While many U.S. citizens living in Canada have recently become aware of the requirement to file annual U.S. individual income tax returns, they may not be aware of the specific filing requirements in regard to certain registered investment plans held in Canada.
RRSPs and RRIFs
Canadian retirement accounts held by U.S. citizens, such as Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs), require specific reporting with the Internal Revenue Service (IRS) in order to receive tax-deferred status in the U.S. RRSPs and RRIFs are not tax-deferred under the U.S. Internal Revenue Code (IRC), and thus the income generated inside these accounts technically is taxable income for U.S. tax purposes. It is only through an election in the Canada-U.S. Income Tax Convention (the Treaty) that these accounts may receive tax-deferred status in the U.S.
To make the election pursuant to Article XVIII(7) of the Treaty, U.S citizens must file IRS Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, for each year the account is held. A separate Form 8891 is required for each RRSP or RRIF account. The form requires certain information regarding the accounts, including the account number and the balance held in the account at the end of the tax year. Form 8891 is to be filed annually with the U.S. individual income tax return.
Failure to file the form will result in the accounts becoming taxable in the U.S., and any income generated within an account must be reported as income on the U.S. individual income tax return, even if no monies are withdrawn from the account. This can lead to U.S. tax owing depending on the amount of income generated within the account.
Under new IRS streamlined filing compliance procedures, U.S. citizens residing in Canada who have failed to file these forms may use the procedures to become compliant, even if they have previously filed their U.S. individual income tax returns. For more information regarding the new IRS streamlined procedures, please refer to our November 2012 U.S. Tax Alert.
RESPs
Another type of registered account commonly held by U.S. citizens living in Canada is the Registered Education Savings Plan (RESP). In Canada, an RESP allows money deposited for a child’s post-secondary education to grow on a tax-deferred basis, with the income ultimately taxed in the child’s hands upon withdrawal. There are also Government of Canada grants that match contributions to this plan, with certain limitations. Unfortunately, unlike RRSPs and RRIFs, the RESP is not granted the same tax-deferral election under the Treaty. Thus the income earned within the RESP is taxable to the subscriber (i.e. the parent) on their U.S. return in the year the income is earned. It is important to note that any grant received from the Government of Canada in the RESP is considered income, and is taxable in the U.S. in the year it is received.
This issue can lead to double taxation, as the income in the RESP is taxed in the hands of the subscriber for U.S. purposes and taxed again for Canadian purposes in the hands of the child when the income is withdrawn from the RESP, usually several years later.
In addition to these negative consequences, the IRS considers RESPs to be foreign trusts, requiring trust returns (Forms 3520 and 3520-A) to be filed on an annual basis in the U.S. There can be significant penalties for failure to file the forms. Form 3520 is due at the same time as the U.S. tax return of the subscriber, including extensions, while Form 3520-A is due on March 15. An extension is available for the 3520-A filing.
One practical solution to these issues is to transfer the RESP into the hands of a non-U.S. citizen/resident subscriber. Typically, a non-U.S. parent, grandparent or other relative becomes the subscriber. This transfer does not, however, address the filing requirements of the U.S. citizen for the tax years in which they were still the subscriber.
Tax-Free Savings Accounts
Similar to RESP accounts, Tax-Free Savings Accounts (TFSAs) are not “tax free” for U.S. purposes. The income earned within a TFSA must be reported on the U.S. individual income tax return in the year earned. Depending on the structure of the TFSA, it may also be subject to the foreign trust filing requirements discussed above, although the IRS has not commented specifically on this issue.
Summary
It is important to recognize that the U.S. tax rules may treat certain items differently than they are treated under Canadian tax rules. Two specific examples presented above are the RRSP and RRIF accounts, which are only tax-deferred for U.S. purposes when the proper election is filed. Further, RESP and TFSA accounts are never treated as tax-deferred vehicles in the U.S., and may be subject to U.S. foreign trust tax filing obligations. Finally, it is important to note that all of the accounts discussed in this article must be disclosed on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) and IRS Form 8938, Statement of Specified Foreign Financial Assets, if the respective filing thresholds for these two forms are met.
Contact your Collins Barrow advisor for more information on your U.S. filing obligations and any other U.S. tax matters.
Matt MacEwen, CPA, CA, CPA (Colorado), is a Tax Manager in the Kingston office of Collins Barrow.
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