Good News For Canadians Preparing US Taxes?

Baloo the IRS

Many Canadian tax preparers have historically offered US tax preparation as part of their overall service to their clients. Some have developed an expertise in the area, taking courses and keeping up with changes in the law. Others are less competent, filling out the forms using guides or computer software without really developing a professional working relationship with the IRC Code.

The situation in the US is no different. Tax preparation is a service that was never historically regulated in the US (or in Canada for that matter)…until, in 2011 the IRS instituted their Return Preparer Regulations , requiring all tax return preparers to register, pay a fee and apply for a Preparer Identification Number (PTIN).

This move effectively put many Canadian tax preparers into a quandary. Should they comply with the regulations, which include submitting to competency tests and continuing education, or simply leave US tax preparation to the US CPA’s and registered tax preparers.

Well, that question may be put on hold for now. In a recent court decision, the IRS was held to be overstepping its bounds with its regulations. Three independent tax preparers went to federal court to challenge the IRS and its policy of regulating tax preparers and won.

As the law stands today, the IRS does not have the right to require tax preparers to comply with their regulations. This week the IRS released a statement with regard to the court decision which it must respect for now. However, they are seeking an injunction and will be appealing the decision within the next 30 days, so it remains to be seen how long-lived this victory will be.




US Residency for Canadians

Oops! Are you Canadian spending too much time in the United States? Then you may be considered a U.S. resident according to the IRS. The U.S. has certain rules which may deem you to be a resident there for income tax purposes based on the number of days you were present in that country.

Just like the sojourner rule in Canada, if you were present in the U.S. for 183 days or more in a calendar year, you are considered a resident for the full year, and may be subject to tax on your world income.

If you are a Canadian resident as well according to Canadian rules, then you must look to the Canada-U.S. tax Treaty’s “tiebreaker rules” to see which country has the right to tax you. But even if the Treaty determines you are a Canadian resident, you must still file a U.S. non-resident income tax return (Form 1040-NR) and claim treaty protection (Form 8833).

Apart from the 183-day rule, there is a second rule known as the “substantial presence test” that could categorize you as a U.S. resident. This test is also based on the number of days you spend in the U.S. You pass this test (or maybe fail is a better word) if you were physically present in the U.S. for 31 days or more in the year, and if the total number of days in the U.S. is 183 or more, using the following formula:

  • Total number of days spent in the year, plus
  • 1/3 the number of days spent in the previous year, plus
  • 1/6 the number of days spent in the second previous year.

As a result of this formula, it is possible that you may be considered to be a resident of the US in a particular year even if you were present in the US for less than 183 days in a single year.

If you meet the above substantial presence test, but were not present in the U.S. for 183 days in a single year, you could be considered a non-resident if you claim the “closer connection” exemption. This would enable you to avoid filing a tax return, but you would still be required to file form 8840 to claim the exemption. This form must be filed by June 15 of the following year.

What’s Your Tax Issue? – Sale of US Real Property

The Tax Issue:

I am a Canadian resident about to sell my property in California. The escrow company will hold 10% of the sale price $300,000 until I complete a W-7 form.  Is there another way of not having my taxes withheld or is this the route I must take to get back that $30k.

I bought the house for $255k and put $15k in it, therefore after sale expenses commissions and such I really only gained about $7k so should not have to owe $30k?

The Answer:

The 10 percent withholding tax, or as we tax geniuses call it, the Foreign Investment in Real Property Tax (“FIRPTA”) is an obligation of the buyer, when a non-resident alien (“NRA”) disposes of  US real estate. If the buyer fails to withhold or remit, he or she may be liable for the tax. The FIRPTA withholding tax is not your actual tax liability but rather a mechanism to assist collection of tax from an NRA.

Amounts to be withheld under FIRPTA are based on the gross proceeds but can, however, be adjusted if you go through the procedure of seeking a withholding certificate from the IRS (Form 8288-B). If a certificate is issued, the withholding will be recalculated, and it will be based on your net gain, rather than on the gross proceeds.

Whether or not you go for the withholding certificate,  you will be required to file a US income tax return (Form 1040NR) to report the gain on the sale, and either pay additional tax if the FIRPTA withholding did not sufficiently cover the US tax liability, or claim a refund if the FIRPTA withholding was in excess of the actual US tax liability.

The first step in either case is for you to obtain a US tax identification number and that’s where the W-7 comes in.

So after reading this, if it sounds like you should seek a US professional to help you out, then I’ve done my job!

Rolling the Dice With the IRS

Contrary to popular belief, only thirty percent of what happens in Vegas, stays in Vegas.

Now we come to one of my favourite topics: Gambling. Like most people, I love gambling, except for the times when I hate it. It’s a complicated relationship.

One thing that’s never happened to me is winning big money in the United States (or anywhere for that matter). Here in Canada gambling winnings are generally tax-free. End of story. Not so simple down south.

Me and poker pro Gavin Smith at a Montreal charity tournament

Many Canadian winners at the casinos in Las Vegas or New Jersey are shocked to discover that the IRS gets a cut of their take. In fact, a 30% withholding tax applies to most gambling winnings by non-resident aliens. There are a few exceptions – no tax applies to winnings from blackjack, baccarat, craps, roulette, or big-6 wheel.

The next obvious question is, can a Canadian winner get back any of this U.S. tax withheld? Maybe. But you’ve got to be a bit of a loser and a great record-keeper to do so. (This doesn’t mean you’re a loser if you keep good records, just a bit anal. :-))

Canadians can deduct their gambling losses from their gambling winnings for the year to reduce the amount of U.S. tax payable. The deduction allowed is only for losses incurred in the same year as the winnings. In other words, you cannot claim accumulated losses from previous years.

In order to make the claim you must file a non-resident personal income tax return (Form 1040-NR), report your gambling winnings (excluding the activities where no tax applies), and deduct your losses as an itemized deduction. Unless you’re a pro, your net gambling winnings will be subject to the flat 30% tax rate.

You must be able to substantiate your losses for the year. Therefore, you should always keep your receipts, tickets, statements or other records that will prove how much you’ve lost during the year.

Good luck!!

Earl Jones Victims Get A Raw Deal From CRA

The latest news that the victims of Earl Jones are now about to suffer even further at the hands of the CRA comes as no surprise to me. Back in August, in the very first issue of The Tax Issue, I speculated on the possibility that these taxpayers might be in for a bit of a shock around tax time. Lo and behold, I was right.

You see, the investors are caught in an unfortunate Catch-22 situation. They made an investment which was supposed to earn them income – a hefty return on their money. Theoretically, these “phantom earnings” were reinvested, although we now know they were used to support the Earl Jones pyramid.

In the real world, investment income such as dividends that are reinvested are still reported on a T5 slip and investors must pay tax on them, even though they don’t see the actual cash. What happens to it? Well, the reinvested earnings get added to the capital cost (ACB) of the investment.

So, here comes the Catch-22. Either the victims pay tax on their phantom earnings, add it to their ACB and claim a capital loss on their invested capital, as I suggested in my August article, or they go with the theory that this was a  fraud from the start, in which case there was never any investment income. In this case, because the investment generated no income, the capital that was lost cannot be taken as a capital loss. However, would the CRA accept that the income was never earned, and allow the victims to claim refunds for 2009 and previous years?  I imagine that will be the topic of the discussions coming up this week.

In a 1991 statement, the CRA concluded that an investor who suffers a loss due to fraud may be entitled to claim a capital loss if certain criteria are met. This makes me think that this is the position the CRA will take here. However, a capital loss may not be of much use to these victims. Capital losses can only be deducted against capital gains, not regular income. While they may be carried forward forever, it may be a while, if ever, before these taxpayers are in a position to generate capital gains and actually benefit from these tax losses.

Contrast this Canadian quagmire with the U.S. victims of fraudsters such as Bernard Madoff. On March 17, 2009, the IRS released a clear and generous tax relief package for these taxpayers. They are allowing the victims of fraud to claim the total of their capital and their reinvested phantom income as “theft losses”, which are fully deductible and may be carried back and forward against all other types of income, thereby generating tax refunds.

Update: In an announcement on March 3, 2010, the Quebec Minister of Revenue has stated that Quebec will, in fact, be granting relief to the victims of the Earl Jones and similar frauds. This relief mirrors somewhat the package offered by the IRS. The victims will be allowed to deduct all phantom income not received from their investment in their 2009 returns. Should this deduction create a loss, it will be considered as a “non-capital loss”, and will be therefore available to be carried back to any of the 3 prior tax years and forward 20 years. No statement was made concerning the loss of capital invested.


The Tax Issue:

I was wondering If I earn money offshore and do not repatriate any of it back to Canada do I have to pay tax on it. (i.e. Work, Investments, etc…)?

The Answer:

The short answer is YES!

With all the talk recently about UBS, offshore bank accounts and tax evasion, this question comes at a crucial time for any Canadian taxpayer with funds offshore.

Generally, if you are a Canadian resident, you are obligated to declare and pay tax on your world income. So, if you go off to Dubai and earn revenue as a systems consultant there for a few weeks, deposit the funds in a Swiss bank account and never bring the money into Canada, you are still obligated to report the income earned on your Canadian income tax return for the year.

Similarly, any investment income earned while that money sits in an offshore account is taxable in Canada as it is earned.

If the income is from employment, and you meet certain criteria, you may be eligible for an overseas employment tax credit to be deducted on your return. You should consult your tax advisor if you were employed on a long-term project offshore at any time in the year.

The Canadian system operates on the basis of residency alone. So, if you leave Canada permanently, you will no longer be subject to Canadian income tax from the time of departure. As a non-resident you will generally not be subject to tax in Canada, even if you are a Canadian citizen.

So, if you’ve read my previous post on the UBS affair and how it affects us here in Canada, you should be aware that any funds deposited in any offshore account that contains proceeds from taxable earnings you derived while a resident of Canada is subject to the scrutiny of the CRA at any time.

Update: See the case of Bensouilah v. MNR (2009 DTC 1327) for an illustration of Canadian resident taxpayer failing to report employment income earned in Saudi Arabia.


What’s all this commotion about UBS? Well if you’ve been out of the loop or simply hiding your head in the sand every time you hear those initials, then it is now officially time to wake up.

First, a bit of background. Around a year ago, a former UBS banker named Bradley Birkenfeld came forward to report illegal tactics by the giant Swiss Bank. UBS was luring big money investors to deposit undeclared income in their bank with promises of the famous Swiss secrecy laws. Birkenfeld was a party to a deposit of $200 million by U.S. billionaire Igor Olenicoff, who was convicted, and required to pay $53 million in taxes and penalties.

The IRS is looking into peoples affairs

The IRS is looking everywhere for offshore bank accounts

The IRS pulled a bit more on the thread. They discovered that a special office over at UBS would regularly make trips to North America to lure big time investors. A part of this office was known as the “Canada Desk”. It is estimated that Canadian investors have deposits of more than $5 billion at UBS.

Why all the Fuss This Week?

The IRS has been trying to get UBS to disclose more names and until last week, has been stonewalled by the bank, who claims it would run afoul of Swiss secrecy laws. On August 19, the Swiss government agreed to loosen those laws in order to cooperate with the IRS. As a result, UBS is now required to hand the names of 4,450 of its biggest U.S. depositors to the IRS.

And it’s only the beginning. In IRS commissioner Doug Shulman’s words “This issue is not going away, and people hiding assets and income offshore will find themselves increasingly at risk due to our efforts in this area.”

What about us poor folk north of the border?

The CRA is chasing after this gravy train like a dog after a truckload of Gravy Train. Revenue Minister Jean-Pierre Blackburn is in a tizzy over Canada’s weak enforcement laws and is recommending major changes to the law to help trace the movement of funds offshore. Lawyers for the CRA are reportedly heading off to Switzerland for “discussions” with UBS officials.

From a Canadian perspective none of this seems to have hit home just yet. To date only seven people have come forward to report their offshore activities. But if more taxpayers intend to do so, they shouldn’t wait too long. The voluntary disclosures program in Canada is designed to give some relief to taxpayers who come forward prior to being investigated. So, if a name is divulged to the CRA and an investigation ensues, no relief will be available.

What kinds of consequences do Canadians face? Tax evasion can come with a two-year prison sentence and fines of more than 50 percent of the tax owing, plus interest compounded daily. Canadian taxpayers are required each year to report their offshore deposits if they exceed $100,000. Failure to file this form can lead to fines of up to $24,000 per year.

Americans have a quick decision to make. The IRS has set up a special framework for voluntary disclosures relating to offshore activities, but this framework has a short life span. If they do not come forward by September 23, taxpayers may face the full force of the law, including possible criminal charges. Here in Canada, the problem is not so urgent, but now would seem to be a good time to think about getting your ducks in a row.

Oh, and one more thing – if you are a professional advisor, you should be aware that our friend, Mr. Birkenfeld was sentenced to 3 years in prison for setting his client up with his UBS account. So don’t say I didn’t warn you.