Tax treatment of Canadian investments in the US can be complex. It can even be difficult to find a tax advisor (U.S. Tax Compliance) who can offer full tax service for such investments. Failure to submit one or more of these forms can result in severe penalties. This article provides an overview of the most common Canadian investments.
Canadian investments include:
- RRSP (Registered Retirement Savings Plans);
- RRIF (Registered Retirement Income Funds);
- TFSA (Tax Free Savings Accounts);
- RESPs (Registered Education Savings Plans; and
- Canadian mutual funds
RRSP and RRIF
In Canada, contributions to the RRSP are deductible from income and earnings are tax deferred until distributed. Distributions are taxed as ordinary income. At the end of the year, when the owner reaches the age of 71, the RRSPs must either be withdrawn entirely (fully taxable) or converted to RRIF with a required annual minimum distribution.
Until the fifth protocol of the tax treaty between the United States and Canada (effective as of 2009), the United States did not allow the deduction of contributions to the RRSP from taxable income. Therefore, RRSPs would have a cost basis for non-deductible contributions made before 2009. Assuming that taxpayers comply (U.S. Tax Compliance) with taxes for all previous taxable years, at the time of distribution, only the portion not attributed to contributions after tax would be taxable. For US non-compliant individuals or non-residents when contributions were made, all distributions would be fully taxable as ordinary income. Currently, however, RRSP and RRIF earnings are tax-deferred in the US.
TFSA and RESP
In Canada, TFSA and RESP contributions are not deductible, and earnings are not taxable. They are generally treated as foreign grantor trusts for US tax purposes. Profits from a foreign grantor trust flow through to the US grantor / owner and are subject to US income tax. Distributions are not taxable to beneficiaries, although there may be reporting requirements involved.
Depending on the nature of the plan, the US owner may be required to file Form 3520-A, Annual Information Statement from a Foreign Trust with a US owner, to report the income statement and the balance sheet of the trust. In addition, the US owner / trustee must provide, by the filing deadline, the owner’s statement for each US owner and the beneficiary statement for each US beneficiary receiving a distribution from the trust during the tax year. Form 3520-A is due on the 15th day of the third month after the end of the trust’s fiscal year and is eligible for an automatic 5 1/2-month extension to file, provided Form 7004 is filed on time.
The US owner and / or US beneficiary must file Form 3520, Annual Statement to Report Foreign Trust Transactions and Receipt of Certain Foreign Gifts, as part of the US tax return. Failure to file or late submission of Forms 3520-A and 3520 can result in significant penalties. Fortunately, in many situations, Form 3520 is no longer required under the 3520 exemptions the IRS issued in March 2020.
Canadian mutual funds
Canadian mutual funds are treated as PFIC (Passive Foreign Investment Company). Beginning in 2013, new regulations issued by the IRS and the Department of the Treasury require all U.S. persons who directly or indirectly own shares in a PFIC at any time during the year to file Form 8621, Shareholder Information Statement of a Passive Foreign Investment Company or Qualified Electoral Fund. The annual filing requirement does not apply if the year-end value of all PFICs owned by the individual does not exceed $ 25,000, and there was no income / distributions from a Canadian mutual fund during the tax year.
Canadian mutual funds held in RRSP and RRIF are not subject to this requirement because earnings from these plans are tax deferred until distribution. However, Forms 8621 may be required for any foreign mutual fund investment held in TFSA and RESP.
Canadian mutual funds are generally treated as Section 1291 funds unless elections are made on Form 8621 for QEF (Qualified Election Fund, Section 1295) or Mark to Market (Section 1296). Income from Section 1291 funds is divided into three categories, each taxed differently:
- Distributions without excess (reported as ordinary dividends);
- Excess distributions assigned to the current year (reported as ordinary income); and
- Excess distributions allocated to prior years (treated as ordinary income subject to deferred taxes and interest charges).
The provisions of Section 1291 funds are treated as excess distributions.
- RRSP and RRIF: Distributions are taxed as ordinary income, similar to traditional IRAs with or without basis.
- TFSA and RESP: Income is taxed to the US owner annually, regardless of distributions. Information returns (Forms 3520-A and 3520) must be filed annually if the plan is considered a foreign grantor trust, although there are now exemptions from this filing requirement.
- Canadian mutual funds are treated as PFIC. Form 8621 must be filed for each Canadian mutual fund.
We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.