NAFTA or Not [And speaking of faith ... you've just got to see the work that one remarkable tax professional put into answering a question. Clearly, I didn't even know where to begin the research. So, I fielded it directly to our friend in Portugal, Roger B. Adams. If you ever need help from someone with expatriate issues - he's your man.] » From: Brownsville, CA Dear TaxMama, This past Oct. I was married to a Canadian citizen. My question is this: Up until we were married, my wife was working in the U.S. under NAFTA. Therefore, she was not required to pay income taxes here in the U.S., only in Canada. Does the fact that we were married in Oct. negate her tax exempt status for the entire year, or only after our wedding date? Any help would be greatly appreciated, as we have asked several tax professionals and have yet to receive a clear and concise answer. Thank you, Bob and Julie <The International Tax Pro Replies> Dear Eva, I am glad that I can be of some small service to you here. Here is the answer: » Background: Julie, a Canadian citizen, marries Bob, a US citizen in October of 2002, and both now reside in the US. Assumption; the governmental organization NAFTA in Canada employs Julie to work on their behalf in the US. The NAFTA organization is not a trade or business. Assumption; Julie is a non resident alien in 2002. » Issues: What portion of Julie's Canadian salary is taxable in the US now that she is married? What is the tax treatment of Julie's other income (if any)? This is a treaty issue. Julie's wages are exempt under the Canada/US double taxation convention. The entire treaty can be downloaded from here. The articles relevant to this situation are: "Article XIX Government Service Remuneration, other than a pension, paid by a Contracting State or a political subdivision or local authority thereof to a citizen of that State in respect of services rendered in the discharge of functions of a governmental nature shall be taxable only in that State. However, the provisions of Article XIV (Independent Personal Services), XV (Dependent Personal Services) or XVI (Artistes and Athletes), as the case may be, shall apply, and the preceding sentence shall not apply, to remuneration paid in respect of services rendered in connection with a trade or business carried on by a Contracting State or a political subdivision or local authority thereof." Thus, Julie's wages from NAFTA are exempt from taxation in the US and taxable only by Canada. Her marital status is irrelevant, and she is neither liable nor subject to US tax on this amount from the first to the last of 2002 as long as she is a non-resident alien. Any other income she receives, either from the US or from Canada, would be taxable according to the other treaty provisions depending on the source and nature of the income. This is no mere quibble. This is not income that falls under the provisions of Art. XXIV (as below) requiring a credit. The US has ceded taxing rights to Canada on this type of income entirely. By virtue of Julie's CITIZENSHIP, and the words "taxable only in that state" (Canada) it is arguable that they need not even report this income on their US return in 2002. If you wish, I will follow that up with the IRS in Paris. "Article XXIV Elimination of Double Taxation 1. In the case of the United States, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, or to a company electing to be treated as a domestic corporation, as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada; and, in the case of a company which is a resident of the United States owning at least 10 per cent of the voting stock of a company which is a resident of Canada from which it receives dividends in any taxable year, the United States shall allow as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada by that company with respect to the profits out of which such dividends are paid." Warning: If Julie is non resident in the US for tax purposes in 2002 do not use the §6013(g) election. This election allows the non citizen spouse to be treated as US resident for tax purposes, and allows the couple to file MFJ. If that election was selected Julie could no longer claim the benefits of the treaty, and her income from NAFTA would then become liable to tax in the US as worldwide income and boost their adjusted gross income. A credit for taxes paid to Canada on other than this NAFTA income should be claimed and deducted from US tax using a Form 1116, and entered on line 45. The next question is, what is Bob's filing status in 2002? If Julie is a non resident alien in 2002, it must be MFS to save the treaty provision. If Julie is a permanent resident (as she must become in 2003), then the "savings clause" applies: "Art XXIX (2) Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and on capital." As you see, once Julie becomes a permanent resident of the US, it is as if there is no treaty between Canada and the US. Art. XIX no longer applies to Julie. Bob and Julie must declare their worldwide income (including the NAFTA wages). Nevertheless, Julie and Bob are given a credit on their US tax for Canadian tax paid by using form 1116. Canada will always have first taxing rights on these NAFTA wages. As to this particular case, I would like to add a few comments (as if the opinion were not long enough). 1. Bob and Julie will be no worse off from a total tax standpoint than when her wages were exempted from US tax, except for the increase in AGI. Generally, Canada taxes at a somewhat higher rate than the US. The only thing that will cause a problem is completing the dreaded Form 1116. At VECTA here in Lisbon, all the volunteers kindly have decided that only I should have the pleasure of completing them. 2. Only foreign income may be credited on a 1116. Julie's income derives from personal services performed in the US, and income from personal services is sourced where the service is performed. The question is how does US source income become foreign source income? Here is the answer: 3. As to the 1116, the very first part calls for the allocation of income into one of 10 baskets. Wages generally go into (j) (General limitation income). In Julie's case however, I would suggest they enter (i)(Certain income resourced by treaty). This is because the US/Canada treaty allocates exclusive taxing rights to Canada. Bob & Julie now attach a note to the 1116 citing the relevant treaty article thus; note: wages earned in the US are resourced under US/Canada tax treaty by virtue of Art. XIX. NAFTA is a Canadian governmental agency. That should be sufficient. I'm sorry this is so long, but it would have been worthless without the citations. This was not an easy question. This answer took about two hours to complete. Best regards, Roger B. Adams For consultation: adams.family@mail.telepac.pt To learn more about VECTA (Volunteer Embassy and Consular Tax Assistance) and Roger B. Adams, please scroll down to the bottom of this Taxmama page.