Paid in America

More and more, international corporations are posting employees to locations within the organization where they are most needed, regardless of the jurisdiction in which the opportunity presents itself.

“It’s definitely a growing area,” says Jerry Alberton, a tax partner with PricewaterhouseCoopers LLP in Toronto. “There is a lot of cross-border movement of employees, in both directions. If companies have a need on a particular project, they want to move the [most appropriate] person for a period of time, then move him or her back home.”

Self-employed individuals also are increasingly finding interested buyers for their products and services beyond our domestic borders. Depending on the circumstances of the service provided – for example, if some of the work involves travelling to the U.S. – such business with U.S. buyers may lead to U.S. tax obligations.

For your client, a variety of factors – such as the number of days in a year spent working and living in the U.S.; whether the client is an employee or an independent contractor; and whether he or she is said to have created what U.S. tax law refers to as a “permanent establishment” (PE) in the U.S. – will ultimately determine the kind of U.S. tax obligations your client will have.

“The worst-case scenario is that [your client] may have to actually pay taxes to the U.S. government,” Cestnick says. “But if he or she does, there is a tax credit available in Canada for the taxes paid to the U.S.”

Any individual or corporation that carries on a trade or business in the U.S. could have an annual obligation to file a U.S. tax return. Making sales, shipping goods or providing services to the U.S., under certain conditions, can constitute carrying on a trade or business.

However, it is possible to obtain an exemption from U.S. taxes by filing a claim under the Canada/U.S. tax treaty, although the requirement to file a U.S. tax return still exists.

Of course, any Canadian client who does work in the U.S. should be directed to seek professional cross-border tax advice. (Clients also should consult a U.S. immigration lawyer to ensure they have the right visa to work in the U.S. Keep in mind: if your client is a U.S. citizen or holds a U.S. green card, he or she has an obligation to file a U.S. tax return on worldwide income every year, even if he or she doesn’t live or work in the U.S. at all.)

Here are a few U.S. tax-related issues that you, as an advisor, should keep in mind if any of your Canadian clients earns part of his or her income in the U.S.:

– PERMANENT ESTABLISHMENT

A PE is considered an effective place of business in the U.S., and could include an office, a factory or a construction project.

If a PE has been created, there is an obligation on the part of your Canadian client to file a U.S. tax return, as well as a number of other relevant U.S. tax forms. Any income related to that PE is subject to taxes in the U.S.

There is no exemption under the treaty.

– “SUBSTANTIAL PRESENCE” TEST

A primary consideration is the number of days your client spends working in the U.S., which always should be tracked.

For a self-employed individual, a key metric is the “substantial presence” (SP) test. This test involves adding together all the days spent in the U.S. in the current year, one-third of the days in the previous year and one-sixth of the days in the year before that. If that total exceeds 183, the individual is considered to be a U.S. resident for tax purposes, meaning that not only must that individual file a U.S. tax return, but he or she generally can no longer apply for exemption from U.S. taxes under the U.S./Canada tax treaty. However, there would be a credit available on his or her Canadian return for the foreign taxes paid, so double taxation generally can be avoided.

In addition to having to file a U.S. return and losing the treaty exemption if the SP test applies, there are a number of other possible U.S. tax-filing requirements, including the obligation to file a U.S. foreign bank and financial accounts form, which requires a U.S. tax resident to report any account held in a foreign financial institution. There may be an additional requirement to declare all foreign financial assets (U.S. Internal Revenue Service [IRS] Form 8938).

For an employee of a company, the key number is generally 183 days in any 12-month period. An employee who works in the U.S. in a given year beyond that number of days could be considered to have established a PE for his employer in the U.S., according to the tax treaty. That means potential U.S. tax liability.

“There’s a lot of paperwork that has to be filed if you go over the 183-day mark,” Alberton says, “particularly if the person has investments in Canada that exceed certain thresholds. The most important thing that a person should be aware of is to keep track of how many days he or she is spending in the U.S., and to try to keep it under 183. If you’re under 183, the individual may still have to pay U.S. taxes, but it’s far simpler.”

A client who falls below the 183-day threshold still has to file a U.S. tax return, but also could file a Form 8833: Treaty-Based Return Position Disclosure with the IRS to get relief from U.S. taxes under the tax treaty.

– EMPLOYEES

When Canadians are sent by their employers to work in the U.S., often some of the logistical concerns regarding the U.S. assignment – such as a work permit, taxation issues and payroll deductions – are looked after by the employer. Or the employer will provide advice and assistance.

“Some companies will keep their employees on Canadian payroll and take care of the U.S. payroll taxes for them,” Alberton says. “[The employer will] help with the tax return, and make sure the foreign tax credits get claimed. Then, the company gets reimbursed for the taxes that they advance on the employee’s behalf.”

Nevertheless, it is important for your clients in these situations to keep track of the number of days they are in the U.S., and to make sure they are aware of the U.S. tax obligations.

“Even if the company is taking care of you and you’re staying on Canadian payroll,” Alberton says, “you may still have U.S. filing requirements – particularly if you’re working in a state that doesn’t follow the tax treaty.”

– STATE TAXES

Some U.S. states, such as New York and Michigan, follow the Canada/U.S. tax treaty, meaning those states may grant an exemption from state taxes as well as federal taxes. However, in other states, such as California and Connecticut, which do not follow the treaty, there is no relief from paying those state taxes, although a credit for foreign taxes paid may be available on your client’s Canadian tax return. Some states, such as Florida and Texas, do not have state taxes, so no obligation exists in those jurisdictions.

It is possible for a Canadian employee on U.S. payroll to file a certificate to opt out of certain U.S. federal payroll taxes, such as those for social security and Medicare, which can represent US$7,000-US$10,000 annually for a high-income individual. However, that exemption is available only to either those Canadians who work for a Canadian company and who are sent to the U.S. to work for an affiliated U.S. company or to those who intend to work in the U.S. for less than five years.

“If you don’t think you’ll be in the U.S. for a long time, and you’re not likely to benefit from U.S. social security or Medicare down the line, then why pay into the system?” asks Terry Ritchie, director of cross-border wealth services in Calgary with Toronto-based Cardinal Point Wealth Management LLC. “It’s not uncommon for me to bump into Canadians who worked in the U.S. and paid these payroll taxes when they could have avoided them.”

In fact, your Canadian clients who work for companies that intend to assign them to the U.S. should look to their employers to provide them with as much assistance as they can get, including tax-return preparation.

“The cost of having tax returns completed [for both countries] is very expensive,” says Cestnick, who estimates the cost of preparing two returns for a high net-worth individual to be anywhere from $3,000 to $12,000.

“That’s a key thing for an advisor to recommend to a client,” he adds. “If [the client is] negotiating contracts [with his or her employer] to do work in the U.S., you want to build into that [contract] additional money to cover the costs of doing [both] returns.”

For a self-employed individual, the U.S. tax obligation will depend on factors such as the number of days spent working in the U.S., the nature of the work and whether he or she has created a PE in the U.S., which could give rise to a U.S. tax liability.

– WITHHOLDING TAXES

If your client is a Canadian contractor who is billing a U.S. client, he or she may have U.S. withholding taxes levied against the billing amount.

This tax is an amount assessed against the individual’s anticipated U.S. tax liability. If the contractor is merely working in the U.S. but hasn’t created a PE, it is possible to file exemption forms to avoid the withholding taxes.

If the withholding taxes have been assessed and paid, it still is possible to be reimbursed for the amount by either claiming a treaty exemption or filing a U.S. tax return and applying the amount of the withholding taxes against net income.

If the service provided for the U.S. company has been completed remotely in Canada, and no work has been done in the U.S. whatsoever, then no withholding taxes will be assessed. Such clients should state on their invoices that no services were provided in the U.S., Alberton says, adding: “And the U.S. company may ask you to fill out the exemption forms anyway.”

Again, depending, on the jurisdiction, there may be U.S. state sales taxes that must be assessed and remitted.

Cross-border tax experts suggest that Canadian clients who do business in the U.S. or are considering an eventual move to the U.S. seek professional advice.

Says Ritchie: “Clients should get a good idea of what they’re jumping into.”

Border Commuters

For those clients who work in the U.S. and commute home every night to their residences in Canada, some special rules may apply.

U.S. tax regulations state that those days on which Canadians travel to a job in the U.S. but return home on the same day do not count against the residency test calculation to determine whether the individual is a full U.S. tax resident.

However, a Canadian commuter may still have to file a U.S. return if his or her U.S. employer is paying the individual directly on a U.S. payroll. It would be up to that individual to claim the foreign credits for U.S. taxes paid on his or her Canadian tax return. If the individual is being paid by a Canadian company to work at a U.S. affiliate, filing a U.S. return still may be required, but he or she can file for relief from U.S. taxes under the Canada/U.S. Tax Treaty.

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