The domestic tax implications of living and working in one country are generally straight-forward. While there may be from time to time some complicating domestic tax issues, generally, with a bit of resourcefulness you don’t need to be a tax specialist to resolve the personal tax matter (although you may like to hand it off to a professional!).
When a Canadian resident individual working for a Canadian employer starts to work in the United States for that employer, the taxation issues associated with this activity become a little, and sometimes a lot more complicated to manage personally. While we often may think about the US federal tax implications of working in the US, often times the state and local income tax implications may be overlooked.
For purposes of our discussion, we will assume that our Canadian resident working for a Canadian employer is not considered to be a US person under US domestic law (i.e. someone who is either a US citizen or a lawful permanent resident).
As a bit of background, a Canadian resident working in the United States for a Canadian employer is generally taxable under US domestic law on income effectively connected with a US trade or business. The taxation of such income is often modified thanks to the provisions of Article XV of the Canada-US Income Tax Convention (“the Treaty”). In many cases, the Treaty will exempt the individual from taxation of the US income; however, a federal US filing obligation may exist to document this Treaty-exempt income.
In addition, state and local jurisdictions will often levy an income tax on wage income earned in the jurisdiction. Most states in the US impose a state income tax on wage income earned in the particular jurisdiction. It should be noted that nine states do not impose an income tax on wage income: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming.
As a state and/or local tax jurisdiction is not a party to the federal income tax treaty, there is not necessarily a Treaty exemption from taxation at the state and local income tax level even though a federal exemption may exist. It should be noted that several state jurisdictions do acknowledge and recognize the application of the federal Treaty and will exempt wage income in their jurisdiction where the federal Treaty also applies.
On the other hand, many states governments do not recognize the Treaty. If a non-US person carries on duties of employment in a state that does not follow the treaty (such as California or Pennsylvania), the compensation may be exempt from federal income tax under the treaty, but the compensation will not be exempt from state income tax. The State of California has a long history of not following the federal Treaty and aggressively asserts its taxation rights. The State of California will also determine the rate of taxation on those state-earned wages based on a taxpayer’s worldwide income and not just those wages earned in the state. This can have an unanticipated effect of a higher than expected income tax rate.
For states that follow the Treaty, the state filing requirements are easy to manage as the filing of an income tax in the state may not be required if his / her compensation earned in the US is exempted from federal income tax under the Treaty.
In addition, many local city jurisdictions impose a local income tax on wages. While this concept of local income tax is unheard of in Canada, individuals working in various cities in Michigan, Ohio, and Pennsylvania are subject to local income tax (often at a rate of 1 to 2%) and are required to file a local income tax return.
If you are lucky to be carrying duties of employment for your Canadian employer in a non-taxing state such as Washington or Texas, good for you. Otherwise, next time you are speaking with your accountant, be sure to mention your employment activity south of the border and don’t forget to consider those state and local income tax reporting requirements.
As cross-border employment taxation can be a complicated area, seeking advice from a specialist is always recommended to ensure you pay the correct amount of tax without the risk of double taxation.
Written by Rita Wang