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U.S. Tax on Canadian Investments
U.S. Tax on Canadian Investments and IRS Offshore Compliance.
The U.S. follows a worldwide income model. That means that if you are a U.S. person, the U.S. requires that all if your
U.S. Tax on Canadian Investments: The United States and Canada have entered into many different treaties, including bilateral tax treaties, totalization agreement, and FATCA. Due to the proximity of U.S. and Canada, there are also specific IRS rules and regulations in place on issues such as visas and reporting — form IRS Form 8891 is one example.
But, when it comes to Canada, the U.S. and IRS taxes on investment income, the issue can get very complicated — especially when it involves investment income, such as interest, dividends, and capital gains.
IRS Offshore Compliance
The U.S. has taken an aggressive approach on matters involving foreign accounts compliance. The typical Canadian Investments that may be subject to IRS Tax or Reporting include:
- RRSP
- RRIF
- TFSA
- PC deferrals
- Canadian Mutual Funds
- Canadian Investment Funds
Common misconceptions we come across with Canada and the U.S.:
- There is a tax treaty, so my income is not taxable in the U.S.
- Canadian taxes are high, so I do not need to file in the U.S.
- RRSP and RRIF escape tax liability at the state level as well.
- Deferred earnings in a PC are automatically safe from GILTI
The following is a list (non-comprehensive) of common investments a person may have in Canada.
With Canada, each investment should be analyzed according to general tax law, along with the three main U.S./Canadian Tax agreements, which include:
- Bilateral Tax Treaty
- Totalization Agreement
- FATCA Agreement
1. RRSP (Registered Retirement Savings Plan)
This plan is recognized by the U.S. Therefore, until a person takes any distributions, they do not have to report any income on the accrued growth within the fund (States may tax the growth).
An individual taxpayer used to have to make an annual election, but that was eliminated a few years back and applied retroactively.
If a person enters the Streamlined Program (and previous OVDP), the penalty associated with the RRSP was waived.
2. RRIF (Registered Retirement Income Fund)
Like an RRSP, this plan is recognized by the U.S. Therefore, until a person takes any distributions, they do not have to report any income on the accrued growth within the fund (States may tax the growth).
An individual taxpayer used to have to make an annual election, but that was eliminated a few years back and applied retroactively.
If a person enters the Streamlined Program (and previous OVDP), the penalty associated with the RRSP was waived.
3. RESP (Registered Educational Savings Plan)
Similar to an 529A, this plan is used as a Savings Plan in Canada. It receives the same benefits as indicated above, BUT when it comes to the Streamlined Program or prior OVDP, the RESP was not specifically excluded from the penalty base – although the taxpayer can take the position that it too should be waived.
4. Bank and Investment Interest
Bank interest is taxable. This is the general rule, even if you have a common TD Canada investment account or similar bank account, and even if the money is not being withdrawn.
5. Mutual Funds
Canadian Mutual Funds (aka Foreign Mutual Funds) are very complicated. Generally, Foreign Mutual Funds are considered PFIC (Passive Foreign Investment Company). If you do not receive any distributions, the analysis may be more simplified.
But, if you did receive distributions (even if they were re-invested) there may be some significant tax analysis and reconciliations required to determine if you have any excess distributions.
Foreign mutual funds are disclosed and calculated using IRS Form 8621.
6. Dividends and Capital Gains
Dividends and Capital Gains are generally taxable (aside from non-distributed gains from RRSP and RRIF). Depending on the type of investment, you may be able to receive preferred qualified dividend treatment, or long-term capital gain.
Generally, the $250K/$500K primary home exclusion and depreciation rules (40 years S/L) also apply.
7. Professional Corporations
Many of our clients in Canada have a Professional Corporation – they are very common due to the tax deferred treatment of (usually) a large portion of income. That income is deferred into various investments, and only taxed at distribution, similar to a 401K.
With the introduction of GILTI, the IRS may no longer treat the deferred portion of the income as non-taxable – even though technically they are “retained earnings” deferred into approved Canadian Investments.
8. Foreign Rental Income
This is a common misconception. Let’s say you earned $10,000 in rental income, but had $11,000 in expenses and taxes – no income to report, right?
Yes and No. Yes, you earned gross rent income, but no, you will have no net income. Nevertheless, the income and expenses have to be parsed out, and reported annually on a 1040 Schedule E.
9. Interest Earned on Future Property Development
This is very common in many developing countries. A client will have paid an up-front fee to a developer for a property(s) abroad. During the time the property is being constructed, the investor (you) receive interest on the money you invested.
This ROI interest income must be included with your taxes.
10. Retirement Contributions
This will be impacted. Oftentimes, if there is a treaty (Canada you may receive tax deferred treatment on the growth, but not necessarily on the contributions, vs. a non-tax treaty county (such as Singapore) — where a CPF retirement fund does not receive U.S. tax deferred treatment.
10 Tax Tips (and Misconceptions) to be aware of:
1. Foreign Tax Credit
If you already paid tax on foreign income, you may be able to receive a Foreign Tax Credit in the U.S.
2. Foreign Tax Credit Refund
If the tax money you paid overseas was refunded to you, it may not be worth the headache to claim the credit, since you will have to adjust your tax returns in the future.
3. Income/Gifts
If your parents are managing your accounts, and you let them keep the income (what a nice son/daughter you are), that does not default to income assignment. Rather, it generally means you report the income and you gave them a gift.
4. Employment Provident Funds
EPFs are through employment, and you may be able to defer tax on the growth, per the a U.S. Tax Treaty (if applicable)
5. FATCA
Just because the FATCA Agreement may exempt certain foreign institutions from having to report accounts, does not mean you (as the individual investor) are exempt.
6. FBAR
If you have to file an FBAR you may also have to file a Form 8938 (or vice versa) – in other words, just because you file, does not mean you can avoid filing the other, if you meet the requirements for having to file both.
7. Foreign Earned Income Exclusion
You may be able to exclude certain earned (not investment) income if you meet either the Physical Presence Test or Bona-Fide Residence Test.
8. Transferring Account Ownership
Once you learn about reporting, the knee-jerk reaction is to consider transferring the accounts to another person. This only makes matters worse, because not only will you be out-of-compliance – but it will look bad to the IRS.
9. Calling the IRS Before Getting Into Compliance (Place Holder)
If you are considering getting into compliance, another knee-jerk reaction is to call the IRS to let them know you plan on getting into compliance. The problem is you may not even be on their radar. By calling them, you have now put yourself on their radar.
10. Be Cautions of Inexperienced Counsel
This has become an epidemic. Inexperienced attorneys tout experience they do not have, and puff their prior experience to make it seem like they have experience in this area of law, when they really do not.
Be sure to vet your attorney properly before retaining a firm.
What if You Have Unreported Income or Assets?
If you are out of compliance, the penalties can be severe. Therefore, you may consider entering IRS offshore voluntary disclosure/tax amnesty, before it is too late.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.
Contact our firm today for assistance with getting compliant.