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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 The taxpayer has not contributed any money to the RRSP nor withdrawn any money from the RRSP since becoming a U.S. resident.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.