Taxation Mistakes US Expats in Canada Should Avoid
The most critical taxation rule of living and working in Canada is that US expats are expected to file returns in both countries. While most immigrants are well aware of this factor, navigating tax laws and understanding how exclusions work can be complex. You’ll need the advice and guidance of an expat tax consultant in Canada who is experienced in managing tax returns for US expats. Read ahead for some detailed information on the most common pitfalls and errors taxpayers make and how to avoid them.
Error 1 – Not Reporting Tax from Worldwide Sources
US expats must use Form 1040 for filing their income tax returns with the IRS and the T1 form for income tax returns in Canada. In an attempt to avoid double taxation, you might make the mistake of reporting only Canada-sourced income in the T1 and US-sourced income in the 1040. However, know that both countries require you to declare all your income, regardless of the source. You’ll use the different provisions made available so people can claim tax credits and lower their taxes.
Error 2 – Not Understanding How to Segregate Earned Income
Keep in mind that all income is categorized into 4 sections and you must calculate your taxes accordingly. For instance:
- General – salary and wages from employment, pension, business income, and others.
- Resourced – interest from US-based investments and US capital gains
- Passive – rental income, interest, and capital gains
- GILTI – income earned under GILTI rules and 962 elections
Remember to deduct payments made toward US Social Security, Canadian Pension Plan, and Old Age Security, since taxes are to be paid only in the country where you reside.
Error 3 – Using the FEIE Provision Incorrectly
The US From 2555 permits expats to pay taxes only on income over and above a fixed bracket. This limit is adjusted each year to account for inflation and set at $108,700 for the year 2021. You can deduct this amount from your taxable income and pay dues only on the amount remaining. Make sure to calculate only earned income for Form 2555 because unearned income like rent, capital gains, pension, and investment income cannot be deducted. Further, using this provision is a mistake because you can carry forward the unused Canadian tax credit to future years’ returns. Most importantly, the FEIE deduction is not recommended for high-income earners.
Error 4 – Miscalculating Exchange Rates
Errors in calculating exchange rates can have a significant difference in the taxes you’ll pay. As your tax advisor will explain, earned income exchange is calculated at the average annual US-Canadian rate. Any capital gains are estimated at historical exchange rates. For instance, if the exchange rate is 1.20% and you calculate 1.30% on an income of $20,000, you might end up paying an additional $2,000 in taxes, which could have been saved.
Understanding how taxation laws work and calculating taxes can be confusing, with a high potential for errors. Avoid mistakes by working with an experienced professional.
