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How The U.S. May Tax a Canadian Tax Free Savings Account

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Qualified individuals in Canada can start a Tax Free Savings Account (TFSA) and earn income in a tax-free manner. The TFSA account provides tax benefits for savings where investment income earnings, including capital gains and dividends, are not taxed when withdrawn. However, unlike the Registered Retirement Savings Plans (RRSP), contributions to a TFSA are not tax deductible for the annual income tax purpose.

tfsaThe TFSA offers a lucrative and general-purpose savings  vehicle for Canadians, who are living in Canada. However, it may not turn out to be as good as it seems for anyone who is subject to tax codes by the US Internal Revenue Service (IRS). This is because, unlike the RRSP, the Internal Revenue Service does not grant tax-deferred status to the Canadian TFSA. Since any income generated in the TSFA is taxed under US law, this taxable status usually takes away any fringe benefits of having a TFSA account for most Canadians residing in the U.S.

Moreover, most Canadians will be required to report the TFSA to the US Department of Treasury on an annual basis, as it is mandatory to submit the Report of Foreign Bank and Financial Account Form TD F 90-22.1. If you are a Canadian, living in the US as a resident, you may have to pay penalties for failing to disclose the TFSA account, which is termed as a foreign bank account.

Again, there are additional concerns regarding whether or not the TFSA will be considered as a foreign trust  under the US tax law. There is considerable confusion regarding this, as the Internal Revenue Service (IRS) has not revealed their official position on this issue yet. In the circumstance that the IRS decides to consider the TFSA as a foreign trust, the Canadian, who is a U.S. taxpayer, will be termed as an owner of a non-resident trust. As a consequence, the Form 3520-A, titled “Annual Information Return of Foreign Trust With a U.S. Owner,” will be required to be filed within two and half months once the trust’s year ends. Any failure to submit the Form 3520-A with the IRS will be subjected to a penalty greater than $10,000 or 5-percent of the gross value of the trust, which is the total amount left in the TFSA at the end of the tax year.

Then, under the Form 3520, titled “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts,” it may be required to disclose contributions to and withdrawals from the TFSA to the IRS. Any failure to submit this additional form may result in a penalty equal to 35- percent of the contribution or withdrawal amount.

In conclusion, Cardinal Point Wealth Management recommends that U.S. taxpayers, regardless of their current residency status in the U.S. or abroad, consider not contributing to an existing TFSA, withdrawing all remaining TFSA funds, and stopping the use of the account. Following these steps, avoids taxation in both Canada and the United States. For further advice on navigating the complications of cross-border wealth management and taxations, contact us today.

Terry Ritchie is the Director of Cross-Border Wealth Services at the Cardinal Point, a cross-border wealth management organization with offices in the United States and Canada.  Terry has been providing Canada-U.S. cross-border financial, investment, tax, transition, and estate planning services to affluent families for over 25 years.  He is active as an author, speaker and educator on international tax and financial planning matters. www.cardinalpointwealth.com

Should this family move to the U.S.?

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This article looks at families who are faced with the prospect of a cross-border move and career changes. Featuring the commentary of Cardinal Point’s Terry Ritchie, it presents a case study to show the potential tax, retirement and estate planning implications of a cross-border move. In the scenario, a hypothetical family from Ottawa is faced with the father’s possible layoff and the mother’s potential job transfer to Texas. The couple also has retirement and education savings considerations. The case study was originally presented at the IAFP Symposium and is intended to show advisors how short-term, retirement and family goals can be managed concurrently.

The article evaluates the family’s three options and the issues and advantages that arise with each. It compares the tax impact and housing markets in Ottawa and Texas, as well as the compensation and employment benefits of each scenario. Ritchie comments on the impact that a move to Texas would have on the couple’s registered account, their unrecognized registered assets, and company savings, as well as what would happen if the family eventually returned to Canada.

Preparing to Exit Canada for the United States? (Part IV)

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In the fourth installment of the series, John McCord looks at the importance of consulting an attorney with cross-border expertise to analyze your estate plan before a move. Estate planning is a sophisticated, rapidly changing subject, and the laws governing it are not uniform between Canada and the U.S. A collaborative approach between cross-border financial advisors, CPAs and other practitioners is recommended when developing a cross-border estate plan. The article also looks at Canadian corporate pensions and how a U.S. move may impact pension taxation. Canadian pensions are taxed at IRS income tax rates when domiciled in the U.S., which can create additional after-tax pension income but also raises the risk of double taxation.

Preparing to Exit Canada for the United States? (Part III)

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The third and final installment of the series addresses what to do with your Registered Retirement Savings Plan (RRSP). This article discusses some of the fundamental decisions that must be made concerning any tax-deferred accounts that are being left in Canada. It also looks at some of the common strategies suggested by cross-border financial planning advisors.

Preparing to Exit Canada for the United States? (Part II)

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Part 2 of the series focuses on the process of emigrating to the United States. The article includes a list of actionable items that support residency and should be undertaken prior to relocating. It also discusses tax treatment for a Canadian Pension Plan (CPP) and Old Age Security Pension (OAS) income following a move to the United States.