The Guaranteed Method for Canadian Credit Card Churners to Obtain an ITIN from the IRS...
…That you don’t want to use.
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What the above is saying, is this is probably a bad idea unless you’re a tax professional that can figure out issues with minimal guidance. Master LPs are already complex enough to report for investors who are resident in the USA for tax purposes.
I wrote this post for fun, because it is an unusual crossover between two areas I follow, taxation and personal finance/credit card churning.
I quite enjoy reading about different personal finance topics for Canadians. There is a lot of wisdom shared by the online community and it’s fascinating to see all the different innovative ideas that people come up with to minimize fees and maximize expenses. One subset of this is in the “churning” world where individuals repeatedly sign up for credit cards in order to collect the signup bonus with little intention of staying past the “first year free” period. However, since the Canadian market for credit cards is relatively consolidated, a lot of Canadians set their eyes on the US market where credit card signup bonuses are lucrative and competition is fierce.
However, the largest barrier preventing Canadians from gaining access is a lack of a Social Security Number (SSN) or Individual Tax Identification Number (ITIN). The US credit bureau uses these numbers as unique identifiers, and credit bureaus piggyback on this as a unique way to identify individuals. The SSN is generally only available to those who work and collect social security benefits, so most churners set their eyes on meeting one of the various criteria for obtaining an ITIN.
Typically, filing an ITIN required filing a 1040NR non-resident tax return along with your application for an ITIN. Previous attempts attempted to circumvent this by qualifying under Exception 1(d) of the W-7 Instructions, by claiming that the taxpayer was receiving distributions and needed to provide an ITIN to the withholding agent. This is detailed in many old posts that revolved around earning royalty income from a variety of sources like Amazon Digital Publishing, or SmashWords (or claiming that they would do so soon), and requesting an ITIN on the basis that the taxpayer needed an ITIN in order to qualify for a reduced withholding tax rate under a tax treaty, under Exception 1(d) of the W-7 Instructions.
Modern methods promoted by personal finance blogs ( PointsNerd, FrugalFlyer) all suggest self-reporting income in the USA and filing the 1040NR along with the W-7 application. The income is usually of the wink, wink, nudge, nudge self-reported gambling income, an amount just enough to require filing a tax return, but small enough that the tax payment is about $5-$10 USD payable with the return and comes tacked with a $95 to $250 payment to a company that will complete both forms for you (I do not endorse either service).
Of course, gambling income isn’t the only type of income that could create a filing obligation in the USA.
Taxation of Non-Residents - Who Must File
Taxation is complicated - there are a number of defined terms, that are not simple at all to explain. In order to increase the readability of this post, it is assumed that the taxpayer in question is a tax resident of Canada that has not previously obtained an SSN or ITIN and is not a green card holder or US Citizen.
There are a number of reasons that could create an obligation for a “non-resident alien”. The IRS puts out a list of general scenarios where a non-resident is required to file a tax return.
Reviewing that list, the IRS appears to be accepting returns for the gambling income method through the 2nd point:
A nonresident alien individual who is not engaged in a trade or business in the United States and has U.S. income on which the tax liability was not satisfied by the withholding of tax at the source.
A trivial amount of gambling income is not a trade or business in the United States, and no tax is withheld on small amounts (taxes are generally withheld on larger winnings).
Note that the first point on the IRS list also creates a filing requirement for someone who is engaged in a trade or business in the USA.
A nonresident alien individual engaged or considered to be engaged in a trade or business in the United States during the year.
Doesn’t it sound like it’s really hard to be engaged in a trade or business in the USA, if you’re not physically present in the USA? As it turns out you can also be considered to be engaged in a trade or business in the US if you are a partner in a partnership (or LLC) that has income that is effectively connected with a trade or business in the USA (assuming the partnership has not elected to be treated as a corporation). There are publicly-traded partnerships purchasable on stock exchanges where some or all of the income is effectively connected with a trade or business in the USA, many of these described as a “Master LP” and there are lists maintained by others though not all are eligible (Disclosure: I owned units of SHLX at time of writing). For example, the 10-K for Enterprise Product Partners LP (NYSE: EPD) reads:
Non-U.S. unitholders are generally taxed and subject to income tax filing requirements by the United States on income effectively connected with a U.S. trade or business (“effectively connected income”). Income allocated to our unitholders and any gain from the sale of our common units will generally be considered to be “effectively connected” with a U.S. trade or business.
So, owning a publicly-traded partnership with effectively connected income in the US will create a tax filing obligation for the taxpayer. So, want an ITIN? Just buy a Master LP with income effectively connected with a trade or business in the US. Since many of them are oil pipelines physically situated in the US, many of them qualify.
Getting the ITIN
It is not clear whether ownership of a publicly-traded partnership would allow the taxpayer to pre-emptively obtain an ITIN, or if they would have to file a 1040NR along with their application for an ITIN (W-7).
Generally, the W-7 Form, Application for an ITIN must be accompanied by a tax return, unless it meets one of the exceptions listed on the W-7 Instructions. On the surface, it would seem like the 1(a) would qualify:
1(a) Individuals who are partners of a U.S. or foreign partnership that invests in the United States and that owns assets that generate income subject to IRS information-reporting and federal tax withholding requirements; or
However, the supporting documentation required to be submitted with the W-7 application to take advantage of this exception don’t seem like they would be attainable:
1(a) A copy of the portion of the partnership or LLC agreement displaying the partnership’s employer identification number and showing that you’re a partner in the partnership that’s conducting business in the United States.
Also available is Exception 1(d):
1(d) Individuals who are receiving distributions during the current tax year of income such as pensions, annuities, rental income, royalties, dividends, etc., and are required to provide an ITIN to the withholding agent (for example, an investment company, insurance company, financial institution, etc.) for the purposes of tax withholding and/or reporting requirements.
However, it’s not clear whether an ITIN needs to be provided to the withholding agent for the issuance of the 1042-S (this is the form provided to the non-resident investor showing the amount of withholding tax deducted at source).
The supporting documentation requirements are:
1(d) A signed letter or document from the withholding agent, on official letterhead, showing your name and verifying that an ITIN is required to make distributions to you during the current tax year that are subject to IRS information reporting and/or federal tax withholding. Self-generated income statements will only be accepted with a copy of the contract or a letter with a postmarked envelope addressed from the withholding agent.
It’s also not clear who would provide this signed letter or document - nor whether the withholding agent would be the partnership or the broker the investment is held with, and if the withholding agent would automatically request an ITIN, or if the taxpayer would have to pro-actively ask the withholding agent for an ITIN request letter.
Tax Filing Obligations
Taxation of a partnership interest is different than that of a publicly traded corporation. A partnership is generally (but not always) a pass-through entity, meaning that the income and loss of the partnership are totalled and allocated to each partner according to the rules set by the partnership agreement and reported on a K-1. Each partner then reports the income on their own personal tax return reporting a split of all the different types of income the partnership receives. This is in contrast to corporations where shareholders are taxed on the dividends received. Partnerships have distributions, similar to a dividend, but these are not directly taxed. However, non-US unitholders have withholding tax applied to distributions at the top tax rate, which may be partially recovered if a return is filed.
Filing a 1040NR Federal Tax Return
Irrespective of whether the taxpayer obtains their ITIN in advance under one of the exceptions, the taxpayer will need to fulfill their tax filing obligations in the USA. A K-1 form, reporting income allocated to the investor from the partnership would be issued, as well as a 1042-S reporting the amount of withholding tax on distributions. A 1040NR would likely have to be prepared based on the above documents, from which the taxpayer would likely receive a refund, as withholding tax is withheld on distributions at the top income tax rate (as noted in the EPD 10-K):
As a result, distributions to a non-U.S. unitholder will be subject to withholding at the highest applicable effective tax rate and a non-U.S. unitholder who sells or otherwise disposes of a common unit will also be subject to U.S. federal income tax on the gain realized from the sale or disposition of that common unit.
Furthermore, some more guidance from the same 10-K on the tax treatment on non-US unitholders who sell units of EPD on or after Jan 1, 2022 (IRC § 1446(f)):
Moreover, upon the sale, exchange or other disposition of a common unit by a non-U.S. unitholder, the transferee is generally required to withhold 10% of the amount realized on such sale, exchange or other disposition if any portion of the gain on such sale, exchange or other disposition would be treated as effectively connected with a U.S. trade or business. The U.S. Department of the Treasury and the IRS have recently issued final regulations providing guidance on the application of these rules for transfers of certain publicly traded partnership interests, including transfers of our common units. Under these regulations, the “amount realized” on a transfer of our common units will generally be the amount of gross proceeds paid to the broker effecting the applicable transfer on behalf of the transferor, and such broker will generally be responsible for the relevant withholding obligations. Distributions to non-U.S. unitholders may also be subject to additional withholding under these rules to the extent a portion of a distribution is attributable to an amount in excess of our cumulative net income that has not previously been distributed. The U.S. Department of the Treasury and the IRS have provided that these rules will generally not apply to transfers of our common units occurring before January 1, 2022. Non-U.S. unitholders should consult their tax advisors regarding the impact of these rules on an investment in our common units.
Filing US State Returns
If that wasn’t enough, the taxpayer may find themselves also liable for state income tax as well, in some of the states that the Master LP does business in. As all income is passed to the taxpayer, individual state rules may require the taxpayer report the income from a trade or business in that state, as noted in an SEC investor alert about Master LPs:
Additionally, investors may need to file state tax returns in states where the MLP operates even though the investors do not live in that state.
Canadian Tax Implications
Finally, the income also needs to be reported on the investor’s personal tax return, however the income should generally be reported using Canadian income taxation rules.
Additionally, the investor’s partnership ACB should also be calculated according to Canadian tax rules (as opposed to US tax rules for calculating basis), in order to properly calculate the capital gain/loss on the eventual sale of the asset.
To summarize, an aspiring credit card churner could easily create the conditions necessary to obtain an ITIN as simple as buying units in one of many publicly-traded partnerships. However, the actual tax filing requirements may often be significantly greater than anticipated and pose a significant time and/or cost burden after the fact.
Bonus: Registering for an ITIN - Proof of Identity
When registering for an ITIN, it is necessary to provide proof of identity, which personal finance blogs often recommend be accomplished by a passport that can either be mailed directly to the IRS, or a certified copy can be obtained from Passport Canada for $45 CAD.
The IRS actually offers a third option, which is to book an appointment at an IRS Taxpayer Assistance Center for an In-Person Document Verification, available in many cities throughout the USA where IRS officials can directly review your identity documents and accept your W-7 ITIN application (along with accompanied tax return and/or supporting documentation). A useful option for people who occassionally visit the USA.
Appointments must be booked in advance, and appointment slots may be booked up for months in advance in major urban centres - this is exacerbated by the closure of many IRS TACs due to COVID-19.
Fortunately, there are still a lot of appointments available in smaller cities that can be booked much sooner for those with a car to get around, such as the one in Erie, PA.