June 2012 Archives

June 25, 2012
Posted by Sanger & Manes, LLP

Canadians with RRSP's living in Palm Springs- the US Will Tax Your RRSP Earnings Each Year Even if You Don't Receive a Plan Distribution, Unless You Affirmatively Elect Otherwise

In the last post, we discussed how the State of California will tax RRSP earnings which sit in Canada on an annual basis, even if the Canadian who is now a US resident does not receive a distribution. Not a good result. But don't forget, the US will also tax the earnings of an RRSP on an annual basis, unless the Canadian living in the US elects otherwise pursuant to Article XXIII(7) of the US-Canada Tax Treaty. How does the Canadian elect that the US should not tax the earnings on an annual basis? He or she files an IRS Form 8891 to defer US tax on income accrued in the RRSP. But what if they forget to file, or only recently recently found out about this obligation?

IRS Private Letter Ruling 201225002 Provides Relief For Past Years For Those Who Recently Discovered the Obligation to File a Form 8891

Just 3 days ago (June 22, 2012), the IRS reviewed a situation where a Canadian (now a US resident) had a RRSP, but had not filed a Form 8891 to defer US federal income tax on the RRSP's earnings. The taxpayer has not contributed any money to the RRSP nor withdrawn any money from the RRSP since becoming a U.S. resident. The taxpayer was not aware of the need to make an election pursuant to paragraph 7 of Article XVIII of the United States - Canada Income Tax Treaty on Form 8891 in order to defer the US tax on income accrued in the RRSP. Then, the taxpayer read a news article that dealt with IRS rules about Canadian RRSP accounts, did further research on the rules, and sought professional advice. The taxpayer then requested from the IRS an official extension of time (in order to cover prior years) to file the Form 8891, to defer the otherwise required federal income tax on the interest component. The request for an extension of the time is the subject of IRS Private Letter Ruling 201225002.

The IRS ruled that it has discretion to grant a taxpayer a reasonable extension of time to make a regulatory election, provided the taxpayer provides evidence to establish to the satisfaction of the IRS that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government. The IRS ruled the taxpayer did satisfy the good faith standard, and granted an extension of time until 60 days from the date of the PLR ruling (June 22, 2012) to make an election for all prior tax years. The IRS further noted that once the election is made it cannot be revoked except with the consent of the IRS. For the previous tax years at issue, the taxpayer must file amended US income tax returns to which he attaches a Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans ) for the RRSP. For each subsequent tax year through the tax year in which the final distribution is made from RRSP, Taxpayer must attach a Form 8891 for RRSP to his U.S. income tax return.

Bottom line: even if Canadian who is now a US resident didn't know he or she had to File a 8891 to defer the otherwise required annual federal income tax on the interest component, Private Letter Ruling 201225002 says it's never too late to do it right.

June 5, 2012
Posted by Sanger & Manes, LLP

Canadians with RRSP's living in California- Careful, California Can Tax Your RRSP Earnings Each Year Even if You Don't Receive a Plan Distribution

If you're a Canadian living now in California (so here we're not really talking about snowbirds, we're talking about the Canadian who has decided to live in California on regular basis...maybe a green card, or a L-1 visa, or maybe we're talking about a dual US-Canadian citizen), you may have a RRSP from your time living and working in Canada. You may wonder, how will the US and the State of California tax my RRSP. We're not talking about when you actually receive a distribution (obviously the US will have a claim to the distribution, and we'll talk about that another time), we're talking about the amounts that sit in the plan, and maybe have earnings each year due to plan investments (but, again, these are not earnings the Canadian living in California will actually see until they receive a distribution from the plan, which may not be for years).

How the US Taxes the Earnings of a RRSP?

As a general matter, the US would probably tax the earnings of an RRSP on an annual basis. So as a general matter, a US citizen (or current resident) who lived in Canada for years and has a RRSP would be taxed each year in the US on the earnings of the plan. But here comes the US-Canada Tax Treaty to the rescue. Article XXIII(7) of the Treaty states:

"effective for taxable years beginning on or after January 1, 1996, that a natural person who is a citizen or resident of either the United States or Canada and a beneficiary of a trust, company, organization, or other arrangement that is a resident of the other country that is generally exempt from income taxation in the other country (a "plan"), and is operated exclusively to provide pension, retirement, or employee benefits, may elect to defer taxation in the person's country of citizenship or residence, under rules established by the competent authority of that country, with respect to any income accrued in the plan but not distributed by the plan, until such time as and to the extent that a distribution is made from the plan or any plan substituted therefor."

What does this provision of the US-Canada Treaty mean? It means US citizens or residents (ie Canadians living in the US with green cards, or visas or dual citizens) do not have to pay federal US income tax on the amount the RRSP earns each year. To earn this good treatment, however, they must affirmatively elect. The election to defer tax on earnings this year (and in future years) is detailed in Rev. Proc 2002-23, by attaching to their timely filed (including extensions) United States federal income tax return for the current year, a statement that includes the following information:

(i) A statement that the taxpayer is claiming the benefit of Article XVIII(7) of the Treaty under this revenue procedure;
(ii) The name of the trustee of the plan and the plan account number, if any; and
(iii) The balance in the plan at the beginning of the current year.

How Does California Tax the Earnings of a RRSP?

So what about the Canadian now living in California who has a RRSP from a time he or she lived in Canada? States are not required to follow treaties when it comes to state taxation (California did not enter into a treaty with Canada), and when it comes to the earnings of a RRSP, California does not have to follow the US-Canada Treaty. In Information Letter 2003-0040, the FTB (Cal. Franchise Tax Board) specifically states the State of California will tax the earnings of the RRSP each year. The letter states that California views the RRSP like a savings account, and every year California taxes its residents' earnings in savings accounts. It may not be so easy for them to enforce, but each year Canadians living in California with RRSPs in Canada should be declaring in California the yearly earnings (not the amounts contributed in the plan from prior years- just the current year's earnings), even though they did not receive a distribution from the plan that year!!!