In comparison with Canada, US tax rates on the income of an individual are lower. US federal individual income tax rates are lower than Canadian federal tax rates and State individual tax rates are lower than provincial individual income tax rates. Moreover, certain States such as Florida and Texas do not levy tax on an individual’s income. The adoption of the Tax Cuts and Jobs Act under the Trump Administration (commonly known as the “US Tax Reform Bill”) has for the most part further reduced federal individual income taxes, but its scope is limited especially for Canadians who earn individual income in the United States. This article presents how the US Tax Reform Bill changes the US federal treatment of individual income and highlights the effects of these changes on Canadians.
US Individual Income Tax Rates
Like Canada the US federal individual tax is levied at progressive rates and grants individual taxpayers certain deductions. In the United States, individual income excludes capital gains and dividends, which are taxed at a different set of rates. The US Tax Reform Bill did not change how capital gains and dividends are taxed, or the applicable tax brackets of these types of income.
Salaried income, income earned through a sole proprietorship, and rental income that is personally earned are treated as individual income and therefore taxed at individual income tax rates. Income earned through “disregarded entities” such as a single-member US limited liability company (“LLC”) or entities taxed on a “pass through basis” such as limited partnerships (“LP”), limited liability partnerships (“LLP”), limited liability limited partnerships (“LLLP”) and S-Corporations that elect to be treated as partnerships, are also taxed at individual income tax rates.
Disregarded entities and pass-through entities are treated in a similar fashion. A disregarded entity has a distinct liability from that of its sole member, but for tax purposes, is not considered separate from its sole member. Instead, all the income of a single member LLC is included in the taxable income of the sole member and no tax filings are made by the LLC. The income of pass-through entities is also solely attributed to its owners and taxed in their hands, but unlike disregarded entities pass-through entities must prepare annual tax reporting filings.
Before the US Tax Reform Bill took effect on January 1, 2018, there were seven (7) tax rate brackets, with the lowest bracket being 10% and the highest tax bracket being 39.6%. In 2017, the threshold for the rate of 39.6% was $418,400 USD for singler filers and $470,700 USD for individuals who filed joint tax returns with their spouses. In contrast, Canadians will trigger a combined federal and provincial tax rate of 50% or more if their taxable income exceeds between $200,000 CAD and $300,000 CAD depending on the province.
The US Tax Reform Bill maintains seven (7) tax brackets, but lowers the rates for each tax bracket and increases thresholds of taxable income for each bracket. The highest tax rate is decreased from 39.6% to 37% and the threshold is $500,000 USD for single filers and $600,000 USD for individuals who file joint tax returns with their spouses.
Changes to US Individual Income Tax Rates – What Does It Mean for Me?
If you live in the United States and have terminated your Canadian tax residency, you will benefit from these tax cuts for a period of time. These tax cuts are only in effect from January 1, 2018 to December 31, 2025. Starting January 1, 2026, the tax brackets will revert to the same ones as in 2017 except the thresholds of each bracket will have been adjusted for inflation since 2017.
However, if you remain a tax resident of Canada, these tax cuts will not decrease your overall tax burden on US sourced income. A Canadian tax resident with no ties to the United States is taxed on his or her worldwide income at Canadian tax rates. He or she will also be taxed in the United States on US sourced income, but can avoid double taxation in Canada by claiming a foreign tax credit for having already paid tax in the United States.
Take the following example. Gary is a Canadian resident who earns rental income from a Florida condominium that he rents out most of the year. If he earns $10,000 USD per year from this property, he will have to declare this income in a US tax return and pay tax in the United States at the applicable US federal tax rate. Florida does not levy a State individual tax rate. Gary will then have to report this income in his Canadian tax return and will be taxed at the applicable Canadian tax rate. If the applicable US tax rate on the rental income was 10% and the applicable Canadian tax rate on his worldwide income was 50%, he can claim a foreign tax credit for the 10% that he has already paid, but will pay a remaining 40% in Canada. His overall tax rate is in effect the Canadian tax rate.
Since Canadian individual tax rates are considerably higher than US individual income tax rates, the US tax cuts do not provide Canadian residents earning US sourced individual income with any effective tax relief.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.
About the author
Sergei Titorenko is an Associate at Levy Salis LLP and a member of the Quebec Bar. He devotes his practice to US and Canadian tax and estate planning, Canadians doing business in the United States, Americans living in Canada, US real estate transactions for Canadians, and cryptocurrency transactions.