U.S. Reporting Requirements for Canadian Citizens
Every so often, the IRS likes to remind people, and that includes U.S. citizens, resident aliens, and those with dual citizenship, that you may have a tax liability and reporting requirement to fulfill. The country of Canada has long been a good partner in the fight against tax evasion and the promotion of voluntary compliance with tax laws. With the implementation of FATCA (Foreign Account Tax Compliance Act), Canada soon after announced that it would enter into an Intergovernmental Agreement (IGA) with its neighbor, the United States, to help with IRS reporting requirements and tax obligations that apply to its citizens. To that end, there are impacts that Canadian citizens should be aware of, and depending on your circumstances, it may be necessary to consult with a legal tax advisor to ensure you are in compliance.
Income taxes are treated quite differently in Canada versus the United States. The overarching reason has to do with residency and citizenship. Namely, in Canada, income tax laws are based on residency, whereas, in the United States, they are based on citizenship. In other words, if a person fully resides in the country of Canada, then that person’s income (no matter the source) is taxed in Canada. On the other hand, if you are a U.S. citizen, no matter where in the world you reside, you are required to file an annual U.S. tax return to the IRS. In a nutshell, U.S. citizens who happen to live in Canada must file two returns each year: a Canadian income tax return as well as a U.S. tax return.
Under FATCA, financial institutes are required to identify U.S. citizens who have financial investments. Completion of IRS Form 8938, Statement of Specified Foreign Financial Assets, is a requirement if the foreign investment exceeds a specific amount. This form will help the IRS match up figures to the taxpayer’s personal return. Secondly, U.S. citizens who have shares in a passive foreign investment company (PFIC) must disclose certain information regarding this investment on an annual basis. Thirdly, individuals with an interest in, or signature or other authority over, foreign financial accounts whose aggregate value exceeded $10,000 at any time during the calendar year must file a FBAR (Report of Foreign Bank and Financial Accounts). FBAR refers to Form 114, which is not part of your tax return, and must be filed with the Financial Crimes Enforcement Network (FinCEN) — a bureau of the Treasury Department.
RRSP / RRIF / RESP
In regards to investments such as Registered Retirement Savings Plans (RRSP), Registered Retirement Income Funds (RRIF), and Registered Education Savings Plan (RESP), there are a few things to take note of.
- RRSP: This retirement savings plan is opened and contributed to by a taxpayer. The Canada Revenue Agency registers it and under Canadian tax law, the contributions to the RRSP are deductible on a Canadian tax return and thus reduce Canadian tax liability. Any income earned in the RRSP is usually exempt from tax as long as the funds remain in the plan; a taxpayer generally has to pay Canadian tax when he or she receives payments from the plan.
- RRIF: This arrangement is between a taxpayer and a carrier (an insurance company, trust company, or bank) that Revenue Canada registers, and where the taxpayer transfers property to the carrier from an RRSP. The minimum amount must be paid to the taxpayer in the year following the year the RRIF is entered into. Earnings in an RRIF are tax-free, and amounts paid out of an RRIF are taxable upon receipt.
- RESP: Income earned in an RESP is taxable for U.S. income tax purposes. Because this investment is considered to be a foreign trust in the eyes of the IRS, any income by way of interest, dividends, and capital gains is taxed as income on an annual return. In addition, Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, must be filed any year that contributions are made or funds have been withdrawn from the plan. Finally, if either the subscriber and/or the beneficiary of an RESP is a U.S. citizen, the U.S. tax filing and reporting obligations associated with a Canadian RESP should be considered to determine the feasibility of establishing (or maintaining) the RESP.
There have been many twists and turns through the years pertaining to the treatment of taxes and certain Canadian investments. In recent years, the IRS has decided to view RRSPs and RRIFs more favorably, which means reporting requirements have simplified. Currently, both Americans and Canadians with these two investments automatically qualify for a tax deferral similar to what is available to people who participate in IRAs or 401(k) plans. This qualification will remain as long as taxpayers continue to file annual tax returns for any year the investments were held and include any distributions as income on their return. This treatment is more favorable because it used to be the case that the tax would be due each year on the income, whether it was distributed or not. It is important to note that RRSPs and RRIFs may need to be reported on Form 8938 and/or FinCEN Form 114 annually.
You have probably gathered that IRS reporting and filing requirements between the United States and Canada can be complex and difficult to fully understand. To complicate matters more, individual state tax requirements can also be subject to changes and not always match what the federal government calls for. For this main reason, if you desire to be in full tax compliance, your best bet would be to consult with a legal tax attorney.
Dallo Law Group can be of service. Our professionals are able to review your investments and carefully advise you on proper elections. We are also experts on state tax laws, so you can rest easy knowing you are in good hands. It makes no sense to avoid these important obligations. Our attorneys specialize in foreign holdings and our extensive experience will help you avoid failures in compliance or reporting. As always, your first consultation with us is free and without obligation.