No one can serve two Tax Masters: A DIY investor’s thoughts about compliance with Canadian and United States taxes

In trying to do my 2010 taxes I realize that it was absolutely the right choice for me to relinquish my United States citizenship.  A significant percentage of my income is “unearned” income.  I’ve tried to come up with a zero return based on my Canadian taxes paid (Foreign Tax Credit) but the Form 116 is hopelessly complicated and I cannot do it myself.  The year 2010 was perhaps my first really good year as an investor, and so I’ve never had to have a Form 116 done for me, since my US income tax was always zero based on the FEIE and the personal exemptions.  I have decided that it is actually impossible to be an investor of any kind as a United States person living in a foreign jurisdiction, even a high tax region like Canada.  Here are some of my reflexions in trying to do my 2010 taxes:

  1. Double taxation is a serious threat to investors.  TaxAct said that my income tax before applying the FEIE (Foreign Earned Income Exemption) or the Foreign Tax Credit (you can’t use both on earned income, only one or the other) was y dollars.  My 2010 Notice of Assessment (Canada) says I paid y dollars of taxes in Canada.  Therefore in principle, I should owe nothing.  But figuring out the Foreign Tax Credit (Form 116) is like doing an entirely new tax return.  I see now why cross-border tax specialists can charge 1-2K to do a tax filing.  Who can understand this gobbledygook?
  2. Capital gains are treated completely different in the United States than they are in Canada:  In Canada, there are series of tests to determine if a stock trader should treat his profits from trades as capital gains or regular income (Is he a frequent trader?  Are the stocks held over the long term?  Is he trading full time?  Does he have professional knowledge in the investing field? Does he use a margin account or other leverage?).  If you generally have long holding period, and your main interest is long term capital gains and dividends, then profits from trading can be treated as capital gains.  In the US there are short term capital gains (stocks held less than a year) or long term gains.  Short term gains apparently are taxed like earned income–but don’t have the designation of earned income  (so forget about using the FEIE to offset it).  Since stock trading is subject to two completely different set of rules, it is impossible for a trader to be a US person and live in Canada.  I had no choice but to relinquish my citizenship so that this nightmare that I am experiencing over my 2010 taxes will go away for future years.
  3. Dividends are treated differently in Canada and the United States.  Canada eligible dividends receive favorable treatment in Canada because the company issuing the dividend has already paid taxes at the corporate level.  If I am not mistaken however, the United States treats these dividends as “foreign” dividends and therefore not subject to this more favorable treatment.
  4. RRSP : Registered Retirement Savings Plan accounts are covered under the Tax treaty between the United States and Canada.  So where is my reduction of income for an RRSP contribution on the US tax return?  As far as I can tell, the RRSP does not defer income tax for a US person.  I thought that the Tax Treaty covered this, but apparently, there is no tax reduction for putting money into a RRSP, only the US lets you to defer your income inside the RRSP.  So here is the thing:  I would be better deferring my RRSP contribution to my 2011 taxes; but that’s bad for my Canadian taxes because I made more in 2011 than in 2010.  So once again, I cannot figure out what to do.
  5. TFSA : Tax Free Savings Accounts are wonderful savings vehicles for Canadians.  But it is not covered under the treaty.  So it is a complicated nightmare for US persons living in Canada.  Leave it alone.  The same applies to RESP and RDSP (registered education and disability plans).
  6. The Alternate Minimum Tax in the United States assassinates investors.

In the end, the dilemma for United States person living in Canada is this:  Whatever tax dodges that are legally available to me in Canada, such as capital gains, Canada eligible dividends, RRSP contributions or gains in a TFSA, will suffer adversely from US taxes.  So I cannot order my life to please Revenue Canada and the Internal Revenue Service both.  No one can serve two tax masters.

I think this is probably worth going to Canadian tax court over.  If the IRS wants to collect even one red cent from me, they are going to have to make the CRA collect it for them.  Then I will explain that I paid y dollars in Canada; i.e., I’ve paid the Tax Master once, why should I have to pay again in a foreign country.

If Chua’s case was thrown out of court Canadian court–it concerned a six figure capital gains tax bill incurred from the sale of US investment (according to Tim–some research needs to be done on this)–then why would the IRS bother coming after me using the CRA?  My total taxes are much less than that by a factor of ten.

Anyway, Jean-Luc Picard expresses how I feel right now (for me the Borg is the United States Federal Government):

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36 thoughts on “No one can serve two Tax Masters: A DIY investor’s thoughts about compliance with Canadian and United States taxes

  1. @Petros

    You are correct but you are minimizing the problems.

    Here are two additional minefields ready to destroy the U.S. citizen trying to live in Canada:

    1. Mutual funds – these are treated as PFICS – There is no way that as a U.S. citizen in Canda you can own one.

    http://renounceuscitizenship.wordpress.com/2011/10/29/investments-effectively-prohibited-to-canada-u-s-dual-citizens/

    2. It is common for Canadian residents to run their business through corporations. This is a problem in itself (form 5471, etc).
    But, there is a whole subpart of the IRC “Subpart F” that penalizes you for accumulating income. Basically under U.S tax rules you will be taxed personally on investment income that is earned in the corporation but that is not distributed to you.

    I kid you not.

    Read Subpart F of the IRC (most of it you will have to pay an accountant or tax lawyer to decipher for you).

    My advice:

    Choose between being a U.S. citizen and having a life.

    You did the right thing in getting out.

    Plus, the accounting and compliance costs of dealing with this stuff is enormous.

  2. Thanks Renounce for adding two more major points. As for the second one, I did not open up my corporation, Petros Research Inc., until after my expatriation, for the very reasons of complexity about which you speak.

  3. Interestingly enough Chua’s lawyer ended up becoming a judge at the Tax Court of Canada. The property in question was a condo in Hawaii that was sold by Chua before he became a Canadian citizen.

  4. @petros, You have come to the same conclusion I came to back in 1977 when, as a US citizen living in Brazil and employeed as managing director of a Brazilian-owned business there creating jobs in the US by selling US exports in that market, I sat down to prepare my US tax return in accordance with the massive change made in the taxation of US citizens living and working abroad brought about by the Tax Reform Act of 1976 which President Ford had signed into law on October 4 of that year.

    Every single one of the tax incentives I had been encouraed to take under Brazilian tax laws to minimize my Brazilian tax obligation served only to increase, dollar for dollar, my US tax obligation. There was no way out, other than to either become a Brazilian citizen and renounce my US citizenship, or return to the US. And the deductions allowed under Brazilian tax law – educational expenses for my children, rent on our residence, charitable contributions to my local church and other Brazilian charities, etc. were not allowed for US tax purposes. And likewise my deductions for US tax perposes were not allowed under Brazilian tax laws.

    I was still young enough that I decided to return to the US and start a new career. Fortunately for me a new job opportunity came to me via a phone call from an old friend woth whom I had once worked in Chicago, so I already had a job in the US before leaving Brazil. But some of our close friends who had Brazilan spouses and Brazilian-born children decided to become naturalized Braziian citizens and renounce their US citizenship. It was much easier for them to renounce US citizenship in those days and it would have been much harder for them to return to the US. They did it reluctantly , but to them there was no other choice. And it was very uncommon for an American do do it back then. One long-time Consular official in Rio de Janeiro told one of my friends he was the very first US citizen he had ever had renounce his US citizenship in all of his years of diplomatic service at US Consulates around the world.

    But today, with FATCA, TIPRA, FBAR, the bill before Congress to revoke the passports of US citizens who the IRS alleges owe the IRS $50,000 or more, and the ability of the IRS to literally destroy financially any US citizens who has missed a jot or a tittle on any of the myrad of forms US citizens abroad are requred to submit to the IRS and the Treasury Deparment, plus having your bank account abroad where you live closed down because of the draconian penalties Congress has legislated against foreign banks that fail to viiolate the laws of their countries by reporting full details of accounts held by “US person,” to the IRS. there is no other choice but to renounce US citizenship, even if it means you may never again be able to set foot in US territory either because the IRS perceives that you still owe it something, or failed to file some obscure form, or because the US dcecides to enfoce the Reed Amendment and bar ex-citizens who reounced for tax reasons from ever entering the US..

    Sad, but so very true. I never expected in my lifetime to witness a Jihad by my own Government against the millions of free but very loyal unofficial ambassadors it has living, working and holding high the American flag abroad.

  5. @all- this just goes to show why anyone who is starting out in life and wants to have a future won’t be able to do it as a U.S. citizen. To be a U.S. citizen or Green Card holder is to be stuck in a spider’s web of investment and travel restrictions.
    To claim that this is not a violation of our rights of freedom of movement is a clearly a lie. It makes no sense to move abroad but to told that you can not use the investment tools of your new place of residence. Horizontal equity is a complete farce. Every U.S. person who lives abroad or in the U.S. is stuck in his/her own version of a U.S. embargo.

  6. It’s the same here in the UK. The UK gives you an initial tax free allowance of about £10,500 for capital gains and generally pay 28% over that. For example, if you made £10,000 in the stock market in the last 12 months, you’d owe the HMRC nothing. However the IRS would want to tax that from 10-35% depending on your US income tax rate as extra tax after you apply your foreign tax credits and foreign exclusion. So you mean I potentially would end up owing the US a few grand dollars after paying all my high taxes in the UK – the US can stick it.

    Then Levin and the other idiots wonder why you become a “non-filer.” It’s not to avoid US tax, but only to be held accountable to one tax master. In the UK, you pay 12% National Insurance, and 20% VAT (and we won’t even talk about £1.40 a litre for petrol which works out to $8.65 a US gallon). You need the small tax breaks along the way to keep your head above water..

    I’m really not interested in the US tax calculation and wouldn’t pay them anyways, I only go by what I owe the HMRC, pay them and keep them happy. Just because the US doesn’t think paying 12% NI and all the rest doesn’t count as a tax, they can get stuffed. Also the US cut their FICA from 7.65% to 5.65% as some sort of PR stunt the country can’t afford which skews the figures even more.

    So there you have it, the IRS takes into account only income tax, forgets about all the consumption, petrol, and social security taxes we pay, and then claims we owe them money because the US tax calculation is suppose to be the “gold standard” we must live by while being allowed to apply the foreign exclusion and credits to “soften” our double taxation blow which the idiots think in Congress is loss revenue to the US government

    Forget ii too complicated and I’m certainly not paying the accountant tax on top of all that.

  7. A little more humour for today –

    The US ex-pat is Harold and his mother represents the idiots in Congress and the IRS. This whole non-sense of citizenship-based taxation makes me feel this way.

  8. @Petros
    ‘a significant percentage of my income is “unearned income”. That statement, alone, is the reason that most retirees and pensioners, living outside the United States, are hurt by the US policy of citizenship taxation. For most pensioners and retirees, their income is interest, dividends and capital gains, and perhaps, if they are lucky, they also have company pension benefits. As you said none of those sources qualify for the FEIE. In the case of the Canadian/U.S. tax treaty, the government pensions (Canada Pension and OAS) are excluded from tax on the U.S. return but all of the other sources above are included without the benefit of the FEIE. In many of those cases, the foreign tax credit (and who can figure out that form), may not eliminate the tax owing in the U.S. So much for the IRS not ‘going after grandmas and grandpas’. I believe both Minister Flaherty and Ambassador Jacobson used those words.

  9. @John 😦
    Suicide is often preceded by a feeling of contentment when the individual finds they have a solution to their problem. Thankfully many of us are still way too cranky for that!

  10. @tiger Exactly right. There are only two kinds of people who can keep their US citizenship: (1) poor people with no savings; (2) people who have only earned income; these latter must also be (1) poor. So the poor can remain off the radar, or even file with no tax consequences. But as soon as you start having a major portion of your income from your savings and investments, you’re screwed.

  11. @tiger, and it is even worse for US citizens who don’t live in Canada. There are US tax treaties between the US and about 1/3 of the other countries of the world, and most of them, unlike the treaty with Canada, do not exclude these foreign pensions from US taxation even though they may not be taxed at all by the country where they live.

    And for those in the other 2/3 of the countries with which the US has no tax treaties, the non-taxable staus of these passive earnings is not recogzed by the IRS. If this is not cruel and unreasonable punishment for the non-crime of having lived, worked and retired outside of the US, I don’t know what is.

  12. @petros- I know that I will probably once again be chided for saying this but it only goes to highlight why it is so important that the young jump ship before they get entangled in this hopeless web. You simply cannot be a success as an U.S. person living abroad.
    The young deserve to have a chance to build a life and not to have their hopes and dreams extinguished. If the disabled can’t even score a break what does anyone who is not disabled think is waiting for them?

  13. All this tax treaty crap goes even further than that – in the UK most families (although the UK government is trying to limit it to people making un £50,000) receive child benefit. It’s only about £21 per week for the first child and £14 per week for each subsequent child – not much.

    If you were to fill in a 1040 I have read on a blog that the US would consider child benefit a “taxable” item. Someone in the US needs to realise that in Europe we pay high taxes and receive money back from the government depending on your circumstances.

    I’m not going to waste my time trying to figure out whether the lousy £2000 or so you get back from the government is taxable under the eyes of the IRS or all the other tax free allowances that apply in the UK but doesn’t apply in he US.

    If anything it’ll get worse if the Democratics take control of the whitehouse and Congress in November. They’ll raise income tax, capital gains, and expect us ex-pats to stump up the difference against the “US tax calculation” via their war against US-expats and the mortal sin of having money in a foreign bank account.

    If I’m brutally honest it would probably be best if the Republicans take total control allowing the extreme righ wing to cut all the taxes, the size of the Federal government, screw the old, poor, middle-class in the US, hand back more power to the states, along with perhaps reducing our tax exposure and the IRS’s ability to enforce tax law. It’s exactly what these jerks like Grassley and Levin deserve.

    The whole situation is really starting to become a bore. The rest of the world seems to be getting on with and the US is stuck in the “we’re the most powerful country in the world” whoopee!

  14. @Roger, it’s punishment for having the audacity to leave the best country on earth. Our errors in judgement deserve punishment (sarcasm keeps me from blowing a valve). It’s further made worse by the creation of Fortress America, as we know fortresses keep people in as well as out.

  15. If my folks had already passed on, I would be taking steps to renounce. But it’s that damn Reed Act that makes me hesitate. It’s still essential that I can continue to visit them but once they’re gone, I will want to do all I can to remove Voldemort from my life.

  16. Excellent post (and follow-ups). This illustrates how there are no reasonable options for many people involuntarily conscripted as U.S. persons to become compliant. The “stop-loss” mentality is rampant.

  17. @monalisa1776, The Reed Amendment has never been enforced and my guess (it is only a guess) is that it never will.

  18. This is an interesting thread. In terms of how this is going to get worse (and it will), consider how Obamacare is proposed to be financed. Basically, the U.S. is going to start taxing “unearned income”. See the following:

    http://renounceuscitizenship.wordpress.com/2011/11/22/reason-to-renounce-u-s-citizenship-medicare-tax-on-unearned-income/

    Now ask yourself this question. Where does the money come from to pay the tax on unearned income?

    This post is confirming what is obvious to anybody who has been affected by this. That is that renouncing U.S. citizenship is an act of self defense.

    @recalcitrant

    I agree with you that the renunciation of U.S. citizenship is a step that should be seriously considered by any young person or any person before they hit the two million mark. The comments on this thread indicate why. To the extent that people disagreed with your post, it was the suggestion of going out and counseling young people to take that step. Don’t believe that anybody disagreed with the main point which was that:

    U.S. citizenship is a very serious “ball and chain” to carry forward in life.

    I am going to make a guess here:

    The U.S. WILL change to territorial taxation for both companies and people. Sooner or later they will see the cost of this insanity. It may be too late (and we will all be gone by then) , but the word is getting out:

    The U.S. is not a good place to be.

    See the following:

    @Roger

    I have never seen the case for renouncing U.S. citizenship articulated better than in your comment!

  19. @mona: “…Reed Amendment…”

    http://renunciationguide.com/Rights-After-Expatriation.html

    “A 2003 Congressional report acknowledged that the rule is unworkable… There have been several very wealthy individuals whose expatriation drew intense media attention and Congressional criticism for tax avoidance, but they nonetheless managed to enter the U.S. after their renunciations with no problems. So unless you’re somehow more of a tax evader and object of media and Congressional scrutiny than they were, you won’t be barred entry.”

  20. All great points everyone. I am especially grateful to John for his UK-based perspective. And the Harold and Maude clip is priceless!

  21. @renounceuscitizenship- I don’t deny that the objections are given out of concern. What I wished to point out is that although some of us may be concerend about having “undue” influence over our children’s decision that the U.S. government has no such cares. Their consular officials will use the same mental tactics on your impressionable young child as they would use on an adult.
    In other words we should not be naive as to what the terms are for the waging of this battle. The U.S. is definitely out to influence our children. It isn’t an academic debate. They are trained at their job and our children won’t be equipped to counter their psychological tactics if we don’t equip them.

  22. @renounceuscitizenship- I think that as FATCA and FBAR news gets out along with the news of all of the other restrictions that are attached to U.S. persons that where the biggest drop off in immigration to the States will occur is with those who have any pre-existent wealth accumulated outside of the U.S.
    In other words the educated and industrious members of a society. These people aren’t going to want to surrender their wealth to U.S. taxation or ownership restrictions. The educated will quickly realize that U.S. personhood will be a hinderance to their ability to advance in their careers and to build wealth.
    The truth is that there are many countries in the world that offer many opportunities for economic wealth and it will be those countries which have the least restrictions on capital and immigration/emigration that will attract this group of people.
    The U.S. will find itself left attracting those who have nothing to lose where they are at by going to the U.S. In other words the least successful members of a population group. Those for whom life in the U.S. is better than life where they are at. But with living standards improving around the world there will be fewer locales like that for the U.S. to pull from.
    The worst advertisement that the U.S. could have for itself is the renunciation of its citizens and the stories that they will be telling to their friends, neighbors and the local press.

  23. @monalisa 1776 – I can understand the parents aspect, sadly I passed that milestone last year where the final parent passed away – it changes your perspective vis-a-vis abouit the US. Especially when both your kids have English accents and they see for themselves the US for what it is – not as we grew up in American schools.

    However they both have US passports as well and I believe fall into that new category of “hard to control” US citizens because of their UK place of birth.

  24. Petros –

    Your willingness to share your agonies and to put your personal situation out in public does a lot to put a human face on excruciating mismatches. The best single summary I have come across (without any serious searching) is

    US citizens resident in Canada — common circumstances where US tax may be payable

    If a willing tax wonk were to take on the task, an open-ended continuously updated list of mismatches could be a useful piece in the hands of Sir Isaac Brock. The foundation is laid in this article and this posting.

  25. @usacanada, There is one important fact that is left of this list. If you know how to get it added, it might be worthwhile. It has to do with Item 8 Charitable Deductions.

    In order to be deductible for US tax purposes, the Charitable deduction must be made to a Chartibable organizaion organized in the US. Canadian charities do not qualify for US tax purposes unless, and this is important, the Canadian charity has taken the actions prescribed in the US-Canada tax treaty to obtain and has been qualified for tax deductability with the IRS.

    Perhaps someone else can provide more detailed information on his.

  26. Petros

    I’ve felt your pain. I had to fill out all those forms for TFSA, RRSP and RESP. Well, truth be-told I helped my Canadian tax preparer work through the forms. She was more than shocked after completing my US return. I did get double taxed, $106 US. 2010 ‘pay for performance’ at work was just a bit too good and I went beyond the FTC, doh! On the upside my Canadian return was very good.

    I was charged $300 to have my US return done. Since this was a bit of a learning lesson for my tax preparer she decided gave me a break. The real cost for preparing my US return was $1550. I can’t justify that cost year after year, so for me renouncing was also the best solution. Although I would have renounced anyway, the feeling of freedom has been fantastic!

  27. Petros – perhaps ex-pats should attach an invoice (for accountant’s fees rendered) to their 1040 either reducing what they owe or adding on to what they get for a refund. A US passport is not worth the “accountant’s tax.” – you made the right choice jettisoning your US citizenship.

  28. I believe accountant fees can only be included as an itemised deduction and would only make a difference if greater than the standard deduction which is around $5800 for married filing separately.

  29. @petros, @john, if you itemize your deductions you can indeed include what you pay for tax preparation fees. You can also dedct the cost of fiing electronically and if you paid a convenience fee to be able to pay your US tax via credit card, that is also deductible. Remember that these expenses are for the year covered by the tax return; not for the the costs of the return you are currently prparing. You can deduct these next year. No need to attach the invoices, but keep them in case of an IRS audit.

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