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Posted on May 28, 2013

A Beginner’s Guide to Foreign Tax Credit

Written by Avner Polatsek | @AvnerPolatsek

foreign currency

If you’re new to living in Canada and are a US citizen, you might not know the details of the Canada – US Tax Treaty. This doesn’t seem like a subject the average person needs to be well versed in, but if you’re a US citizen living in Canada, you should get familiar with the way these neighbours have worked out their relationship.

The main benefit to knowing about the treaty is so that you don’t pay double the taxes you owe and also that you don’t unintentionally neglect to file certain forms and have to pay fines. No one wants that!

The Canada – US Tax Treaty was signed in 1980 and can be used as guideline for how to make sure that your taxes are correct in both countries. (Note: You do need to file in both Canada and the US.)

The Big General Rule

If you’re a US citizen living and working in Canada, you will be paying Canadian taxes for the money you earn in Canada. The Canada – US Treaty allows the taxes you pay in Canada to be deducted from the taxes you would pay in the US, lowering the possibility of you being taxed twice on the same earnings. This is known as the Foreign Tax Credit.

Qualify for the Foreign Tax Credit:

According to the IRS, You can only claim income tax you’ve paid to Canada as a Foreign Tax Credit if:

  1. The tax was imposed on you.
  2. You paid or accrued the tax.
  3. The tax is the legal and actual foreign tax liability.
  4. The tax is an income tax (or a tax in lieu of an income tax).

What do I need to do?

If you would like to claim a foreign tax credit (which shows that you paid taxes in Canada and don’t want to pay them again in the US), you’ll need to complete Form 1116 and attach it to your US tax return. You could also claim Canadian taxes as an itemized deduction.

It’s always best to talk to a tax professional before completing and sending these forms, as there might be exceptions or other rules to consider.

There is a limit!

When you file a foreign income tax credit, there is a limit to how much foreign tax you can receive a credit for. Fortunately, you can carry forward unused foreign income tax for 10 years.

Documents to hold onto:

If you plan on claiming a foreign tax credit, you’ll want to keep copies of:

  1. Your foreign tax payment receipt
  2. Your foreign tax return
  3. Any payee statements showing that you had foreign taxes reported to you.

Other items of interest from the US – Canada Tax Treaty

US Social Security

US social security paid while you’re a Canadian resident is taxed in Canada as if they are a part of a Canada Pension Plan. US citizens will have 15% of this benefit exempt from Canadian tax.

Alimony

Alimony or child support payments made by a Canadian source to a US citizen are tax-exempt, just as they would be in Canada.

The US – Canada Tax Treaty and the Foreign Income Tax Credit can save US citizens living in Canada significant money and should be taken advantage of. That being said, when you’re claiming any credit, you should make sure that you are following all of the laws. The best way to ensure that you’re filing any tax return correctly is through the guidance of a tax professional.

Contact us if you would like any help claiming your Foreign Tax Credit!