Matriculating Abroad: Canadian Students in America

Good morning Toronto! While we do some things similarly to the United States, our neighbours to the south approach taxation quite differently regarding taxes! Today's article aims to provide a comprehensive overview of the US tax system, residency status, and provisions of the Canada-US Tax Treaty, highlighting key considerations for Canadian residents that intend to study in the US.

The US tax system uses several distinct terms from the Canadian tax system, which are summarized below:

A significant variation between our tax systems lies in determining tax residency and liability. For example, if any Canadian resident maintained sufficient residential ties to Canada when absent (assuming they did not avail of any tie-breaker clause), they would be considered a factual resident and fully liable for all worldwide income. In other words, the Canadian tax system is blind to immigration status in considering tax liability. In contrast, citizenship or residence in the US determines tax liability. We shall consider the following statuses:

• US Citizens (USCs)
• Resident Aliens (RAs)
• Non-Resident Aliens (NRAs)

The US is one of two countries in the world that operate a citizenship-based taxation regime — the other being Eritrea. The effect of this regime is that US citizens are treated as US tax residents. A USC will NEVER be treated as a non-resident, barring renunciation of citizenship. US citizenship is conferred on a jus soli basis, meaning that any individual born in the US — regardless of the parents' status — are USCs.

Under US law, an 'alien' is anyone who is not a US citizen. An alien is a US resident if they meet either of the below tests:

• Green Card Test (GCT): Held Lawful Permanent Residence (LPR) status at any point during the year.
• Substantial Presence Test (SPT): Spent at least 31 days in the US in the current year AND a weighted total of 183 days over the current year and the two preceding years.

In the context of this article, any individual who holds a student visa (i.e. F-1 status) is considered an exempt individual for the SPT. Thus, students will be considered to be 'Non-Resident Aliens (NRAs)', who are taxed only on US-source income.

USCs and Resident Aliens are taxed in the same manner, both being liable to tax on all worldwide income. In addition, USCs and RAs living abroad are subject to extensive reporting requirements. First, if the aggregate (combined) value of all bank accounts is over US$10k at any point during the year, the taxpayer must file a Report of Foreign Bank and Financial Accounts (FBAR). Furthermore, those holding financial assets that have an aggregated value of over US$50k must file an information return with the IRS under the Foreign Account Tax Compliance Act (FATCA). FATCA also compels foreign governments and foreign financial institutions to report accounts held by USCs and RAs to the IRS.

While Canada also requires its own tax residents to report foreign assets if their cost of acquiring the asset is over CA$100k under the T1135/T1134 regime, FATCA is significantly more far-reaching due to its arguable intrusion on the sovereignty of foreign jurisdictions. To that end, the powers of the US expand to its tax treaties. As discussed in Matriculating Abroad: Understanding Canadian Tax Residency, tax treaties have tie-breaker rules which aim to deem an individual who would be considered a tax resident in two jurisdictions to be resident of only one for taxation purposes. With respect to the Canada-US Tax Treaty (herein referred to as the 'Treaty'), Article XXIX(2) provides that:

Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing [the US] from taxing [...] its citizens [...] as if there were no convention between the United States and Canada with respect to taxes on income and on capital.

This 'saving clause' of the Treaty specifically prevents USCs from claiming tie-breaker provisions which may assign residency to Canada. This means that a US citizen residing in Canada would, in effect, remain resident in both jurisdictions and be subject to tax on their worldwide income in both jurisdictions.

To reduce double taxation, both Canada and US allow for Foreign Tax Credits (FTCs), a dollar-for-dollar credit against income tax for ANY foreign income taxes paid.

Canadian students studying in the US will likely have three types of income:

• Employment income
• Scholarship/fellowship income
• Educational Assistance Payments (EAPs) from an RESP

Generally, NRAs have more recourse to claiming exemptions over USCs. Canadian employment income will only be taxed in Canada, as NRAs are only taxed on US-source income. US employment income is generally taxed at the usual federal graduated tax brackets in the US. However, if the taxpayer made less than US$10k in a year across all employers, then Article XV(2)(a) of the Treaty provides that this income will be totally exempt from US taxation. To avail of this provision, a taxpayer must file a 1040-NR return and also use Form 8833 to disclose the Treaty-based benefit. Such US employment income, regardless of meeting XV(2)(a), is taxable in Canada.

Unlike Canada, where scholarships are tax-exempt for full-time students, US law establishes that a scholarship's tax liability depends on what portion of the scholarship is for qualified (education) or non-qualified (living) expenses. Only the non-qualified portion is taxed, at the usual graduated tax brackets.

Finally, given RESP EAP payments resolve from Canadian financial institutions, they are tax-exempt in the US for NRAs.

In contrast, a Canadian resident who is a US citizen studying in the US would not be able to avail of many Treaty provisions due to the savings clause. With respect to foreign scholarship income, Internal Revenue Manual 21.8.1.12.17 provides that if a scholarship's terms are unclear AND it is used for tuition expenses, it shall be treated as tax-free. To that end, it is extremely advisable to keep a record of what the scholarship funds were spent on to ensure against a potential audit.

In all, the rules surrounding Canada-US taxation are extremely convoluted. In these cases, having professional advice can be crucial in fully understanding your rights and responsibilities in each country. In the next article, join us as we discuss the implications of Canada-UK taxation.

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