Figuring Out Tax on US Dividends in Canada

tax on US dividends in CanadaA discussion on tax efficiency in the comments section over at Freedom 35’s blog (yes, riveting stuff) has spilled over here: where, oh where, to put plain vanilla US dividend paying stocks for Canadians? The obvious insta-blurt-out-without-thinking answer is in the RRSP. But is it the best place? You get the benefits of no foreign withholding taxes and contributions are deductible from taxable income. It’s probably the best choice in a “between a rock and a hard place” scenario, but it’ll depend on your specific circumstance. Let’s consult the tax efficiency matrix.


 

In the RRSP

tax on US dividends in Canada RRSP

Pros:

  • You get to contribute pre-tax money: contributions are deductible from income tax.
  • The only account where there are no Foreign Withholding Taxes.
  • No tax on the dividend by the Canadian government.
  • No tax on capital gains.

Cons:

  • Contribution space limited to 18% of max income, to a maximum of $25,930 (in 2015).
  • Tax on income at time of withdrawal in retirement (will vary dependent on circumstance).
  • No capital loss credits.

In the TFSA

tax on US dividends in Canada TFSA

Pros:

  • No tax on withdrawal of money from account.
  • No tax on the dividend by the Canadian government.
  • No tax on capital gains.

Cons:

  • Contribution space limited to $41,000, with $10,000 yearly increases.
  • Foreign Withholding Tax on dividends.
  • No capital loss credits.

In the Regular Account

tax on US dividends in Canada regular

Pros:

  • Foreign Withholding Tax is recoverable through the Foreign Tax Credit.
  • Ability to gain capital loss credits, which can be used to offset taxes on other capital gains.

Cons:

  • The Canadian government will tax the dividends at your full marginal tax rate (ouch).
  • Capital gains are taxed.

In the Fantasy World

tax on US dividends in Canada impossible

Pros:

  • No taxation – hurray!

Cons:

  • Highly illegal.

Our Allocation

For most people, stuffing your US dividend paying stocks in the RRSP makes the most sense in terms of tax efficiency. That would be the plain vanilla answer I would give if I didn’t know anything about your particular situation.

But that’s not how our accounts are set up. We have US dividend paying stocks in one TFSA; cash in the other TFSA. One RRSPs hold cash. Why?

Interest on fixed income (bonds, GICs, savings account interest, etc) is taxed at your full marginal tax rate. The most efficient place to put fixed income is into registered, tax-sheltered accounts like the RRSP and TFSA. Why so much fixed income in the limited, tax-sheltered accounts?

The majority of it is for a downpayment on a home in the future. While our cash earns ~1-2.25% interest, we want it sheltered completely from tax because it would be taxed at our full marginal tax rate.

The lone TFSA, which is stuffed with US dividend paying stocks, is set up this particular way because we don’t currently want to use the RRSP room for stocks. Between being taxed 15% on the dividends with no capital gains taxes in a TFSA versus being taxed at our full marginal tax rate on the dividends with access to capital loss credits in the non-registered account, we chose the TFSA.

Why not Canadian dividend paying stocks instead, which have 0% tax and no capital gains inside the TFSA, you may be wondering? That has to do with my circle of competence: I currently understand US companies more than I understand Canadian ones. I would rather pay the 15% withholding tax on the dividends and understand the companies I own.

Ultimately, in order to maximize tax efficiency, the accounts will eventually settle in this order:

RRSP: US dividend paying stocks.

TFSA: Cash, Fixed Income, Dividend paying stocks.

Regular, Non-Registered: Canadian (eligible) dividend paying stocks.

This personal example should demonstrate that, while in a generic sense, it is fairly simple where you should place US dividend paying stocks, it could really vary depending on your unique circumstance, strategy, and needs.

In conclusion, this timeless maxim holds true:

Nothing in life is certain except Death and Taxes.

  • “highly illegal.” lol, I suppose that’s why you put it in the fantasy world scenario. Thanks for the mention and going into so much detail in this post as well as in the comments section on my blog. I hold some U.S. stocks in a TFSA because of that 18% limitation in RRSP which I want to save for other U.S. equities with higher yield. That’s cool you understand more about the stock market in the U.S. than in Canada. There are certainly more opportunities on the NYSE to grow a diversified portfolio. Most of my exposure is to Canadian equities for now. But lately I’m buying more U.S. stocks. Currently looking at JNJ. 🙂

    • Personally, it was easier for me to delve into the annual reports of Berkshire Hathaway or Hershey’s or IBM – all these big iconic names – than it was to start with Canadian companies that didn’t have as much luster. Obviously, one has to start from where they feel they will be most effective. I figured I’ll get the snowball rolling with US companies in the TFSA – even though it isn’t the most tax efficient way – as opposed to not starting at all. Canadian equities are most efficient in non-registered accounts and since wisdom holds that it is prudent to take advantage of every registered account available before diving into un-registered accounts, this is how its played out for us.

      • Stephen Hodgson

        Ugh, I am the same way. As a Canadian, I really have a horrible handle on what good Canadian companies, but of my overall 17 holdings at this point, only 2 are Canadian (TD, BNS). Also, I might be wrong, but a good place for UK domiciled stocks is the TFSA. Ones like UL, DEO, etc, because I don’t think they get dinged by the withholding tax. I haven’t tried it (ran out of money/valuation isn’t currently there) but that is what I have heard.

        I really do with there was no withholding on the TFSA – that would make it the ultimate account. I mean, 15% isn’t the end of the world but it does hurt, especially knowing as your dividends growth they keep getting skimmed with it over and over.

        • A large portion of the TFSA is in a mega-cap US company that doesn’t pay a dividend – the idea of putting some US dividend payers in there was to pool together the dividends throughout the year and pool it with fresh contributions every year and buy more of said mega-cap US company that does not pay a dividend.