Hello and thank you for your question.
The answer is controlled by the US-Canada Income Tax Treaty. You'll
report the income in both countries, but you'll get foreign tax
credits that will eliminate most of the double tax.
"The treaty contains a credit provision (Article XXIV) for the
elimination of double taxation. In general, the United States and
Canada both allow a credit against their income tax for the income tax
paid to the other country on income from sources in that other
country. ...See paragraphs (4) and (5) of Article XXIV for certain
provisions that affect the computation of the credit allowed by the
United States forCanadian income taxes paid by U.S. citizens residing
in Canada."
http://www.irs.gov/pub/irs-pdf/p597.pdf
Article XXIV
http://www.intltaxlaw.com/treaties/canada/treaty.htm#CaArticle XXIV
"Paragraphs 4 and 5 of Article XXIV of the Convention provide double
taxation relief rules, for both the United States and Canada, with
respect to U.S. source income derived by a U.S.citizen who is resident
in Canada. These rules address the fact that a U.S. citizen resident
in Canada remains subject to U.S. tax on his worldwide income at
ordinary progressive rates, and may, therefore, be subject to U.S. tax
at a higher rate than a resident of Canada who is not a U.S.citizen.
In essence, these paragraphs limit the foreign tax credit that Canada
is obliged to allow such a U.S. citizen to the amount of tax on his
U.S. source income that the United States would be allowed to collect
from a Canadian resident who is not a U.S. citizen. They also oblige
the United States to allow the U.S. citizen a credit for any income
tax paid to Canada on the remainder of his income."
http://www.irs.gov/pub/irs-trty/canatech.pdf
So on your Canada return you'll take a credit for US tax paid on the
US-source income, and on your US return you'll take a credit for
Canada tax paid on your non-US-source income.
In other words,
"Liability for U.S. income tax is based on citizenship, as well as
residence. As a U.S. person, you must file annual U.S. income tax
returns regardless of where you live or how long you have been away
from the U.S. For U.S. tax purposes, you must report your worldwide
income from all sources. You can, however, claim a credit against your
U.S. tax liability for taxes you pay in Canada or where the income is
earned. In many cases the credit will be enough to eliminate any U.S.
tax liability, since Canadian taxes are generally higher. However,
because of the U.S. alternative minimum tax, in some cases there may
be an additional U.S. tax liability that can't be eliminated with a
foreign tax credit claim. Note that other non-tax information
reporting requirements may also apply.
"Canadian tax law will limit foreign tax credit claims allowed to U.S.
persons. It is Canada's position that foreign tax credits will only be
permitted for taxes that would be paid by Canadian residents (non-U.S.
persons) in a similar situation. This may result in additional tax
costs for U.S. persons living in Canada."
http://www.bdo.ca/en/library/publications/taxpub/taxbulletins/taxconseqforusinca.cfm
Search terms used:
canada income treaty site:irs.gov
canada income treaty "us citizen" example credit
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