New tax on Americans working in Canada

U.S. net investment income tax to fund ‘Obamacare’

Effective Jan. 1, the United States introduced a tax called the Net Investment Income Tax to help fund the Patient Protection and Affordable Care Act (PPACA) — more commonly referred to as “Obamacare.”

This tax is equal to 3.8 per cent of an employee’s investment income if his total earnings are above the following:

• US$250,000 for a married couple filing jointly

• US$125,000 for a married person filing separately

• US$200,000 for a single taxpayer.

Generally, investment income is interest, dividends, annuities, rents, royalties and most net gains. It includes income from passive activities and does not include distributions from qualified retirement plans.

U.S. citizens working in Canada may incorrectly believe they are exempt from this tax because they are exempt from paying U.S. income tax while working in Canada.

However, this new tax is described as a “medicare contribution” — not an income tax.

U.S. citizens working in Canada may also believe they are exempt from the tax because of the Social Security Totalization Agreement, which is an agreement between the two countries designed to prevent workers and their employers from being subjected to owing payroll taxes to both the country in which they work and their home nation. The totalization agreement doesn’t specifically cover the Net Investment Income Tax. This tax is not dedicated to the Medicare Trust Fund and, as a result, might not be exempt from the agreement.

These employees may also believe that because their income is subject toCanadian tax, they get a foreign tax credit on their U.S. return and this process is merely a paper filing exercise only. However, it’s important to note the investment income could be generated from U.S. investments. One might think if the Canadian tax rate is high enough, then the employee will get a full Canadian foreign tax credit and the problem is eliminated. But if you live in Alberta or a territory, for example, the Canadian tax rate may be lower than the U.S. rate and the employee’s effective tax will now increase.

The problem can occur in other ways in the rest of Canada, as well. Sometimes income can be exempt from Canadian tax, but subject to U.S. tax. For instance, the Canadian real estate market has been in a healthy state for a number of years and the Canadian dollar has appreciated against its American counterpart.

When one sells a house, they may have a gain (measured in U.S. dollars) of more than $250,000 ($500,000 for a married couple). The excess is subject to regular U.S. tax and to this new tax — even though it’s exempt from Canadian tax.

The employee could also earn regular Canadian investment income.

If he’s in a province other than Alberta, the income is probably subject to Canadian tax at rates higher than those in the U.S. Under the Internal Revenue Code, there is no foreign tax credit allowed against this new tax. It is arguable that the tax treaty provides for a credit, but at this point, this position isn’t definite.

Kevyn Nightingale is a U.S. tax expert at MNP LLP in Toronto.

Latest stories