With many of the pandemic restrictions now behind us, Canadians are once again travelling to the United States for work. To the extent that they have workdays in the US, these individuals may be subject to US federal, state, and local tax, because the US, like Canada, taxes non-residents on their employment income, business income, and property income sourced from the particular jurisdiction. Only those whose employment-related income is excluded by treaty are exempt.
As I discussed in the November/December 2015 issue of CPABC in Focus magazine,1 the “Dependent Personal Services” article in Canada’s income tax treaties can provide relief from tax in a foreign jurisdiction. The Canada–United States Convention with Respect to Taxes on Income and on Capital provides such an exemption from US federal tax for employment income where the conditions of the treaty2—including the “borne by” condition—are satisfied.
One area of caution, however, is where a Canadian employer with a US parent shareholder is a Canadian Unlimited Liability Corporation (ULC)—a disregarded entity for US tax purposes—as this may restrict the availability of the treaty exemption for employment income.3 For Canadian corporate law purposes, ULCs are only allowed in the provinces of Alberta, British Columbia, and Nova Scotia, and while they are treated as corporations for Canadian tax purposes, ULCs are treated as flow-through entities for US tax purposes.
Consequently, a ULC’s expenses are claimed as deductions in the US tax return of the US shareholder, and the employee remuneration could be viewed as being “borne by a permanent establishment in the US.” This is because the treaty article does not require the Canadian company employer to have a permanent establishment in the US—rather, it stipulates that the employee remuneration cannot be borne by (allowable as a deduction by) any permanent establishment in the US.
Additionally, even though employment income resulting from business travel may be exempt from US federal tax by virtue of a tax treaty, employers may still have withholding and reporting obligations for US payroll, which will require them to apply for an Employer Identification Number (EIN).
Furthermore, state and local taxes may still apply as state and local governments are generally not party to the income tax treaties and are not required to provide a similar exemption. Given the number of states in the US and the varying rules in each of these jurisdictions, a detailed discussion of every state’s requirements is beyond the scope of this article.
Applying for an IRS Employer Identification Number (EIN)
You can apply for an EIN online, by phone, or by completing Form SS-4, Application for Employer Identification Number. Visit the IRS website for details.
When employment income is not treaty exempt
In accordance with US domestic tax law,4 every employer that pays wages is required to deduct and withhold income tax. However, even where the employment income is not treaty exempt, remuneration for employment services is deemed not to be income from sources within the US and is excluded from mandatory withholding5 where:
- The non-resident employee is temporarily present in the US for a period (or periods) not exceeding a total of 90 days during the taxable year;
- Compensation from US sources does not exceed US$3,000 in total; and
- The non-resident employee is employed by a foreign employer that is not engaged in a trade or business within the US.
If these tests are not satisfied, the mandatory withholding exceptions will not apply, and the employer will be required to withhold income tax and remit the tax withholdings to the Internal Revenue Service (IRS) on a periodic basis, and report the income and the tax withholdings for the year on a Form W-2, Wage and Tax Statement.
To facilitate the withholding and reporting of income tax in the US, the non-resident employee will be required to obtain either a Social Security number (SSN) or an Individual Taxpayer Identification Number (ITIN). The non-resident employee will also be required to file a US tax return—specifically, Form 1040-NR, U.S. Nonresident Alien Income Tax Return—to calculate the applicable taxes that may then be claimed as a foreign tax credit on their home country’s tax return.
Applying for an IRS Individual Taxpayer Identification Number (ITIN)
- Complete Form W-7, Application for IRS Individual Taxpayer Identification Number and provide the required documentation, which includes proof of identity, such as a passport. If you’re unable to submit original documents, you may submit certified copies from the issuing agencies; note that each document must be certified as an exact copy of the original and stamped with the official seal of the issuing agency.
- Generally, if you’re applying for an ITIN, you must include a US federal tax return with your application. There are certain exceptions, however—for example, you will be exempt if you submit Form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual, or if you are subject to US tax withholding on your employment income.
When employment income is treaty exempt
Where it is determined that employment income is treaty exempt, there are two alternatives available, both of which require the non-resident employee to obtain either an SSN or an ITIN.
The first option is for each non-resident employee to apply for a waiver on an annual basis by completing Form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual. The completed Form 8233 is provided to the employer’s payroll agent who, in turn, signs and forwards the form to the IRS within five business days. The payroll agent must then wait 10 days to determine if the form is accepted by the IRS. If the form is rejected, the payroll agent must withhold and remit US tax at a 30% treaty rate.
At the end of the year, in lieu of completing Form W-2, Wage and Tax Statement, the employer will have to report the income (including the applicable treaty exemption codes) and the tax withholding (if any) on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. Any additional wages paid to the non-resident employee over and above the income tax treaty amounts must be reported on Form W-2.
The second option available to employers of non-resident employees is to deduct and withhold income tax on a periodic basis based on the IRS’s prescribed withholding tables. Employers who choose this option will need to report the end-of-year income and tax withholding amounts on Form W-2.
For both of these options, the non-resident employee is required to file a US tax return (Form 1040-NR) in order to obtain the tax treaty exemption and a refund of any tax that may have been withheld during the year. Failure to file a US tax return claiming the treaty exemption may result in a denial of the exemption, which would result in a US tax liability. (Non-resident employees are not required to file Form 8233 with their US tax returns.)
Social Security contributions
In addition to income tax considerations, social security issues need to be addressed. In the US, Social Security and Medicare taxes are collectively known as the Federal Insurance Contributions Act (FICA) tax. FICA tax withholding is required on all compensation in respect of services performed in the US. Under US domestic law, there is no minimum threshold or exemption for non-resident employees; therefore, non-resident employees who work in the US—even for short periods of time—are subject to the FICA tax.
However, Canadians who work temporarily in the US may be exempt from FICA tax contributions as a result of the Canada-US Social Security Totalization Agreement. One of the primary objectives of this agreement is to eliminate situations in which employees who are temporarily sent to work in the US might have to contribute to its Social Security program for the same work that would be covered by the Canada Pension Plan (CPP). Note, however, that the exemption provided under this agreement only applies if the period of work in the US is not expected to exceed 60 months. Intermittent work periods of short duration are viewed as separate periods of work.
In order to contribute only to the CPP and remain exempt from the US Social Security program, the employee must obtain a certificate of CPP coverage from the Canada Revenue Agency. However, according to the US Social Security Administration,6 a certificate of coverage is only required if the non-resident employee will be working in the other country for more than 183 days or the other country requests one.7
A lot to consider
As business travel ramps up once again, there are many tax implications to consider—whether you’re a Canadian employee who works temporarily in the United States or the employer of one.
Lawrence Bell is a senior tax manager with the people advisory services group – global mobility and rewards practice of Ernst & Young LLP in Vancouver.
This article originally appeared in the July/August 2023 issue of CPABC in Focus.
1 Lawrence Bell, CPA, CA, “Dependent Personal Services – Myths and Realities,” CPABC in Focus, November/December 2015 (42-43).
7 In the context of this article, “the other country” is the United States.