U.S.-Canada Tax Treaty Will Affect Mobility

Recent changes in the tax treaty between the U.S. and Canada will have an impact in a variety of areas, including 401(k) contributions and stock options, as well as the ability of taxpayers to move across borders.

“The important thing to note about the changes in the U.S.-Canadian treaty protocol is that these changes are breaking down some of the barriers to mobility from the tax perspective,” said Ernst & Young partner Cheryl Spielman. “The two countries recognize that it’s a very globalized and mobile workforce. The changes acknowledge that people are moving from country to country, and they need to have pensions that are portable, with the associated tax benefits they would have gotten in their home country.”

Under the old rules that were effective for tax years ending before Jan. 1, 2009, pension deductions were allowed only for country-specific pensions — for example, qualified plans in the U.S. and registered plans in Canada. Under those rules, the U.S. did not allow a U.S. taxpayer to deduct contributions made to a Canadian pension plan, and Canada did not allow a Canadian taxpayer to deduct contributions to a U.S. pension plan.

The new rules will allow a deduction in 2009 and subsequent years in two specific circumstances: short-term cross-border assignees, and commuters. In addition, the U.S. will allow employer contributions to a Canadian qualified retirement plan to be made without a resulting taxable benefit to the employee.

“Under the old rules, prior to the protocol, you couldn’t get any tax benefit on your 401(k) contributions,” said Spielman. “You would have to pay taxes on your full income. Similarly, if I were a Canadian person, I wouldn’t get that benefit on my U.S. return for a Canadian qualified retirement plan. The protocol broadened the definition of a qualified plan to include the other country’s plan to give you a benefit.” The change is effective for tax years beginning Jan. 1, 2009.

The protocol also provides guidance for the allocation of stock option benefits between Canada and the U.S., resolving an issue that has been a potential cause of double taxation for some taxpayers. The application of the new guidance to other stock-based incentives is not specifically addressed in the protocol. However, the changes could encourage more mobility.

“A couple of years ago when the stock market was in its heyday, with people sitting on tremendous value in their stock options, key executives who potentially wanted to make a move between the U.S. and Canada wanted to understand the tax implications,” Spielman noted. “They would say, ‘Wait a second, this is going to cost me.’ A lot of these changes are clearly very positive from the standpoint of promoting mobility between the two countries.”

In some of the U.S. states that have close proximity to the Canadian border, for example, it is common for people in one country to commute to the other, particularly in the automobile industry — although even there the effects may be limited, especially as the auto industry downsizes. “I don’t think it will push an individual to gravitate to one country or another,” said Spielman. “It will just make cross-border assignments a lot easier.”

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