US Expats living in Canada face specific tax challenges especially those that own a share in Canadian Partnerships.
Taxation of US Expats owning Canadian Partnerships
US Citizens and permanent residents who are partners in Canadian Partnerships are required to report their taxes to the IRS just as if they were a partner in the United States – usually to include the filing of form 8865 and it’s appropriate schedules.
What is a Canadian Partnership?
A partnership is a business owned by two or more persons, corporations, or other partnerships.
In Canada, when individuals are the partners, this is referred to as a general partnership. Other Canadian Partnerships include the Limited Partnership and the Limited Liability Partnership.
Regardless of the type of Canadian Partnership, US Persons who are partners of these arrangements must report all income and expense activity on their US taxes – just as if the partnership was operating in the United States.
US Taxation of Canadian Partnerships for US Persons
Any taxable income and expense activity of a partnership flows through to its partners according to an agreed upon share of the profits and losses.
For example, let’s say you own 50% of an ice cream shop. The ice cream shop sees 60,000 Canadian Dollars in sales and has 40,000 Canadian Dollars in expenses. The ice cream shop also had a bank account and earned 400 Canadian Dollars in interest.
As a US partner you should report $10,000 of ordinary income and $200 of interest income on your US individual income tax return.
If you are active in performing services for the ice cream shop, you are also required to consider the income as self employment income, which could have additional tax implications.
Partnerships in the United States (as in Canada) are required to file their own tax returns. The partnership tax return reports the activity in detail and divides it up on paper to the partners.
Many types of income are taxed differently and these types maintain their character when passed through to the individual.
In the United States, the partnership tax return includes a schedule called a K1. The K1 is the form that explains to the partner how much income to report and what types of income to report.
IRS form 8865
Canadian partnerships, of course, are not required to file US tax returns.
Since the US Tax code dictates that this activity is to be reported just as if you were in the United States, the IRS developed form 8865 for US Persons to report the activity of any non-US Partnership.
Form 8865 is similar to a US partnership tax return and most categories of filers are also required to create and file the form K1 as well. The form also has schedules that explain the “money flow” to and from the non-US Partnership and it’s partners.
Since there have been unethical tax practices where US persons use non US business to hide and shelter themselves illegally from US taxes, the IRS imposes very heave penalties on filers that skip out on filing this form.
While I understand where policy makers are coming from, but unfortunately this somewhat long-reaching requirement creates an expensive filing situation for US persons who are partners in even very small partnerships.
If you are in this situation, we can help.