Taxation of Canadians in America. David Levine
be curious about the cost of preparing a US tax return with cross-border issues. Of course, we cannot speak for all of our peers, but based on our experience, you can expect to pay approximately $1,000 at the low end, up to $5,000 at the high end, depending on the complexity of your situation. These estimates do not include Canadian returns or business returns. For your first US return, you can expect to pay double, due to the calculations, elections, etc. that need to be made in the first year.
In the more than 20 years KeatsConnelly has been specializing in cross-border issues, we believe that we have seen every situation and have heard every question. We are using that experience as the basis for writing this book. We are writing this book to address most of the tax issues that Canadians need to know while living in the US.
To the best of our knowledge, this is the first and only book dedicated to the topic of taxation of Canadians living in the US and we hope it will become an indispensable guide for Canadians living in the US.
Other books written by the professionals at KeatsConnelly that are part of the Cross-Border Series include, The Border Guide: A Guide to Living, Working, and Investing across the Border, A Canadian’s Best Tax Haven: The US, and Buying Real Estate in the US: The Concise Guide for Canadians. You can find these books at www.self-counsel.com/default/personal-finance.html, www.crossborderseries.com, www.crossborderseries.ca, or crossborderseries.net, or www.crossborderbooks.ca.
We are writing another book that will cover the Taxation of Americans in Canada. This book should be released in 2013 and will also be on the Self-Counsel Press, crossborderseries.net, and crossborderbooks.ca websites when ready.
1
The Basics of US Taxation
The US Internal Revenue Code (IRC) is synonymous with the Canadian Income Tax Act and is among, if not the most, complex system of taxation in the world. This book will cover a very small segment of the IRC, and even for the IRC sections we do discuss, we will not be going into great detail.
There are two basic points we want to make sure are clear and said up front; the US taxes its citizens and residents on their worldwide income, and that the US tax burden is about one-third less than that of Canada. In this chapter, we will discuss the Internal Revenue Service (IRS), IRS audits, filing requirements, and the basic layout of a US tax return.
1. History of the Internal Revenue Service (IRS)
In 1862, during the US Civil War, President Lincoln and Congress created the position of Commissioner of Internal Revenue and enacted an income tax to pay war expenses. The income tax was repealed ten years later. Congress revived the income tax in 1894, but the Supreme Court ruled it unconstitutional the following year.
In 1913, the 16th Amendment gave Congress the authority to enact an income tax. That same year, the first Form 1040 appeared after Congress levied a 1 percent tax on net personal incomes of more than $3,000, with 6 percent surtax on incomes of more than $500,000.
In 1918, during World War I, the top rate of the income tax rose to 77 percent to help finance the war effort. It dropped sharply in the postwar years, down to 24 percent in 1929, and rose again during the Depression. During World War II, Congress introduced payroll withholding and quarterly tax payments.
In the 1950s, the agency was reorganized to replace a patronage system with career, professional employees. The Bureau of Internal Revenue’s name was changed to the Internal Revenue Service (IRS). The IRS Commissioner and Chief Counsel are selected by the president and confirmed by the Senate.
The IRS Restructuring and Reform Act of 1998 prompted the most comprehensive reorganization and modernization of the IRS in nearly half a century. The objective of the act was for the IRS to reorganize itself in a way that would resemble the private sector model of organizing around customers. Few outside of the IRS would say that objective was met.
The IRS is a bureau of the Department of the Treasury and in fiscal year 2010, the IRS collected more than $2.3 trillion in revenue and processed more than 230 million tax returns.
The following mission statement describes the roles of the taxpayers and the IRS:
• In the United States, the Congress passes tax laws and requires taxpayers to comply.
• The taxpayer’s role is to understand and meet his or her tax obligations.
• The role of the IRS is to help the large majority of compliant taxpayers with the tax law, while ensuring that the minority who are unwilling to comply pay their fair share.
The IRS is organized to carry out the responsibilities of the Secretary of the Treasury. The Secretary has full authority to administer and enforce the internal revenue laws and has the power to create an agency to enforce these laws. The IRS was created based on this legislative grant.
The Internal Revenue Code provides for the appointment of a Commissioner of Internal Revenue Service to administer and supervise the execution and application of the internal revenue laws.
2. The Basics
Income taxes are based on income and are imposed at the federal level, most state levels, and some local city levels within the US. Each state or city may define taxable income differently; however, most states refer to the federal law for determining taxable income. Common examples of income that may be taxed differently by a state than by the federal government are Social Security income, interest income from US treasury obligations, and pension benefits from that state’s governmental workers. Cities typically tax income earned within that city. Cities that impose a separate tax are generally limited to the states of Ohio, Pennsylvania, and New York. In the US, you must file separate returns to the federal, state, and city governments, similar to filing separate Canadian federal and Quebec provincial returns.
In the US, individuals, estates, trusts, and certain corporations are subject to income tax. Partnerships and corporations that make an election to be treated as a small business (known as making an “S election”) are not taxed. Partnerships and S corporations are what are called “flow through” entities. This means that the income, expenses, and ultimately the income tax flows through to the individual partners or shareholders. Nonresidents of the US are not allowed to be shareholders of an S Corporation.
Regular corporations (sometimes referred to as “C corporations”) are subject to double taxation because the corporation pays tax on the income and when a dividend is paid, the individual pays tax on the dividend. The corporation does not receive a deduction for the dividend and the individual does not receive a credit for tax paid by the corporation.
Federal and many state income tax rates are graduated, meaning that at higher levels of income you pay progressively higher levels of tax. The tax rate that corresponds to your highest level of income is known as your marginal tax rate. For individuals, the income level at which the various tax rates apply, varies by your filing status.
For the 2011 tax year, individuals are subject to federal graduated tax rates from 10 to 35 percent; the 35 percent tax rate applies to taxable income of more than $379,150 for couples filing jointly and single individuals. Also for 2011, corporations are subject to federal graduated rates of tax from 15 to 35 percent; the 35 percent tax rate applies to corporate taxable income of more than $18,333,333. State income tax rates vary from 0 to 11 percent. State and local taxes are generally deductible in computing federal taxable income.
The Federation of Tax Administrators website www.taxadmin.org/fta/rate/ has information on the latest tax rates, surveys, and rankings.
3. Dealing with the IRS
While the IRS is not the demonic organization it is frequently made out to be, it’s an organization you do not want to get on the bad side of. Fortunately, staying in the IRS’s good graces is relatively easy to do; file your taxes on time and pay