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Snowbirds should understand tax rules south of the border

What a difference 30 years can make. Think back to 1973 and compare life at that time to life in 2003.

Back then: Long hair. Today: Longing for hair.

Back then: Going to a new, hip joint. Today: Receiving a new hip joint.

Back then: Rolling Stones. Today: Kidney stones.

Back then: Moving to California because it's cool. Today: Moving to California because it's warm.

If you can relate to any of this -- particularly the last one -- then chances are pretty good you know someone who is a snowbird today. Maybe you're planning on heading south yourself. Before you go, understand the tax issues you'll face down south.

The test

You should be aware that you may have filing requirements in the United States even if you have no tax to pay south of the border. Certainly if you're a U.S. citizen you're required to file a tax return in the United States each year.

But even those who are residents of Canada and non-citizens of the United States (known as non-resident aliens) may have filing requirements in the United States depending on the number of days spent there each year.

In short, you'll be considered a resident of the United States for tax purposes, which will require tax filings in that country, if you meet the "substantial presence test." Here's the test: Add the total days you are present in the United States in the current year (it must be more than 30 days or you will not be caught by this test), plus one-third of the days you were present in the United States in the prior year, plus one-sixth of the days you were present in the United States in the year before that. If the total of these is 183 days or more, then you've met the substantial presence test, will be considered a U.S. resident, and will have U.S. tax filing requirements.

Here's the general rule: If you regularly spend more than four months (122 days) each year in the United States, the substantial presence test formula will catch you.

As an aside, when counting your days stateside, you may be able to exclude some of the days you remained in the United States because of a medical condition, days spent as a commuter or while in transit between two foreign countries, and days in the United States as a teacher, trainee, student, or professional athlete competing in certain charitable events.

The escape

Okay, what's an unsuspecting snowbird to do? You've met the substantial presence test, and you're concerned about having to file a tax return and pay tax in the United States. I've got good news. There are two key ways to escape filing a full-blown tax return and paying tax on your worldwide income in the United States.

Option 1: Claim the closer connection exception. You can avoid being considered a U.S. resident under U.S. domestic tax law if you have a closer connection to another country. All you have to do is file U.S. Form 8840 with the Internal Revenue Service, which details the number of days you've spent in the United States, and the factors that establish your closer connection with Canada. Keep in mind, you can claim this closer connection only where you have spent less than 183 days (about six months) in the United States in the year and do not have (and have not applied for) a green card.

Option 2: Claim protection under the treaty. If you can't claim the closer connection exception, you may be able to rely on the "tie-breaker" rules in the Canada-U.S. tax treaty to avoid U.S. residency for tax purposes. How? By filing a U.S. income tax return (Form 1040NR) for the year.

You'd have to report all your U.S.-source income on this return (which will usually consist of interest and dividends, likely subject to withholding taxes). You'll also have to file U.S. Form 8833, which is simply a statement explaining that you're a resident of Canada and, under the Canada-U.S. tax treaty, are not subject to regular tax rates in the United States. In most cases, this will be enough to prevent you from paying more tax to the IRS than the withholding taxes already paid.

The deadlines

You'll have to file either the closer connection exception (Form 8840), or the U.S. return (Form 1040NR) along with the claim for treaty protection (Form 8833) by June 15 of the following year (June 15, 2004 for 2003).

If you have to claim treaty protection, there may be non-disclosure penalties of $1,000 for each item of income involved if you don't file on time.

Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.

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