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The United States taxes not just individuals living in the United States, but also U.S. citizens and residents living abroad. It is possible to be a resident of the United States, even if you live in Canada, for instance, by holding a ‘green card’.
There are many Americans (living in the U.S., Canada and third countries) who hold individual Canadian retirement accounts. These accounts come in a range of flavours. The ones addressed here include:
• Registered Retirement Savings Plan (RRSP)
• Registered Retirement Income Fund (RRIF)
• Locked-in Retirement Account (LIRA)
• Life Income Fund (LIF)
• Locked-in Retirement Income Fund (LRIF)
There is some uncertainty as to whether a ‘group’ RRSP would fall into this category. This is a very technical question that is not addressed in this blog.
A Tax-Free Savings Account (TFSA) doesn’t fall into this category. For the treatment of a TFSA, see my article in Wolters Kluwer Tax Topics #2146, April 25, 2013.
This article does not address pension plans or other group plans.
The old rules (‘current taxation’)
The default U.S. tax treatment of these plans is that they are ‘grantor trusts’. This means the contributor has the ability to obtain back the money he or she put in. This is clearly the case for a regular plan; it’s a little more complicated for a spousal plan, but the result is the same.
With a grantor trust, the plan is seen merely as an account like any other. This means income and gains earned inside the plan are taxable to the individual as they are earned.
There are two problems with this, in relation to taxation and reporting:
1. For Canadian purposes, the income earned inside the plan is tax-deferred until it is withdrawn. The U.S. timing doesn’t match, meaning that it is possible that the U.S. foreign tax credit mechanism won’t work – it’s easy to get double taxation.
2. The default reporting of these plans (forms 3520 and 3520-A) is a lot of work and complicated.
The old fix (‘deferral election’)
To deal with this problem, it has been possible to elect under the Canada-U.S. tax treaty to defer the U.S. recognition of the income earned inside the plan until withdrawal. Since 2004, individuals have been able to file form 8891 to make the election, which is much less work than the 3520/A (these forms are not required anymore).
The negative here is that it has historically been necessary to make the election, which means filing the forms. Many people don’t think to do this, but if they did think about it, they believed that simply doing nothing yielded the same result.
Deferral is the new default
The IRS is essentially reversing the default treatment. In general, an individual will be considered to have made the treaty election for deferral, unless they opt out. You no longer need to file form 8891.
Not everyone falls into this category. Basically, it’s open to anyone who hasn’t already filed a U.S. return utilizing the non-treaty approach (the ‘old default’, above). So to be eligible for the new treatment, a U.S. person must have:
• Filed a U.S. tax return for each year (presumably, complying with the streamlined filing procedure is sufficient);
• Not reported undistributed earnings on any of those returns; and,
• Reported previous distributions (if there were any) as though he or she had made the treaty election.
One really great thing about this new approach is that it applies retroactively. If you meet the criteria above, you have the “deferral” treatment back to the first date it would have applied (the later date between when you made the contribution and the date you became a U.S. person).
Once you are using the ‘deferral’ approach, in order to move to the ‘current taxation’ approach, you have to ask the IRS for permission. If you don’t meet the eligibility requirements above (basically, you’ve reported the plan income on a contemporaneous basis), you’re stuck with that approach unless you get permission to change from the IRS.
No need to file form 8891
Regardless of whether you use the ‘current’ or ‘deferral’ approach, the requirement to file form 8891 is revoked for tax year 2014 and future years (and forms 3520/A are also not required).
Because contributions are non-deductible for U.S. purposes, it is important to track them. The U.S.-taxable amount of withdrawals will be different than the Canadian amount.
Foreign financial account and asset reporting
Individuals who have to report foreign (non-U.S.) financial accounts and assets (see my blog here) still have to do that. The above changes don’t affect this requirement. If you are following the new rules, and you do not file form 8891, the balance in the plan must be reported on form 8938 (assuming the total assets are above the filing threshold).
Reference: Rev. Proc. 2014-55, IR 2014-97
Related Topics:U.S. Tax; International Tax; IRS
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