a U.S. resident. The U.S. Internal Revenue Service (IRS) applies a test known as the “substantial presence test” to determine whether an individual who spends part of the year in the U.S. is a resident of the U.S. for U.S. income tax purposes.
Substantial presence test
Under the substantial presence test, you will be considered a U.S. resident under U.S. domestic tax law if:
- the weighted total of the number of days you spent in the U.S. over the last three years (determined using the formula set out below) equals or exceeds 183 days, and
- you have been in the U.S. for more than 30 days in the current year.
The weighting formula that is used in the substantial presence test is as follows:
The number of days in the U.S. this year
1/3 of the number of days in the U.S. last year,
1/6 of the number of days in the U.S. the year before last
Obviously, if you spend 183 days (roughly 6 months) in the U.S. in any given year, you will meet the substantial presence test. However, if you regularly spend as much as 4 months a year in the U.S. (122 days), you will also be considered a U.S. resident under this formula.
Given that the substantial presence test relates to the number of days you are in the U.S., it is important that you count your U.S. days carefully. Even if you are present in the U.S. for just a portion of a day, it is counted as a full day for the purposes of this test. However, some of the days you are in the U.S. may be excluded from the calculation. Days that are excluded include:
- Days that you commute to work in the United States from Canada;
- Days you were in the U.S. where you can show that you intended to leave earlier, but were unable to because of a medical condition that developed while in the U.S.;
- Days when you were in transit in the U.S. for less than 24 hours on your way to another foreign country (for example, if you had a layover in Chicago on your way to Mexico);
- Days in the U.S. while on a special student or teacher visa.
To exclude days of presence in the U.S. for purposes of the substantial presence test calculation, you may need to file Form 8843, Statement for Exempt Individuals and Individuals with a Medical Condition, to explain the basis of your claim. Filing deadlines are discussed later in this bulletin.
COVID-19 relief for the substantial presence test
Previous Internal Revenue Service (“IRS”) guidance under Revenue Procedure 2020-20 provided specific guidance with respect to the substantial presence test in light of COVID-19 for calendar 2020. Such guidance does not apply to years after 2020.
Consequences of being considered a U.S. resident
If you meet the substantial presence test in any given year, you're automatically considered a U.S. resident for U.S. tax purposes for that year. Absent taking any measures to disclaim U.S. residency, you would be subject to U.S. tax and filing requirements based on your worldwide income. This will be so, even though you may also be a Canadian resident and pay Canadian taxes.
If you are considered a U.S. resident, you can do one of two things to disclaim U.S. residency:
- you can claim the "closer connection exception" allowed under the Internal Revenue Code (the Code), or
- you can claim treaty benefits under the Canada - U.S. Income Tax Convention (the Treaty).
Claiming the “closer connection exception”
You can avoid being considered a U.S. resident by claiming that you actually have closer connections with another country (such as Canada). To claim the closer connection exception, you must file Form 8840, Closer Connection Exception Statement for Aliens, with the IRS. On Form 8840, you must indicate the number of days you spent in the U.S. and you must answer questions that demonstrate that you had a closer connection with Canada during the year.
Factors that indicate a closer connection with Canada include:
- having a permanent home in Canada,
- having family in Canada,
- having personal belongings in Canada,
- being entitled to health care services paid by a provincial health insurance plan,
- banking in Canada,
- carrying on business in Canada,
- having a Canadian driver's licence, and
- voting in Canada.
Questions about your involvement in social, cultural, religious, political and professional organizations are not on the form. However, these factors are still relevant in establishing a closer connection to Canada.
You cannot claim the closer connection exception if:
- you spend 183 days or more in the U.S. in the current year,
- you have, or have applied for, a U.S. “Green Card” to establish permanent resident status in the U.S., or
- you did not file Form 8840 by the due date, and cannot establish reasonable cause for late filing to the satisfaction of the IRS.
When filing Form 8840 to claim the closer connection exception, you do not need a U.S. taxpayer identification number. However, you must sign Form 8840 under penalty of perjury, which means you could be subject to prosecution for reporting false information.
The deadline for filing Form 8840 and the penalties for failure to file are discussed below.
Dual resident individuals (non-U.S. citizens)
If you cannot claim the closer connection exception, then you are a dual resident and therefore considered to be a resident of both Canada and the U.S. under each country's tax laws. In such cases, the Treaty has “tie-breaker” tests under which your residence for purposes of income taxation is ultimately determined.
Canadian resident under tie-breaker tests
For those who are resident of both Canada and the U.S. under their respective domestic tax laws, the Treaty lays out tie-breaker tests that must be applied in sequence until one of the tests becomes determinative in favour of Canadian or U.S. residency. The tests are:
- location of “permanent home”
- location of “center of vital interests” (based on familial, social and economic ties)
- location of “habitual abode”
- mutual agreement of Canadian and U.S. tax authorities
The application of the tie-breaker tests is based on one's facts and circumstances, and often requires professional judgment.
If you tie-break to Canada, the Treaty will generally protect you from having to pay U.S. tax on income from sources outside the U.S. However, you are still subject to the filing requirements of the Code and the penalties for not adhering to them.
If you are considered resident in the U.S., but you cannot claim the closer connection exception (for example, if you spent 183 days or more in the U.S. in the year), you must file Form 1040-NR, U.S. Nonresident Alien Income Tax Return, for the year in question and also claim treaty benefits as explained below. In addition, you may also still be subject to certain U.S. foreign reporting requirements normally applicable to U.S. residents.
On the Form 1040-NR, you must declare all U.S. source income. For snowbirds, this is usually only interest and dividends, both of which are normally subject to a flat non-resident withholding tax (with interest currently subject to a 0% withholding rate and dividends subject to a 15% withholding tax rate). Any income and taxes withheld are reported on Form 1040-NR and this return must be signed under penalty of perjury.
Claiming Treaty benefits
To claim Treaty benefits, you must attach a completed Form 8833, Treaty-Based Return Position Disclosure under Section 6114 or 7701(b), to your Form 1040-NR. On Form 8833, you must explain that you are a resident of Canada and are not subject to regular U.S. income tax rates on this U.S. source income under the provisions of the Treaty.
Both the Form 1040-NR and Form 8833 require a U.S. taxpayer identification number. For individuals who are not eligible to obtain a Social Security Number (SSN) (generally individuals without permission to work in the U.S.), this number is known as an “Individual Taxpayer Identification Number” (ITIN). To obtain an ITIN, you must file Form W-7, Application for IRS Individual Taxpayer Identification Number, with proof of identity and foreign status, along with your original completed tax return. After the W-7 has been processed, the IRS will assign an ITIN to you and process the return. If you do not have a return filing requirement, but meet one of the exceptions for obtaining an ITIN (for example, individuals subject to third party withholding on passive income or on proceeds from sale of U.S. real estate), you will be required to file specific documentation with the W 7 instead of a tax return.
Normal filing deadlines
Individuals are taxed based on the calendar year in the U.S., just as they are in Canada. Form 1040-NR with Form 8833 (to claim treaty exemption) must be filed by June 15 of the following year. However, if you have employment income subject to U.S. withholding tax, the filing deadline for Form 1040 NR is April 15 of the following year. Form 8840 (to claim the closer connection exception) and Form 8843 (to exclude U.S. days for purposes of the substantial presence test) are filed together with Form 1040-NR, if the Form 1040-NR is required to be filed. Otherwise, Forms 8840 and 8843 should be filed separately by June 15.
If you fail to file Form 8840 by the due date and the IRS subsequently determines that you met the substantial presence test, the IRS could require you to file a U.S. tax return. Although you can claim Treaty protection from U.S. tax at the time you file the return, you would still be subject to the non disclosure penalties under the Code. These penalties could be as much as $1,000 for each item of income involved. Note that the Treaty does not protect you from these penalties.
In addition, as mentioned above you could be subject to U.S. foreign reporting requirements if you fail to file Form 8840 on time. The penalties associated with non-compliance in connection with these requirements could be very high, depending on the applicable form. Several of these forms carry penalties of $10,000 or more for late filing or failure to file.
These penalties are the main reason we encourage clients to file when required. There is usually no U.S. tax cost to filing and you can protect yourself from incurring substantial penalties at some point in the future.
U.S. resident under tie-breaker rules
If, after applying the tie-breaker rules, you are considered a U.S. resident, you would pay tax on your worldwide income in the U.S. and only be subject to Canadian tax on your Canadian source income. If you were previously a Canadian resident, that's not the end of the story.
In such a case, you may be treated as a non resident for Canadian income tax purposes. This means that, whether you intentionally emigrated or not, you will be deemed to have disposed of most of your non-registered assets for Canadian tax purposes, and will have to pay tax on any capital gains that have accrued. Most commonly, the deemed disposition rules apply to marketable securities and foreign real estate holdings. Registered accounts are not subject to this deemed disposition. Registered accounts include pensions, RRSPs, RRIFS, RESPs and TFSAs. The disposition will occur on the day that you are considered to have left Canada.
These rules could affect individuals who leave Canada for a short-term stay in another country, and where, for example, they do not retain a home in Canada. Proper planning can reduce the impact of these rules. Your BDO advisor can assist you in determining how these complex rules apply to you.
Commuters are individuals who are not U.S. citizens and who regularly commute to work in the United States from their residence in Canada. The term “commute” means that you travel to work in the U.S. and return to your residence in Canada within a 24-hour period. You are considered to regularly commute from Canada if more than 75% of your workdays are in the U.S. As noted above, if you meet these criteria then the days you are working in the U.S. are not considered as days present in the U.S.
If you are working for a U.S. employer, you will receive a Form W-2 statement of wages. Since you have wages subject to withholding, you must file a tax return Form 1040-NR by April 15 of the following year. You may request an extension of time to file your tax return to October 15 by filing Form 4868 on or before the original due date of April 15. Any balance owing should be paid by April 15 to avoid any potential penalties and interest.
If your wages are subject to state and local tax withholdings, you will need to file tax returns in those jurisdictions as well.
When you file your Canadian income tax return, you may claim a foreign tax credit for taxes paid to the U.S. to reduce your Canadian taxes payable.
If you are working for a Canadian employer but regularly report to work in the U.S., you may have U.S. filing obligations.
COVID-19 guidance for commuters
Previous guidance issued in 2021 by the Canada Revenue Agency (CRA) clarified its positions with respect to COVID-19 and commuters who are on the U.S. payroll of their employer and were working from home in Canada as a result of travel restrictions.
Under the Treaty, an individual should source their employment income between Canada and the U.S. based on the number of days worked in each country. Sourcing determines which country has the first right to tax the income. This would mean that for those days worked from home, the commuter would ultimately be paying tax in Canada as opposed to the U.S. For example, if a Canadian earned $100,000 from a U.S. employer, and worked 75% from home in Canada in 2020, $25,000 of their wages would be sourced to the U.S., and $75,000 would be sourced to Canada. Filing tax returns accordingly would create a large balance of tax payable in Canada (where no tax has been withheld on the $75,000), and a large refund in the U.S. (where tax has been over-withheld on the full $100,000).
As stated above, the CRA clarified the options for 2020 and 2021 for commuters working from home in Canada. A commuter could choose to source their wages based on days worked pursuant to the Treaty and file their Canadian and U.S. tax returns based on where they physically worked. Alternatively, an individual could file their Canadian and U.S. returns as they have in prior years without having to source their wages based on days worked in each country. If an individual chose to file based on sourcing income based on days worked in each country, additional guidance was provided by the CRA.
At this point, the CRA has not indicated that they will extend this relief to the 2022 tax year and beyond and a commuter should carefully consider the cross-border tax implications of working from home in Canada for a U.S. employer.