Updated May 17, 2023
For Canadian investors, having exposure to the US stock market is very important. There are several reasons.
First, the United States is the world’s largest stock market. Exposure to US equities is necessary to avoid home bias and have a globally diversified investment portfolio.
Second, there are certain sectors that are undervalued in the Canadian stock market. Examples include healthcare, technology, and consumer staples. Interestingly, these sectors are among the strongest in the US market.
In order to invest in US stocks, Canadian investors need to understand how this affects taxes.
This article discusses the tax implications for Canadians investing in U.S. stocks, including examples of dividend and non-dividend stocks held in both taxable and tax-exempt accounts.
table of contents
We recommend that you read this article to the end, but you can also use the table of contents below to skip to specific sections of this article.
capital gains tax
There are two types of investment taxes that Canadian investors pay when investing outside of tax-exempt retirement accounts. The first is the capital gains tax, which I will discuss first.
A capital gain occurs when a security is sold for more than its purchase price. Conversely, a capital loss occurs when you sell a security for less than the purchase price.
Canadian investors must pay capital gains tax on 50% of realized capital gains. The tax rate for these transactions is the same as the personal marginal tax rate.
The marginal tax rate consists of a federal portion (all Canadians pay the same amount) and a provincial portion (depending on which province you live in).
According to the Canada Revenue Agency, the current federal tax rates for each tax category are as follows:
- 15% first time taxable income of $50,197, +
- 20.5% next $50,195 of taxable income (the portion of taxable income greater than $50,197 and up to $100,392); +
- 26% next $55,233 of taxable income (the portion of taxable income over $100,392 up to and including $155,625); +
- 29.38% next $66,083 in taxable income (the portion of taxable income over $155,625 and up to $221,708); +
- 33% of taxable income that’s all $221,708.
As mentioned earlier, state tax rates vary from state to state. The examples in this article use tax rates for Ontario, Canada’s most populous province. Ontario’s tax rates by tax category are shown below.
- 5.05% first time Taxable Income $46,226, +
- 9.15% next $46,228, +
- 11.16% next $57,546, +
- 12.16% next $70,000, +
- 13.16% on amounts over $220,000
So how does the capital gains tax for holders of US stocks differ?
Fortunately, the capital gains tax paid on investments in US stocks is the same as the capital gains tax paid on Canadian securities. The only minor difference is that capital gains must be expressed in the form: Canadian Dollar For the purpose of calculating an investor’s tax liability.
Here are some examples to help you understand capital gains tax from US stocks in light of these Canadian tax classifications. Suppose you are a Canadian investor and execute the following trades.
- You bought 100 shares of Johnson & Johnson (JNJ) for $100 when the exchange rate between the US dollar and the Canadian dollar was 1.25.
- Sold Johnson & Johnson shares for $125 when the US dollar to Canadian dollar exchange rate was 1.15
You will be required to pay capital gains according to the difference between the purchase price and the sale price. expressed in Canadian dollars. The following table will help you understand the proper method for calculating CAD denominated capital gains. Although not directly calculated in the image above, the capital gains for this trade are – expressed in US dollars – is USD 2,500. However, this is not relevant for calculating capital gains tax as capital gains tax is calculated based on the transaction price. Canadian Dollar. What really matters is the $1,875 CAD capital gain shown in the bottom right cell of the table.
This is the amount used to calculate capital gains. As mentioned earlier, half of this amount is taxed at the investor’s marginal tax rate. For simplicity, let’s assume that the investor belongs to the highest tax bracket, i.e. 46.16% for Ontario residents.
The following table details the capital gains tax calculation for this hypothetical investment in Johnson & Johnson (JNJ).
This calculation is quite complex and shows how complex the calculation of capital gains tax can be for Canadians.
Luckily, if you hold U.S. stocks (or stocks from other countries) in your Canadian retirement account, you can avoid capital gains tax entirely. His two types of retirement accounts in Canada (TFSA and RRSP) are discussed in a later section of this article.
We now turn to discuss the taxation of dividends paid by US companies to Canadian investors.
dividend tax
Unlike capital gains tax (which is calculated the same way for US and Canadian stocks), the tax Canadian investors pay on international stock dividends is different than the tax they pay on domestic dividends.
This is due to a special type of dividend tax called a “withholding tax”.Unlike other taxes that Canadian investors pay, these taxes are withheld at the source It is taxed (by the company paying the dividend) and remitted to its tax authority (the Internal Revenue Service (IRS) for US companies).
Dividend withholding tax significantly reduces the income Canadian investors can earn from U.S. stocks. Fortunately, this impact is partially offset by a special tax treaty between the United States and Canada (called the Treaty between Canada and the United States). The US withholding tax rate levied on a foreign investor on US dividends is normally 30%, but the treaty reduces him to 15% for Canadians.
How does this compare to the average withholding tax in countries around the world?
flat rear Given the impact of special tax treaties, the United States remains an unfavorable market for Canadian investors from a tax efficiency perspective. According to BlackRock, the weighted average foreign withholding tax on international equity dividends is 12%.flat rear Considering tax treaties, Canadians still pay a 15% withholding tax. This is 25% higher than the weighted average dividend withholding tax worldwide.
Canadian investors will be pleased to hear that this foreign withholding tax can be refunded in due time. The Canada Revenue Agency allows you to claim a foreign tax credit for withholding tax paid on US dividends. This prevents investors from paying double tax on dividend income.
Still, US dividends are not as tax efficient as Canadian dividends. The reasons are somewhat complicated and relate to a Canadian tax principle called the “dividend tax credit”. The dividend tax credit significantly reduces the tax that Canadians pay on dividends, making dividend income the most tax-effective form of income for Canadians.
According to Moneysense:
For non-residents investing in US stocks or US exchange traded funds (ETFs), the standard withholding tax on dividends is 30%. Canadian residents are entitled to a reduced withholding rate of 15% under the treaty between the two countries if they file a Form W-8 BEN with the brokerage firm holding their investment.
Our recommendation for Canadian investors seeking exposure to US equities is to hold US equities in a retirement account. This reduces the tax burden and at the same time significantly reduces the tax complexity of investment portfolios. The next section of this article discusses dividend tax on retirement accounts.
Dividend tax on retirement accounts
The best way for Canadian investors to gain exposure to US equities is through a retirement account.
There are two main retirement accounts available to Canadian investors.
Both offer Canadians tax-friendly opportunities to invest their capital in financial assets. That said, there are important differences in the functionality of each account.
Tax Free Savings Account (TFSA) allows investors to make donations income after tax to your account. Investment profits and dividends held in the account are tax free and withdrawals from the account are also tax free. The TFSA is functionally similar to the US Roth IRA.
Another type of retirement account in Canada is the Registered Retirement Savings Plan (RRSP).These accounts allow Canadian investors to make donations income before taxIt is then deducted from gross income for the purpose of calculating annual income tax.income tax is paid later, upon withdrawal from the RRSP. RRSP is functionally equivalent to 401(k) in the United States.
Both of these retirement accounts are very attractive as they allow investors to manage their funds in a very tax efficient manner. In general, capital gains and dividends are tax-free as long as shares are held in a retirement account.
Unfortunately, there is one exception to this rule. Withholding tax paid to the IRS on dividends from US companies will continue to be paid within the TFSA. For this reason, US stocks should not be held within the TFSA if possible.
Instead, RRSPs are a great place to hold US stocks (not MLPs, REITs, etc.). Exempt from dividend withholding tax.No tax is actually paid Jeez For US stocks held within the RRSP. This means that Canadian investors should hold all dividend-paying U.S. stocks within the RRSP if they have enough room to contribute. US stocks that do not pay dividends should be held in the TFSA. Finally, to take advantage of the dividend tax credit, Canadian shares must be held in a non-registered account.
final thoughts
The article began by discussing some of the benefits of owning U.S. stocks for Canadian investors, then detailed the tax implications of implementing such a strategy. After describing the tax characteristics of US stocks for Canadians, we concluded that best practices are:
- Holding dividend-paying US stocks in the RRSP
- Own US non-dividend stocks in TFSA
- To take advantage of the dividend tax credit, hold Canadian shares in a taxable account. Holds Canadian stocks with particular dividends.
If you are a Canadian dividend investor interested in researching the US stock market, the following Sure Dividend database contains some of the highest quality dividend stocks in our investment space.
- Dividend Aristocrats: S&P 500 stocks with 25+ consecutive years of dividend increases
- Dividend Achievers: Dividend stocks with 10+ years of consecutive dividend increases
- Dividend Kings: Considered to be the best of the best when it comes to dividend growth, Dividend Kings are an elite group of dividend stocks with more than 50 years of consecutive dividend increases.
Alternatively, you may be looking to tailor a very specific group of dividend stocks to meet specific yield and dividend characteristics. If this is indeed the case, you’ll be interested in the following databases from Sure Dividend.
Another way to approach the US stock market is to build a portfolio to own companies in each sector of the stock market. For this reason, Sure Dividend maintains his database of 10 stocks in each sector of the market. You can access these databases from:
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