The Canada-US border is the longest undefended border in the world. Over one million Canadians live in the US, and a similar number of Americans live in Canada. Since there is so much crossover, it would make sense for Canada and the US to recognize the tax-exempt status of each other’s retirement and savings accounts.
Unfortunately, certain tax-deferred and tax-exempt retirement and savings accounts held by individuals moving across the border can cause unfavourable tax consequences: the Internal Revenue Service (“IRS”) does not recognize the tax-exempt nature of certain Canadian retirement and savings accounts, and, similarly, the Canada Revenue Agency (“CRA”) does not recognize the tax-exempt nature of certain US retirement and savings accounts.
However, there is hope that change is on the horizon due in large part to recent efforts by the American Institute of Certified Public Accountants (“AICPA”) and the Chartered Professional Accountants of Canada (“Canadian CPAs”). Before providing details about these efforts, I’ll review some of the most pressing cross border issues regarding certain retirement and savings accounts.
Cross Border Issues: Canadian Tax-Deferred/Tax-Exempt Accounts
Currently, the IRS deems the Tax Free Savings Account (“TFSA”) as a foreign grantor trust. As a result, US persons with a TFSA must make extra tax filings, such as IRS Forms 3520 and 3520A, which they may have to pay an accountant to complete. They may also have to pay tax on annual earnings inside their TFSA. Should US persons with TFSAs fail to file the required IRS forms, they will be subject to large fines. Due to all of the costs associated with holding a TFSA as a US resident, it is generally not beneficial for Canadians who become US residents to maintain TFSAs.
Registered Education Savings Plans (“RESPs”) are also troublesome for Canadians moving to the US. If a US person sets up an RESP for a child, the RESP could be considered a foreign grantor trust for the subscriber since the subscriber can reclaim the capital if the funds don’t end up being used for education purposes. Similar to a TFSA, an RESP is considered a trust for US reporting purposes. All the same filings and costs associated with maintaining the TFSA in the US would be applicable to the RESP. In addition, the US subscriber would be taxed on the income as it is earned within the plan, while the beneficiary would be taxed by the CRA on the income as it is withdrawn, creating double taxation. The Registered Disability Savings Plan (“RDSP”) has the same tax filing requirements and consequences as the RESP should a Canadian subscriber maintain such an account after he or she moves to the US.
Although neither the Canadian nor American governments have taken much action to address the disparate way that certain savings and retirement accounts are treated in each country, some of the cross border issues that plague retirement and savings accounts have recently begun to be addressed.
Recent Advancements re: Canadian Tax-Deferred/Tax-Exempt Accounts
IRS Form 8891
For example, prior to fall 2014, Canadians living in the US were required to file IRS Form 8891 in order to maintain the tax-deferred growth of their Registered Retirement Savings Plans (“RRSPs”). This was yet another form that needed to be filed and yet another cost for Canadians living in the US during tax season. In September 2014, it was announced that taxpayers with RRSP accounts would no longer be required to file IRS Form 8891. This change was a welcome surprise; taxpayers hoped that the eradication of IRS Form 8891 would be the beginning of Canada and the US making an effort to ease the transition from one country to the other with respect to cross border financial planning.
Recently we have witnessed yet another step in the right direction. On March 4, 2016, the AICPA submitted a request to the US Department of Treasury asking to provide tax relief for US residents who have made contributions to tax-deferred and tax-exempt savings accounts in Canada such as the TFSA, the RESP and the RDSP.
In the letter, the AICPA recommended several measures for the US Department of Treasury with regards to the TFSA, namely:
- Exempting a TFSA from the grantor trust rules as well as treating distributions from a TFSA in a manner comparable to the treatment of such distributions by Canadian tax provisions;
- Exempting Canadian mutual funds held within a TFSA from the definition of a Passive Foreign Investment Company (“PFIC”) and the associated reporting requirements for PFICs (i.e. to treat Canadian mutual funds held within TFSAs the same way they are treated inside RRSPs); and
- Exempting a US owner of a TFSA from the complex foreign trust information reporting requirements if the TFSA is considered a foreign trust for US tax purposes.
Several similar measures were also recommended for the tax treatment of both the RESP and the RDSP, including exempting both savings accounts from the IRS’s punitive grantor trust rules and complex foreign trust information reporting requirements. Other recommendations included:
- Allowing a tax deferral of plan income until it is distributed to beneficiaries, as per Canadian tax provisions; and
- Taxing the beneficiary (if a US person) on the distribution in the year it is received.
Additional Advancements on Cross Border Issues re: Tax-Deferred/Tax-Exempt Accounts
The AICPA’s submission came on the heels of a similar submission made on February 25, 2016. On that date, the Canadian CPAs submitted a letter to the Canadian Department of Finance requesting tax relief to the US-equivalent of the Canadian plans discussed above: the 529 plan (similar to the RESP), the Roth IRA (similar to the TFSA) and the Qualified Section 529A Disability Benefit Plan (similar to the RDSP).
The American Chamber of Commerce in Canada, which is committed to promoting trade opportunities; advancing economic growth; and facilitating the mobility of people, goods and services across the border, also intends to send letters to both the US Department of Treasury and the Canadian Department of Finance to promote more symmetry between US and Canadian tax-deferral accounts.
When the IRS Form 8891 filing requirement was eliminated near the end of 2014, it signalled the beginning of a more symbiotic relationship between the Canadian and American governments and their tax residents. Although the AICPA and Canadian CPAs’ submissions do not mean that change is imminent, these submissions have prompted both governments to think about making certain accounts easier to manage for Canadians moving to the US and Americans moving to Canada.
MCA Cross Border Advisors, Inc. is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.