As the wave of baby boomers start to retire and have more free time, one’s thoughts might be spent more on travelling than ever before. Whether it’s a Mediterranean cruise, scuba diving in the Caribbean or just exploring our neighbours to the south, one desire for many Canadians is to escape our winter’s bitter cold. A common way for many Canadians to do so is by going the ‘snowbird’ route and spending their winters in the southern United States. However, what is less commonly known is that a Canadian resident that does not have a U.S citizenship, green card or even any U.S.-source income may, nonetheless, be subject to U.S. income tax on their worldwide income by being deemed a resident alien of the U.S. The Internal Revenue Service (the “IRS”) may make this determination if it believes that you have a ‘substantial presence’ in the U.S.
So, Do I Have a Substantial Presence in the U.S.?
In order to determine whether you have substantial presence, the IRS applies a two-stage formula:
- Stage 1 – did you spend at least 31 days in a year in the U.S.?
- Yes – move on to stage 2, or
- No – you are not a resident alien subject to U.S. income tax.
- Stage 2 – calculate your physical presence by adding up:
- all days spent in the U.S. during the current year,
- 1/3 of days spent in the prior year, and
- 1/6 of days spent in the second prior year.
If you’ve spent at least 31 days in the U.S. and your calculation for stage 2 is at least 183 days, the IRS will consider you to have a substantial presence in the U.S.
Fortunately, for purposes of the substantial presence calculation, not every time that you take a step into the U.S. will necessarily be counted as a day in the U.S. Your days will not be counted towards having a substantial presence if you’re:
- a Canadian professional living near the border and commuting into the U.S. for work,
- passing through the U.S. while in transit to another country, such as due to a flight stopover,
- unable to leave the U.S. due to medical reasons, and
- in the U.S. as a teacher, trainee, student, crew member of a foreign vessel, or professional athlete participating in a charitable sports event.
I Don’t Meet any of the Exceptions, so now I Owe U.S. Tax? This Seems Asinine
You’re right it is asinine! Thankfully, the IRS allows individuals to maintain their non-U.S. resident status, thus avoiding being subject to U.S. income tax, by filing Form 8840 – Closer Connection Exemption Statement for Aliens (“Form 8840”). To be eligible for filing Form 8840, a Canadian must have:
- spent fewer than 183 days in the U.S. in a calendar year,
- a tax home in Canada (main place of business/employment, or where an individual lives for a majority of the time), and
- have a closer connection to Canada than to the U.S. during the year.
The IRS will make a determination on your closer connection status based on the answers you provide on Form 8840. These questions are meant to determine where your main personal and work activities take place, and consist of questions such as where is your permanent home, where does your family live, in what jurisdiction are you registered to vote, where are you financial accounts located, among others.
In the majority of cases, Canadians that are simply vacationing in the U.S. for personal reasons will likely be exempted from U.S. income tax due to the closer connection exemption. If you do meet the closer connection exemption to the substantial presence test, you should be filing Form 8840 with the IRS by June 15 of each year to establish your exemption from U.S. income tax.
As a final point, we would strongly advise against “taking your chances” with the IRS. The Canada and the U.S. have a strong commitment to share border crossing information. Furthermore, the IRS has significantly more resources than the Canada Revenue Agency, and if you come up on their radar, the IRS will find you. Instead, if you’re concerned about having exposure to U.S. income tax, come see us at HSS and we’ll make sure you don’t fall into any of the IRS’ traps.