The US-Canada border is one of the friendliest in the world. As a result, many people move back and forth across the border. I am one of those people. I grew up in Canada, went to university and worked in the US, moved back to Canada for a few years, and now live back in the US.
Those considering a cross-border move should understand the personal tax system differences. Although the principles in each country are similar, the implementation is quite different.
In my last post I wrote about the differences in tax agencies, the impact of moving, filing status, and income tax rates.
This time I’ll tackle deductions and credits, which is more than enough for one post.
Income tax rates are deceptive because they have little to do with how much tax you actually pay.
You don’t actually pay 33% if your income is in the 33% combined federal and state/provincial tax bracket. 33% is the marginal tax rate, which means 33 cents of tax is owed for each additional dollar earned.
However, your average tax rate is your income tax paid divided by your total income.
Thanks to deductions and credits, most people would be surprised at how low their average tax rate is.
Deductions reduce the amount of income you are taxed on. For example, in both Canada and the US, qualifying retirement contributions are deducted from taxable income before calculating tax owed.
Credits directly reduce the amount of tax you pay dollar for dollar. For example, the child tax credit in the US reduces tax by $1000 for each child.
Deductions and credits are part of both the Canada and US tax systems, but the implementation is much different. The US primarily uses deductions and Canada primarily uses credits.
In Canada, the amounts used to calculate credits are similar to the amounts the US uses for deductions. However, rather than being deductions, these amounts are added up and then multiplied by 15% to find the credit.
The end result is similar, but the US system results in more tax savings if your income above the 15% tax bracket.
For example, in the US a $1000 deduction for someone in the 25% tax bracket provides tax savings of 25% of the deduction, or $250. A Canada resident in the 25% tax bracket who is allowed a credit on $1000 gets a 15% reduction in taxes, or $150.
Confusing, I know, but it’s an important concept to understand if you want to understand how you are taxed.
The following comparisons are highlights and not comprehensive lists.
Deductions and credits similar between the US and Canada:
Retirement contributions: RRSP contributions in Canada and 401(k) contributions in the US are both treated as deductions.
Personal and Dependent: deductions or 15% credit for the filer and dependents.
Charitable Donations: Canadians benefit from a 29% credit on donations instead of 15%, and provinces add an additional credit. Alberta adds an extra 21% credit, which means Albertans get back 50% of their donations. Donations are a regular deduction in the US.
Deductions and credits different between the US and Canada:
Mortgage interest: Americans love that they can deduct interest on their personal residence mortgage.
Property tax: To further incentivize home ownership, property tax on a personal residence is deductible in the US.
Child tax credit: The US provides double tax benefits for kids. US residents get a $1000 credit for each child in addition to a deduction for each dependent.
State income tax: US residents get a federal deduction for state income tax.
Deductions and credits can be complicated, but it is important to understand how they impact the tax you actually pay. Thanks to deductions and credits, most people do not pay nearly as much tax as their top tax bracket indicates.
Disclaimer: I am a CPA in both Canada (Chartered Professional Accountant) and the US (Certified Public Accountant), but I am not a tax expert and this post is not meant to be professional advice. My goal is not to write a definitive guide. Rather, my goal is to give you a starting point for your own further research and/or discussions with your tax advisor.