Citizens and residents of the U.S. who have Canadian retirement assets are subject to different U.S and Canadian tax requirements. Canadian retirement assets are generally not taxed by Canada until distributions are made. Unless action is taken, foreign residents in the U.S. and U.S. citizens living anywhere in the world who have Canadian retirement interests must pay U.S. tax each year on any undistributed earnings of their Canadian retirement assets.
However, under the U.S.-Canada Income Tax Convention, U.S. citizens and residents may elect to defer current U.S. taxation on any undistributed interest income, dividends and capital gains accrued on Canadian retirement interests until those earnings are actually distributed.
- Canadian Retirement Interests
A U.S. citizen or resident may defer U.S. taxation on interests in any one of the following Canadian entities:
- Registered Retirement Savings Plan (“RRSP”)
- Registered Retirement Income Fund (“RRIF”)
- Registered pension plan
- Deferred profit sharing plan
- Election to Defer Current Taxation on Canadian Retirement Assets
To defer U.S. income taxation on the earnings in a Canadian retirement interest, a U.S. taxpayer must file an attachment with his or her U.S. income tax return, which provides:
- A statement that the taxpayer is claiming the tax deferral benefit under Article XVIII(7) of the U.S.-Canada Income Tax Convention and under Revenue Procedure 2002-23.
- The name of the plan trustee and account number, if any.
- The balance in the plan at the beginning of the current year.
The U.S. taxpayer making the deferral election must continue to attach a copy of the statement to his or her U.S. income tax returns for every year until retirement interests are fully distributed from the Canadian entity (or any transferee plan).
- Form 8891 for Canadian RRSPs and RRIFs
In addition, a U.S. citizen or resident must attach a separate Form 8891 for each and every Canadian Registered Retirement Savings Plan (“RRSP”) or Registered Retirement Income Fund (“RRIF”) in which the taxpayer has an interest. The taxpayer may also use Form 8891 to elect to defer taxation on an RRSP or RRIF until amounts are distributed from those interests. The filing requirement applies whether or not the taxpayer elects to defer taxes.
Taxpayers must retain supporting documentation relating to the information reported on Form 8891, including Canadian forms TARSP, TARIF or NR4, and periodic or annual statements issued by the custodian of the RRSP or RRIF.
If an election to defer income taxation on an RRSP or RRIF is not made, the U.S. citizen or resident must pay taxes on undistributed income and earnings in each Canadian plan or fund. A U.S. taxpayer who is receiving distributions from a Canadian RRSP or RRIF must file the Form 8891 with the Form 1040 in each year in which he or she receives a distribution, and pay U.S. taxes on the portion of the distributions subject to tax.
- Statutes of Limitations
The rules regarding the election to defer taxation on Canadian retirement interests have been in effect for a number of years. For those U.S. taxpayers who have never reported their Canadian retirement interests or failed to make a deferral election, back taxes, interest and penalties may be due. The U.S. statute of limitation for back taxes is generally three years unless the taxpayer omits more than 25% of gross income or if the omitted income is in excess of $5,000 and it is attributable to a foreign financial account, in which case a taxpayer must go back six years and pay the taxes, interest and penalties due. However, if a U.S. taxpayer fails to file a tax return or if the IRS suspects fraud, the statute of limitations remains open indefinitely, and the resulting back taxes, interest and penalties due can be significant. The Form 8891 filing requirement first went into effect in 2003.
- Reporting Requirements in Foreign Assets
A U.S. taxpayer may also be required to report Canadian retirement interests on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”). A U.S. taxpayer who has an interest in, or signatory or other authority over accounts outside the U.S., must file an FBAR if the aggregate value of their foreign accounts exceeds $10,000 at any time during the calendar year. The FBAR is filed through the Financial Crimes Enforcement Network’s Bank Secrecy Act E-Filing System on or before June 30th of the year following the calendar year being reported.
Beginning in 2011, a U.S. taxpayer may also be required to file Form 8938, Statement of Specific Foreign Financial Assets, with his or her annual tax return, depending on the value of his or her foreign assets. For example, a single taxpayer living in the U.S. must file Form 8938 if the total value of his or her interest in specified foreign financial assets is more than $50,000 on December 31 of the tax year, or more than $75,000 at any time during the calendar year. If a taxpayer is married filing jointly, then the limits triggering the filing requirement are more than $100,000 of foreign financial assets on December 31 or more than $150,000 during the year. Different limits apply for U.S. citizens living outside the U.S.
Failure to comply with the reporting requirements for foreign investments can lead to substantial civil penalties. Failure to file an FBAR may result in penalties from $10,000 to as high as 50% of the balance in the account per violation. The IRS can impose a separate $10,000 penalty for failing to file a Form 8938. Depending on the facts and circumstances, a taxpayer may also be subject to criminal liability.
- Correcting Errors in the U.S. Reporting of Canadian Retirement Assets
If a U.S. taxpayer has neither paid U.S. tax on the undistributed earnings in his or her Canadian retirement assets nor elected to defer U.S. taxation on those earnings, then the foreign investment income is subject to U.S. tax, interest and penalties. To stop the running of additional U.S. tax penalties and interest, the taxpayer might file amended U.S. tax returns reporting his or her foreign investment income, and pay the requisite tax, interest and penalties.
However, filing amended tax returns to report previously undisclosed foreign income, does not protect the taxpayer from potential criminal prosecution for fraud or failure to file, and may lead to civil examination and the imposition of significant penalties. Instead, using the 2014 Offshore Voluntary Disclosure Program can protect taxpayers from criminal prosecution and reduce the penalties for which the taxpayer is otherwise subject.
A U.S. taxpayer with unreported Canadian retirement income may mitigate his or her overall tax liability by making a retroactive election to defer tax on his or her Canadian retirement interests, and filing delinquent FBARs under one of the new streamlined offshore programs.
There are two streamlined offshore programs: one for U.S. individuals (and estates) residing in the U.S., and the other for those residing outside of the U.S. Under either program, and provided that certain conditions are met, an eligible taxpayer can retroactively elect to defer the U.S. taxation of earnings on his or her RRSP, RRIF or other Canadian retirement interests.
To defer income tax on Canadian retirement assets retroactively, the taxpayer must provide a dated statement, signed under penalties of perjury, describing:
- The events that led to his or her prior failure to make the deferral election.
- The events that led to the discovery of that failure.
- If he or she relied on a professional advisor, the nature of the advisor’s engagement and responsibilities.
The taxpayer must also submit a Form 8891 for each applicable tax year for each Canadian retirement plan or fund, and describe the type of plan covered by the submission.
To participate in the streamlined offshore program, the U.S. taxpayer must also certify that his or her failure to report his or her Canadian retirement interests was not willful, and provide a specific reason for his or her failure to comply. For this purpose, conduct is not willful if it is negligent, inadvertent, a mistake, or the result of a good faith misunderstanding of the legal requirements.
Eligible non-resident U.S. taxpayers participating in the streamlined offshore program will not be liable for any penalties if they are successful in making a retroactive election to defer taxation of their Canadian retirement interests.
However, U.S. resident taxpayers who successfully elect retroactively to defer taxation on their Canadian retirement interests will be subject to a 5% “miscellaneous offshore penalty” on the foreign assets that should have been but were not reported on an FBAR or Form 8938, or on foreign assets that were properly reported but on which tax was not properly paid.
- Action Needed
U. S. citizens living anywhere in the world, and foreign residents living in the U.S. are subject to U.S. tax liability, penalties and interest on the undistributed earnings on their Canadian retirement assets unless they elected to defer U.S. taxation on such interests. U.S. taxpayers with Canadian retirement interests should seek tax counsel for mitigating their U.S. tax liability on those interests and reducing any criminal exposure. IRS correction programs can help taxpayers mitigate their liability for failure to address the U.S. taxation of their Canadian retirement interests.