Paying tax once is definitely enough. Yet for those who live, work, or invest across borders, it is not that unusual to see the same income taxed twice. Such a situation—called double taxation—is a reality for many U.S. citizens living in Canada, Canadian residents with U.S. earnings, or businesses with operations in both countries. The good news is, it can generally be prevented.
What Leads to Double Taxation?
Double taxation occurs when both the United States and Canada (or any other country) claim taxing rights over the same income. The typical triggering actions are listed below:
- Holding U.S. citizenship while residing in Canada
- Earning Canadian income as a U.S. resident
- Working remotely across the border for a foreign employer
- Receiving cross-border dividend or royalty payments
Tools That Help Prevent It
Specific mechanisms exist to prevent individuals or establishments from being taxed twice. However, these need to be claimed in a proper manner. A cross-border tax accountant may present assistance in establishing the right path forward using the methods outlined below:
- Foreign Tax Credit (FTC): Allows a dollar-for-dollar credit on U.S. returns for Canadian taxes paid (and vice versa when applicable).
- Tax Treaty Benefits: The U.S.-Canada tax treaty has a determining feature on which country gets the right to tax certain income. In many specific cases, this lowers or fully eliminates tax in one of the jurisdictions.
- Foreign Earned Income Exclusion (FEIE): U.S. citizens abroad might exclude part of their foreign earnings if they fulfill eligibility tests.
- Accurate Forms: Applying the correct filings—like IRS Form 1116 for FTC or Form 2555 for FEIE—is fundamental. Skipping or misfiling leads to denial of credits.
Tax Treaty Benefits Are Not Automatic
The U.S.-Canada tax treaty contains provisions that have a limiting impact on withholding tax on cross-border payments—dividends, interest, and royalties as presented below:
- Dividends: typically 15%
- Interest: often reduced to 0%
- Royalties: commonly capped at 10%
These rates only apply if treaty benefits are correctly claimed—usually via the submission of a treaty form (such as IRS Form W-8BEN for non-residents). Without it, the maximum statutory rate could be withheld. Such a situation may cause cash flow delays or outright overpayment.
Key Takeaways
Avoiding double taxation necessitates a structured and timely as well as jurisdiction-specific approach. The following actions can be taken into consideration:
- Filing early to correct withholding errors
- Keeping records of all tax paid abroad
- Choosing the right tax credit vs. exclusion route
- Working with a cross-border tax accountant expert in foreign income tax planning
It should be acknowledged that tax filings across borders are rarely straightforward. Yet the right steps, which are taken in time, can result in considerable savings. You may consider contacting Dimov Tax for professional services in terms of avoiding double taxation and cross-border tax matters.