In Short:

Canadians who are working in the United States for long enough to be considered “residents” under U.S. tax law will be taxed on the earnings of Canadian retirement plans unless they file Form 8891 to report the plans, and make an election to defer tax on the earnings.  They must also file Foreign Bank Account Reports (FBAR’s) with the U.S. Treasury Department if the value of those accounts is at least $10,000 during the year, check a box on Schedule B of the U.S. tax return whether or not those accounts exceed $10,000, and file Form 8938 with the U.S. tax return reporting those accounts if the value exceeds $50,000 at the end of the year or $75,000 at any time during the year.  Companies with Canadian employees in the U.S. should make sure those employees understand these requirements, as failure to comply can result in substantial tax liabilities and penalties.

The Full Story:

Today’s tax quote:  “The trick is to stop thinking of it as ‘your’ money.”   Anonymous tax auditor

As discussed in detail below, Canadians who are resident workers in the U.S. need to be very careful in dealing with their Canadian retirement plans if they wish to continue thinking of those accumulated funds as “their” money.

As has been discussed previously in this space (see the blog entry “U.S. and Canada Issue Border Action Plan,” January 24, 2012, by Tristan North) Worldwide ERC and the Canadian Employee Relocation Council (CERC) have worked jointly to assist their respective governments to address cross-border issues in order to facilitate movement of employees between the two countries.

While this important and worthy effort has not focused on taxes, citizens of either the U.S. or Canada moving to the other country to work also face tax questions, some of which can lead to quite unfortunate results if not properly understood.  One of these concerns the treatment of Canadian retirement plans left behind in Canada. 

Canada treats Registered Retirement Income Funds (RRIF’s) and Registered Retirement Savings Plans (RRSP’s) the same as IRA’s and 401k plans are treated in the United States.  That is, tax on the earnings is deferred until the earnings are withdrawn or the beneficiary reaches a certain age.  Unfortunately, U.S. tax law does not allow for this deferral for U.S. citizens or residents who maintain RRIF’s or RRSP’s.   Owners of those accounts would be taxed on the earnings without some form of relief.

Relief is provided under the United States-Canada Income Tax Convention (“Treaty”).  Under the Treaty, an individual who is a beneficiary of a Canadian retirement plan that is exempt from Canadian income tax may elect to defer U.S. tax on the accrued but undistributed income of the plan until the income is actually distributed. 

IRS implementation of this provision over the years has been somewhat confusing.  A series of IRS Revenue Procedures and Notices beginning with Rev. Proc. 89-45, and including Rev. Proc. 2002-23 and Notices 2003-25, 2003-57, and 2003-75, addressed how and when to make the required election, and for a time IRS was insisting that beneficiaries of these accounts not only make the required election, but also file Forms 3520 reporting the ownership of “foreign trusts.”  Eventually, however, IRS issued Form 8891, which currently must be filed by any U.S. citizen or resident who is a beneficiary of a Canadian retirement plan, and is also used to make an election to defer tax on earnings of those plans.

A separate Form 8891 must be filed for each retirement plan, and attached to the Form 1040 U.S. income tax return.  If spouses are each beneficiaries of a plan, each must file a separate Form 8891.  And if the beneficiary elects on the Form 8891 to defer tax on the earnings of the plan, that election is irrevocable. 

Canadians moving to the United States to work, and who remain in the United States long enough to be considered a “resident,” (ordinarily, more than 183 days during the year), must file Form 8891 to report any Canadian retirement plans they still own, and unless they want to pay U.S. tax on the accrued income, must make the election to defer tax.  Unfortunately, sometimes these workers are not aware of the requirements, and that lack of awareness can create major problems. 

If the Form 8891 is not filed, and no election is made, the deferred income from the retirement plan should have been reported on the Form 1040, and tax paid.  Failure to do so will lead to an underpayment of tax, interest on the underpayment, and potential penalties for negligence and failure to pay.  Moreover, if the Canadian has been a resident for several years without the required filing and election, IRS may go back and assert tax for at least three of those prior years under the normal statute of limitations on assessment of tax, or six of them if the omission of income was substantial, or all of them if the omission was due to fraud. 

Nor is the taxpayer ordinarily permitted to go back and make a retroactive election, unless the taxpayer obtains specific permission to do so from the IRS by filing a private letter ruling request asking for relief under section 301.9100-1(c).  Doing so is difficult, costly, and will not be successful unless done before IRS itself discovers the failure to report and elect. 

As if these unfortunate results were not enough, there are also two other reporting requirements for beneficiaries of Canadian retirement plans, with substantial penalties for failure to comply. 

Owners of foreign financial accounts exceeding $10,000 in value during the year must file a Foreign Bank Account Report (FBAR), Form TD F 90-22.1, with the Treasury Department by June 30 of each year.  Generally, a Canadian RRIF or RRSP worth $10,000 or more would require such a report.  There are substantial penalties even for an inadvertent failure to file the FBAR.  Such accounts also require that a box be checked on Schedule B of Form 1040, revealing that the taxpayer has foreign accounts, even if the accounts do not exceed the $10,000 FBAR reporting threshold.  And, beginning for the 2011 tax year, a new Form 8938 is required to be filed with the U.S. tax return reporting foreign assets whose value exceeded $75,000 at any time during the year, or $50,000 at the end of the year, which is a threshold that  many existing Canadian retirement accounts would no doubt exceed. 

Consequently, for companies moving a Canadian to the U.S. to work, the U.S. requirements concerning retained Canadian retirement plans simply must be a part of the instruction and planning for that assignment.  The employees should be informed and counseled as to the requirements to make sure that they do not incur costly U.S. tax liabilities and penalties for failing to report the accounts. 

Posted by Peter K. Scott