Frequently at gatherings I'm asked tax questions related to Canadians and their tax issues in the US. At a recent holiday gathering, a nice gentleman, who is a terrific interior designer in Calgary I believe, asked about the possibility of doing some interior design work for Canadians who also had a second home in California (most likely in the Palm Springs area). So he asked me, if he did some interior design work for Canadian customers in their California homes, would he be subject to US (and California for that matter) tax?
A terrific question, so let's review....
First, Is it a Big Deal if the Canadian has to Pay US Tax to Do Business in the US? I Don't Think So...
Personally, I don't think it is a big deal if a Canadian, who wants to conduct business in the US, has to pay tax in the US. The US and Canada have a very progressive tax treaty with each other, and there is a tax credit system honored by both countries. So let's start with this premise: just because the Canadian may pay tax in the US on the business income does not mean he or she will have to pay a double tax (once in the US and once in Canada) on the same income. Most likely, because of the treaty and credit system, the Canadian doing business in the US will pay no more federal tax than if he or she were doing business in Canada, they just might now pay some of that tax to the US government instead of the Canadian government. So the Canadian should not let fear of additional taxes stop he or she from doing business in the US, because there probably won't be much (if any) extra federal taxes for doing business in the US. There maybe an additional state tax to the state of California, however, because there is no Canadian tax credit available for state taxes.
Second, the Canadian doing Business in the US May Need to Enter the US on a Different Visa.
Most Canadian snowbirds are in the US as tourists - for fun and recreation. They can stay up to 6 months a visit, just by showing their passports at the border. But this is for tourism, not for business. If you're going to be doing work in the US, you don't want to lie to the border guards. And so, the Canadian snowbird who wishes to do steady work in the US may wish to apply for the E-2 Visa, so as to be able to work regularly in the US without problems. A project or two in the US, maybe don't worry about a new visa (although you may be a little nervous at the border). Consistent and regular work in the US, the Canadian should consider applying for the E-2 Visa.
What are the General Rules on When Any Non-US Resident is Subject to Tax in the US?
Under UStax law, a Canadian (or any non-US resident) is subject to US federal tax if they have income that is "effectively connected with the conduct of a trade or business within the United States". This is an ongoing test, which means that if you carry on a trade or business in the US at any time in the year, you will be subject to US tax for that particular year. If you are engaged in a US trade or business, you will be taxed in the US at graduated rates on a net basis on income that is effectively connected with the conduct of that US trade or business. The good news is, the non-US resident will be allowed to claim deductions to reduce the effectively connected income, but only to the extent that the deductions are connected with that income. The ability to claim the appropriate US deductions can keep the US tax element quite reasonable.
How Can We Tell if We Have Income Which is Effectively Connected with the Conduct of a Trade or Business within the United States?
There is no clear answer to this question, it comes down to facts and circumstances test. The level of activity required for effectively connected to a "trade or business" status in the US is relatively low. The following situations could mean that you are subject to US tax (again, these examples are for any non(US) resident alien, we will consider how the US-Canada Treaty loosens these rules for Canadians in the next post) :
A) If the nonresident alien makes sales into the US market, he or she may have a U.S. trade or business. If, however, he or she is merely accepting unsolicited purchase orders from US customers, will probably will not be considered to be carrying on business in the US.
B) The nonresident alien may be considered as having a US trade or business if he or she has employees or agents travel regularly to the US to make sales calls or if your employees or agents are doing marketing, demonstrating goods, or soliciting orders in the U.S.
C) If the nonresident alien (or his or her employees and/or independent contractors) performs employment or self-employment services in the US, they are likely considered to be carrying on a US trade or business. For example, if the non US resident alien goes to the US on consulting contracts and work at customer sites, he or she will likely be considered to have a U.S. trade or business.
Note, this last example (Example C) seems to clearly indicate our Canadian interior designer will be subject to some US taxes for doing interior design work for houses located in the US. And once again, except for the fact that the Canadian interior designer may wish to obtain a different Visa (probably the E-2), this should not be a big deal (at least for total federal taxes owed, whether to Canada alone or to Canada and the US). But does our Canadian interior designer really have to declare income in the US, or does the US-Canada Treaty offer relief from the general rules? We will look more closely at this in Part 2 of this series....