How are you taxed?

The Canada and US tax system are similar in some ways but are very different in application of details. Canada taxes its Canadian residents on their world income and non-residents are taxed on specific types of income from Canadian sources. On the other hand the U.S. taxes its citizens on their worldwide income, whether or not they are physically located in the United States. Therefore, U.S. citizens living in Canada (or in another foreign country) must file tax returns in both countries.

Based on the fact that you will have to file in both countries there are a number of ways to avoid double taxation if you meet certain requirements living abroad. One way is using the "foreign earned income exclusion". On your U.S. tax return, you may exclude from your income a certain amount of earned income from services provided outside the U.S. Therefore depending on your level of income you may be able to escape U.S. tax completely. Another way to avoid double taxation is by using the "foreign tax credit". If you are subject to U.S. taxation, but have paid tax to Canada on Canadian-source income, you generally claim a foreign tax credit to offset your U.S. tax on that income. The same credit applies if you earned U.S. source income and paid U.S. taxes you can use the taxes paid to offset the Canadian tax that applies to the income.