Canadian citizens who have not inadvertently become US residents must still pay certain taxes in the US. What sort of taxes are these? First, remember we are assuming the Canadian citizen merely visits the US frequently, but at no point becomes a US resident. There are 2 basic types of categories of income to consider: (A) income effectively connected to a US trade or business; and (B) income not effectively connected to a US trade or business, but stemming from a US source.
Effectively Connected to a US Trade or Business
What does it mean to have income “effectively connected to a US trade or business”. If a non-US resident conducts a US trade or business, the effectively connected US income is taxed in the same manner as business income of a US citizen-resident (i.e., standard ordinary US income rates (currently 35% maximum federal rate for an individual, but with normal deductions available as well)). There exists very little guidance as to what it means to be engaged in a trade or business (see IRC Section 864 generally). For example, a non-US resident individual merely collecting interest or dividends from a US payer is likely not engaged in a US trade or business. However, if a foreign taxpayer conducts US business activities through an office located in the United States, that may rise to a US trade or business. When sales of products are consummated in the US, they are generally effectively connected to a US trade or business. Although there is no bright-line test, the threshold for conducting business in the US is low, so typically some business conducted in the US will qualify as effectively connected income.
Noneffectively Connected Income But From a US Source
Non-US resident citizens are also taxed on their noneffectively connected income, provided the income is US source income. There is a big difference in the tax treatment of effectively-connected income (to a US trade or business) versus noneffectively connected income from a US source. Canadians with income effectively connected to a US trade or business are generally treated like US citizens (income at ordinary US rates plus deductions). But for non-effectively connected income, the general rule provided in under IRC Section 871(a) is that the nonresident is subject to a flat 30% tax on US source income (no deductions available here). However, the US-Canada Treaty (as do many US tax treaties) generally reduces the rate on many types of US source income. The various types categories of income addressed in the treaties (subject to the flat tax lowered by the treaties include the following):
1) Interest income
2) Dividend income
3) Rents (watch the distinction here between rents connected to the active management of property (ie, effectively connected to a US trade or business taxed at ordinary US rates) versus the passive receipt of rent, subject to the flat tax and the lower rate provided by the treaty.
4) Pensions and other Retirement Plan Distributions
5) Capital Gains
6) Income from services performed in the US (almost always deemed effectively connected to a US trade or business and taxed at ordinary US rates).
We discuss each of these categories individually, and the US-Canada Tax Treaty treatment of them, in the next post……