Is a Canadian Pension Plan Taxable in US?

US Taxation of Canadian Pension

US Taxation of Canadian Pension Plans

US Taxation of Canadian Pension Plans: There are various different types of pension plans in Canada. Like many foreign countries, the Canadian Pension system is a 3-Pillar system. There is the government portion, the employment portion and personal investment portion.

Some of the common pension plans, include:

• CPP: Canadian Pension Plan
• RPP: Registered Pension Plan
• RRSP: Registered Retirement Savings Plan
• RRIF: Registered Retirement Investment Fund (Post-RRSP)

We will summarize the different types of tax treatment of pension plans from Canada.

With the IRS taking an aggressive position on matters involving offshore account compliance and unreported foreign income — understanding the reporting and tax protocols are crucial.

Here is an introduction to the US Taxation of Canadian Pension.

Pillar 1 Canadian Government

Canada Pension Plan (CPP)

In Canada, the CPP is most similar to social security. In accordance with the World Bank Pillar system, CPP is the Pillar administered by the government. It comprises one portion of the Pillar 1 system and is based on the employment/employer contributions similar to U.S. social security. The Pillar 1 also includes:

• Old Age Security Program (OAS)
• Guaranteed Income Supplement Program (GIS)
• Guaranteed Annual Income System (GAINS)

Pillar 2 Employment Pension

The 2nd Pillar refers to employment-pension. The most common is the Registered Pension Plan.

RRP (Registered Pension Plan)

The Registered Pension Plan is an employer/employee pension plan. These types of pension plans are “Registered” with the CRA — Canadian Revenue Agency. Both the employer and the employee can deduct contributions and the growth is tax deferred. There are two classification of RPP, which are Defined Benefit and Money Purchase RPPs.

While the RRP is similar to the RRSP in name, the main difference is that the RRSP are individual retirement plans, while the RPP is an employer plan.

*It also includes employment RRSP and DFSP.

Pillar 3 Individual/Personal Pension

The 3rd Pillar does not require an employer. Rather, it is a personal pension — similar in part to an IRA and 401K.

The main type of investment under Pillar 3 is the RRSP. Since the RRSP is the key component to most retirement plans, we will focus heavily on the RRSP.

What is an RRSP?

An RRSP is a retirement vehicle that is very similar to the U.S. 401K.

Just like a 401K in the U.S., the money you deposit into the Canadian RRSP is pre-taxed and grows tax-free until it is withdrawn.

The goal of the RRSP is the same as the 401K, which is to defer the tax now, during the working years, with the goal of the contributions growing tax-free. Then, when the investment is distributed to the beneficiary at the time of retirement, it is (presumably) taxed at a lower progressive tax rate.

One main difference between the 401K and the RRSP is that the RRSP does not carry the automatic 10% penalty for early withdrawal. The fact that the withdrawal rules for an RRSP are more relaxed had previously impacted how the IRS treated the growth within the fund — and required the annual filing of Form 8891 (see below).

In addition, there are different carry-over rules for unused contribution limits for the RRSP than there are for the 401K.

RRSP US Taxation Rules

In general, the RRSP works similar to the 401K.

Many Canadian & U.S. dual-citizens or permanent residents from Canada (aka U.S. Persons) have an RRSP, and therefore have a U.S. tax and IRS reporting responsibility for their RRSP.

While the IRS has increased enforcement of foreign accounts compliance and unreported foreign income, when it comes to the  RRSP, the IRS has relaxed the rules involving RRSP.

We will summarize the general foreign pension tax rules in accordance with U.S. Canadian Tax Treaty, and reporting rules.

United States/Canadian Pension Income Tax Basics

In general, the default position is that a Taxpayer who is a US person such as a US Citizen, Legal Permanent Resident, or Foreign National who meets Substantial Presence Test is taxed on their worldwide income. This would also include income that is being generated in Canada, and may be tax-free or exempt under the tax rules of Canada — unless an exception, exclusion or limitation applies (such as with Canadian Pension).

Saving Clause in US/Canada Income Tax Treaty & Canadian Pension

As we work through the United States & Canada Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted into tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

What does the Saving Clause Say?

• • • Except as provided in paragraph 3, nothing in the Convention shall be construed as preventing a Contracting State from taxing its residents (as determined under Article IV (Residence)) and, in the case of the United States, its citizens (including a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of income tax, but only for a period of ten years following such loss) and companies electing to be treated as domestic corporations, as if there were no convention between the United States and Canada with respect to taxes on income and on capital.

Limitations on the Saving Clause

Despite any limitation created by the saving clause, certain portions of the tax treaty are still immune from the saving clause — which means the tax treaty will stand on issues involving the following tax matters:

The provisions of paragraph 2 shall not affect the obligations undertaken by a Contracting State:

• • • (a) Under paragraphs 3 and 4 of Article IX (Related Persons)

      • paragraphs 6 and 7 of Article XIII (Gains)

      • paragraph 5 of Article XXIX (Miscellaneous Rules)

      • paragraphs 3 and 5 of Article XXX (Entry into Force), and

      • Articles XVIII (Pensions and Annuities)

      • XIX (Government Service), XXI (Exempt Organizations) XXIV (Elimination of Double Taxation)

      • XXV (Non-Discrimination) and XXVI (Mutual Agreement Procedure); and

    • (b) Under

      • Article XX (Students), toward individuals who are neither citizens of, nor have immigrant status in, that State.

What does this Mean?

It means that the Saving Clause does not apply to Pensions and Annuities.

ARTICLE XVII Pensions and Annuities

When it comes to the US and Canadian Treaty, the portions involving pensions and annuities have been revised and augmented on several occasions. 

• 1. Pensions and annuities arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State, but the amount of any such pension that would be excluded from taxable income in the first-mentioned State if the recipient were a resident thereof shall be exempt from taxation in that other State.

What does Paragraph 1 Mean

It means that the baseline pension tax rule for Canadian Pension and US Pension is that when a pension is generated in one contracting state, and paid to a resident of the other contracting state — it may be taxed in the other state, with the caveat that if it would have been excluded from taxable income in the first state (the source of the pension income) then it will be exempt from tax in the second state where the resident resides.

• 2. However:

• • • (a) Pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment; and

    • “(b) Annuities may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of an annuity payment, the tax so charged shall not exceed 15 per cent of the portion of such payment that would not be excluded from taxable income in the first-mentioned State if the beneficial owner were a resident thereof.

What does Paragraph 2 Mean 

Paragraph 2 (a) clarifies paragraph one insofar as pensions may also be taxable in the contracting state in which the income rises and under the laws of the contracting state except that if the resident resides in the other state and is the recipient of a periodic pension payment — the tax amount cannot exceed 15% of the gross of such payment. Paragraph (b) refers to annuities — beyond the scope of this summary.

• 3. For the purposes of this Convention:

• • • (a) The term “pensions” includes any payment under a superannuation, pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income-averaging annuity contract or, except for the purposes of Article XIX (Government Service), any benefit referred to in paragraph 5; and

    • (b) The term “pensions” also includes a Roth IRA, within the meaning of section 408A of the Internal Revenue Code, or a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007 that the competent authorities have agreed is similar thereto. Notwithstanding the provisions of the preceding sentence, from such time that contributions have been made to the Roth IRA or similar plan or arrangement, by or for the benefit of a resident of the other Contracting State (other than rollover contributions from a Roth IRA or similar plan or arrangement described in the previous sentence that is a pension within the meaning of this subparagraph), to the extent of accretions from such time, such Roth IRA or similar plan or arrangement shall cease to be considered a pension for purposes of the provisions of this Article.

• 4. For the purposes of this Convention:

• • • (a) The term “annuity” means a stated sum paid periodically at stated times during life or during a specified number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered), but does not include a payment that is not a periodic payment or any annuity the cost of which was deductible for the purposes of taxation in the Contracting State in which it was acquired; and 

    • (b) An annuity or other amount paid in respect of a life insurance or annuity contract (including a withdrawal in respect of the cash value thereof) shall be deemed to arise in a Contracting State if the person paying the annuity or other amount (in this subparagraph referred to as the “payer”) is a resident of that State. However, if the payer, whether a resident of a Contracting State or not, has in a State other than that of which the payer is a resident a permanent establishment in connection with which the obligation giving rise to the annuity or other amount was incurred, and the annuity or other amount is borne by the permanent establishment, then the annuity or other amount shall be deemed to arise in the State in which the permanent establishment is situated and not in the State of which the payer is a resident.

• 5.Benefits under the social security legislation in a Contracting State (including tier I railroad retirement benefits but not including unemployment benefits) paid to a resident of the other Contracting State shall be taxable only in that other State, subject to the following conditions:

  • • (a) a benefit under the social security legislation in the United States paid to a resident of Canada shall be taxable in Canada as though it were a benefit under the Canada Pension Plan, except that 15 per cent of the amount of the benefit shall be exempt from Canadian tax; and

    • (b) a benefit under the social security legislation in Canada paid to a resident of the United States shall be taxable in the United States as though it were a benefit under the Social Security Act, except that a type of benefit that is not subject to Canadian tax when paid to residents of Canada shall be exempt from United States tax.”

What does Paragraph 5 Mean

Paragraph five refers to Social Security and provides that benefits paid under the Social Security rules of a contracting State to a resident of the other is taxable in the other state but with certain caveats such as the following:

• • • • A resident of Canada who receives US Social Security shall be taxed in Canada as if it was being paid under Canadian pension plan rules — except 15% of the benefit will be exempt under Canadian tax.

      • If a resident of the United States receives Social Security from Canada, it will only be taxable in the United States as if it was being received as U.S. Social Security — except that if it would have been exempt in Canada then it will be exempt from U.S. tax as well.

• 6. Alimony and other similar amounts (including child support payments) arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable as follows:

  • • • (a) Such amounts shall be taxable only in that other State;

      • (b) Notwithstanding the provisions of subparagraph (a), the amount that would be excluded from taxable income in the first-mentioned State if the recipient were a resident thereof shall be exempt from taxation in that other State.”

• 7. A natural person who is a citizen or resident of a Contracting State and a beneficiary of a trust, company, organization or other arrangement that is a resident of the other Contracting State, generally exempt from income taxation in that other State and operated exclusively to provide pension or employee benefits may elect to defer taxation in the first-mentioned State, subject to rules established by the competent authority of that State, 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.

• 8.Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State by or on behalf of an individual shall be deductible or excludible in computing the individual’s taxable income in the other Contracting State, and contributions made to the plan by the individual’s employer shall be allowed as a deduction in computing the employer’s profits in that other State, where:

  • (a) The individual performs services as an employee in that other State the remuneration from which is taxable in that other State;

  • (b) The individual was participating in the plan (or another similar plan for which this plan was substituted) immediately before the individual began performing the services in that other State;

  • (c) The individual was not a resident of that other State immediately before the individual began performing the services in that other State;

  • (d) The individual has performed services in that other State for the same employer (or a related employer) for no more than 60 of the 120 months preceding the individual’s current taxation year;

  • (e) The contributions and benefits are attributable to the services performed by the individual in that other State, and are made or accrued during the period in which the individual performs those services; and

  • (f) With respect to contributions and benefits that are attributable to services performed during a period in the individual’s current taxation year, no contributions in respect of the period are made by or on behalf of the individual to, and no services performed in that other State during the period are otherwise taken into account for purposes of determining the individual’s entitlement to benefits under, any plan that would be a qualifying retirement plan in that other State if paragraph 15 of this Article were read without reference to subparagraphs (b) and (c) of that paragraph. This paragraph shall apply only to the extent that the contributions or benefits would qualify for tax relief in the first-mentioned State if the individual was a resident of and performed the services in that State.

• 9. For the purposes of United States taxation, the benefits granted under paragraph 8 to a citizen of the United States shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

• 10. Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State by or on behalf of an individual who is a resident of the other Contracting State shall be deductible or excludible in computing the individual’s taxable income in that other State, where:

  • (a) The individual performs services as an employee in the first mentioned state the remuneration from which is taxable in that State and is borne by an employer who is a resident of that State or by a permanent establishment which the employer has in that State; and

  • (b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the individual performs those services. This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the first-mentioned State.

• 11. For the purposes of Canadian taxation, the amount of contributions otherwise allowed as a deduction under paragraph 10 to an individual for a taxation year shall not exceed the individual’s deduction limit under the law of Canada for the year for contributions to registered retirement savings plans remaining after taking into account the amount of contributions to registered retirement savings plans deducted by the individual under the law of Canada for the year. The amount deducted by an individual under paragraph 10 for a taxation year shall be taken into account in computing the individual’s deduction 17 limit under the law of Canada for subsequent taxation years for contributions to registered retirement savings plans.

• 12. For the purposes of United States taxation, the benefits granted under paragraph 10 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

• 13. Contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of a citizen of the United States who is a resident of Canada shall be deductible or excludible in computing the citizen’s taxable income in the United States, where:

  • (a) The citizen performs services as an employee in Canada the remuneration from which is taxable in Canada and is borne by an employer who is a resident of Canada or by a permanent establishment which the employer has in Canada; and

  • (b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the citizen performs those services. This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in Canada.

• 14. The benefits granted under paragraph 13 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

• 15. For purposes of paragraphs 8 to 14, a qualifying retirement plan in a Contracting State means a trust, company, organization or other arrangement:

  • (a) That is a resident of that State, generally exempt from income taxation in that State and operated primarily to provide pension or retirement benefits;

  • (b) That is not an individual arrangement in respect of which the individual’s employer has no involvement; and

  • (c) Which the competent authority of the other Contracting State agrees generally corresponds to a pension or retirement plan established in and recognized for tax purposes by that other State.

• 16. For purposes of this Article, a distribution from a pension or retirement plan that is reasonably attributable to a contribution or benefit for which a benefit was allowed pursuant to paragraph 8, 10 or 13 shall be deemed to arise in the Contracting State in which the plan is established.

• 17. Paragraphs 8 to 16 apply, with such modifications as the circumstances require, as though the relationship between a partnership that carries on a business, and an individual who is a member of the partnership, were that of employer and employee

What does Paragraph 8-17 Mean

Paragraphs 8-17 were added as part of the (more) recent protocol. It is a great benefit which provides in general that as long as contributions are being made — or benefits accrued — under a qualifying retirement plan in one contracting state — it will be deductible (or excludible) in the other contracting state — up to a certain amount. Noting, there are various restrictions and requirements in order to obtain this benefit and it does require it to be through services performed in the other state. The benefits under certain paragraphs that are allowed to be deducted/contributed are limited based on the limitations set by in the treaty.

Reporting Canadian Pension to IRS (5 Common Forms)  

The following is a summary of five (5) common international tax forms.

FBAR for Canadian Pension (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938 for Canadian Pension

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:

• Single or Filing Separate (in the U.S.): $50,000/$75,000
• Married with a Joint Returns (In the U.S): $100,000/$150,000
• Single or Filing Separate (Outside the U.S.): $200,000/$300,000
• Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520 for Canadian Pension

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• Gift from a Foreign Person: More than $100,000.
• Gift from a Foreign Business: More than $16,649
• Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.
• Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.
• Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.
• Category 4: Control of a foreign corporation for at least 30 days during the accounting period.
• Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621 for Canadian Pension

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance from Canada

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Canada Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Canada that report US account holder information to the IRS. The list can be found here: Canada FFI List:.

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• Bank Accounts
• Investment Accounts
• Retirement Accounts
• Direct Stock Ownership
• ETF and Mutual Fund Accounts
• Pension Accounts
• Life Insurance or Life Assurance Policies

Totalization Agreement Between Canada and US

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

• • • “The United States has entered into agreements, called Totalization Agreements, with several nations for the purpose of avoiding double taxation of income with respect to social security taxes.

    • These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the social security taxes of a foreign country”

The United States has entered into 26 Totalization Agreements, including Canada (as of 1984).

United States/Canada Pension Tax Treaty Rules are Complex

In conclusion, The US and Canada tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure on matters involving the United States/Canada Tax Treaty

Contact our firm for assistance.