How the IRS can make RRSP cleanups painless


Posted by:
Phil Hodgen

Written on:
April 29, 2012

Posted in:
RRSPs

I get two or three calls a week from Canadians living in the United States who learn — to their horror — that U.S. tax paperwork should have been filed for their RRSPs. At the moment, the only official solution is an expensive one: ask the IRS to issue a private letter ruling to allow you to file late Form 8891s to fix the problem.

There is a short-term and a long-term solution. I’m working on both.

Short-term solution

The short-term solution is that I will do a workshop in July. Ten people maximum. You will do your own private letter ruling. I will give you all of the forms to use. You do the work and save gobs of money. Sign up on the RRSP workshop mailing list to learn more about this.

The workshop won’t solve the problem entirely, but it will make it a lot cheaper for you to get a solution.

Long-term solution

The long-term solution is to get the government to change the rules. The problem with unfiled Form 8891s is a problem created by the tax laws. Tax laws can be changed to eliminate the problem they create.

I am going to Washington DC to meet with people from the IRS. The magic date is May 7, 2012, 10:00 a.m. Along with my co-author, Steven Walker, I will be presenting a position paper suggesting that the IRS change the rules. If this is successful, I will have participated in killing a small cottage industry for tax lawyers. That’s a good thing.

In advance conversations with IRS personnel, I find them to be sympathetic and openminded about making some changes. They have asked for concrete suggestions–what can they do, and what legal authority do they have for taking these actions?

Here are three ways I think the objective can be accomplished.

Option 1 — “Everything’s OK, carry on”

The first and easiest solution would be for the IRS to issue a notice telling the world “Hey, if you didn’t file a Form 8891 for your RRSP in the past, it’s OK. We won’t take any action.”

This has actually happened before. Notice 2003-25, issued by the IRS, was one of a string of pronouncements from the Service about RRSPs. These pronouncements eventually culminated in Form 8891 and an admirably simpler system than had been in operation before that.

In Notice 2003-75, the IRS said:

Treasury and the Internal Revenue Service have become aware that many taxpayers with interests in Canadian registered retirement savings plans (RRSPs), as well as the custodians of such plans, are unfamiliar with the requirements for filing Forms 3520 and 3520-A. Under the circumstances, the IRS has determined that it will enforce neither filing requirements, nor penalties under section 6677, for Forms 3520 and 3520-A with respect to such plans for tax years before 2002, and will grant additional time to file these forms for 2002.

An immensely sane and humane solution. Taxpayers didn’t know they had a problem. The government understood that this was a “no harm, no foul” situation. It was a paperwork issue only. The IRS said “we won’t chase you for penalties, and here is some extra time to take care of things for the tax season you’re in right now.”

It won’t happen again, unfortunately. This perspective does not exist at the IRS any more. Exhibit A: any sentence that has the words “voluntary disclosure” in it.

But it would be a great solution. It is impossible to commit tax evasion with an RRSP. It is as ludicrous as pretending you will use your 401(k) plan to cheat on your taxes. It’s impossible. So there is no risk to the government. And in fact the government has less paperwork to deal with. Every time a piece of paper is filed with the IRS, someone has to deal with it. Why not cut out unnecessary work at the IRS?

This could be coupled with a change in the presumption. Currently the law says that if you are a Canadian and you become resident in the USA, your RRSP is not treated like a pension (thus tax-exempt) in the USA unless you make a specific election under the US/Canadian treaty. It would be just as easy for the presumption to be that RRSPs are automatically treated as pensions in the USA unless you specifically opt out and make them taxable.

I understand that this reversal of presumption was actually discussed in the early 2000’s but the Treasury Department shot the idea down. Pity, that. If the IRS could save itself from processing a few hundred thousand useless pieces of paper, it might save a buck or two in its budget.

TL;DR – The IRS could say “Go and sin no more” to eliminate past problems (they’ve done this before), and give Canadians an automatic treaty election to protect their RRSPs in the USA going forward. Won’t happen.

Option 2 — PLR lite

The next option is not pie in the sky. It is possible.

Here’s the idea. The current rules say that if you didn’t file Form 8891 in prior years, the only way you can fix it is by asking the IRS for permission to do some late filings. The authority that the IRS has for giving you a hall pass to file a late Form 8891 is in Treasury Regulations Sections 301.9100-1 and 301.9100-3. (Insider jargon: this is “9100 relief”).

This is done by applying for a private letter ruling. The current lowest filing fee charged by the IRS is $2,000. You do a bunch of paperwork, tell the IRS why you should get to fix your problems, and if you’re lucky (and you usually are), you will get a ruling in your favor. You then take that piece of paper, make a bunch of copies, and file amended tax returns going back six or eight years (currently the IRS Associate Chief Counsel’s office will allow you to go back eight years.

Even if you don’t hire a law firm like us to do your private letter ruling, you’ll have to hire someone (and spend money) or do it yourself (and invest the time). Plus you have the out of pocket cost of the filing fee. The bare minimum cost is the $2,000 filing fee the IRS charges. Which by the way was $625 until February, 2012. Grrrr.

Remember the key thought here — you are asking for “9100 relief” so you can file late Form 8891s.

Let’s now jump to a completely different area of tax law and see where the IRS has created a “9100 relief lite” system for dealing with late paperwork. I think they can adopt the same logic (and the same solution) for RRSPs and late filing of Form 8891.

Rev. Proc. 2009-41 is where you can find the template for the RRSP solution.

Form 8832 is a form you can file to choose the way a particular business entity will be taxed. Depending on the circumstances, you might treat a limited liability company as a corporation, a partnership, or it might be treated as if it doesn’t exist.

As you might guess, sometimes people start up a business and forget to file this form. They plow forward in life assuming their business is going to be taxed in a certain way, but because they forgot to file Form 8832, their assumption is . . . uhhhhh . . . wrong.

No problem, says the IRS. If you catch your problem within 3 years and 75 days, you can make a retroactive election and all is forgiven. Just jump through the hoops that are described in Rev. Proc. 2009-41.

Three years! Many of my callers would jump at this. It would solve their problems entirely. They could fix their RRSP late Form 8891 problems on their own, without spending money on lawyers.

To fix the Form 8832 problems, you tell the IRS that the U.S. Treasury won’t suffer as a result of the retroactive fix you’re doing, and you give a reasonable cause statement — why you didn’t file Form 8832 on time, and why this was reasonable.

This is relief under Treasury Regulations Section 301.9100-3 (just like relief for late Form 8891 problems with RRSPs) but expedited. If this concept was extended to RRSPs, this means that anyone who caught the problem within three years would be able to file some paper with the IRS (for the cost of the paper, postage, and time) and the problem would be solved.

My suggestion for this mechanically would be that a person would file an amended tax return (Form 1040X) with the late Form 8891 attached, and also attach a statement modeled after the statement required in Rev. Proc. 2009-41.

I can see this as a possibility. I’m cautiously hopeful.

Option 3 — use the treaty election rules

The third option the IRS could use to solve the “late Form 8891″ problem is by looking at the problem through the lens of the income tax treaty.

Form 8891 is a form by which a taxpayer makes an election under the US/Canadian income tax treaty to have an RRSP taxed (in the USA) as a pension, just as it is in Canada. Remember this key concept: Form 8891 is a treaty election form.

Section 6114 is the law that says a taxpayer must report a treaty-based position to the IRS. This means if you are claiming the benefits of a treaty to reduce your tax liability, you can only do so if you notify the IRS that you’re doing it.

There are Treasury Regulations issued under Section 6114. They give us a possible escape hatch right now. If not, they give us a clue to what could be done with an amendment to the Treasury Regulations.

Treasury Regulations Section 301.6114-1(c)(2) says:


Reporting [i.e., telling the IRS about your treaty-based claim] is waived for an individual if payments or income items otherwise reportable under this section (other than by reason of paragraph (b)(8) of this section), received by the individual during the course of the taxable year do not exceed $10,000 in the aggregate or, in the case of payments or income items reportable only by reason of paragraph (b)(8) of this section, do not exceed $100,000 in the aggregate.

The reference to paragraph (b)(8) is a reference to making a treaty election to be treated as a resident of another country. We don’t care about that problem. We’re dealing with someone who is a Canadian fully resident in the USA. So what this provision tells us is that the IRS gives out a hall-pass and you don’t have to do any reporting if you are a human and you have income items under $10,000 in a year.

Well. Let’s just say that most RRSPs do not generate $10,000 of income in a particular year. So filing the treaty election isn’t technically required.

The IRS has specific statutory authority under Section 6114(b) to waive treaty reporting requirements:

The Secretary may waive the requirements of subsection(a) with respect to classes of cases for which the Secretary determines that the waiver will not impede the assessment and collection of tax.


RRSPs should be a classic case for exercising that discretion.

In summary

I think there are three different ways that the IRS could solve the problems of late Form 8891 filings and allow people to straighten out their tax paperwork and get their RRSPs fully compliant.

The IRS will not lose any tax revenue by doing this. When distributions are made, the CRA will collect tax by withholding. The U.S. will know about this because the IRS and CRA talk to each other. So every dollar of RRSP distribution will be taxed in the USA.

The IRS will have less work to do. Less paper to file. Fewer private letter rulings to process at Associate Chief Counsel (International). Taxpayers will have less stress and less expense. What’s not to like?

 

 

Comments

Anon says:

If we had an IRS that any semblance of “service” in it they would have worked all of this out for themselves pro-actively. Instead they need somebody from the private sector to arrive and beat them over the head with some common-sense. Good luck with that. I hope you are billing them for your time.

Does the “$10,000 of income in a year” include capital gains? If so, it seems that a log more retirement plans might be in scope than might be thought at first. Can any of these solutions also apply to non-Canadian plans? Over time these accrue vastly worse issues than RRSPs.

Phil Hodgen says:

@Anon,

I will be meeting with the IRS in early May and will talk to Those Who Know. Perhaps this will work for people from other countries as well to mitigate a bit of the damage.

Phil

The IRS may or may not care about all the needless trauma they’re causing taxpayers, but they probably DO care about all the PLR requests they receive. Perhaps that will influence them. Good luck!

Phil Hodgen says:

@Michael,

These PLR requests are (I’m guessing) boring busy work for Associate Chief Counsel (International) Branch 1. And they apparently have a lot of them on the table right now.

As you say, it would be a win for the lawyers at Branch 1 to get them off the brain-dead 9100 relief PLRs and on to more important stuff. And a win for taxpayers, too. Branch 1 would be solving problems that need solving.

AGN says:

I have been advising quiet disclosure and back-filing of 8891 ever since Rev proc 2002-23 allowed it, without issue.

PLR is a money grab, and not required for 8891.

Phil Hodgen says:

@AGN,

If this policy can be confirmed with the IRS at Associate Chief Counsel (International) Branch 1, this is good news indeed. If only I knew someone who could ask them . . . .

WAIT! I will be there next Monday! I will ask them about this and see what they say.

I agree, however, that the PLR process is unnecessary overkill. Unfortunately it appears to be the officially mandated policy, unless I can verify the informal procedure you’ve described. Which I hope will turn out to be true.

I wrestled with _two_ such situations this morning. One for a dormant, small balance RRSP (under $1,000), and another where the balance is $11,000. PLRs in situations like that are just a very bad idea.

G(gee) says:

Phil,
Hi Phil,

As you no doubt are aware, a similar situation exists for other such accounts of US persons/citizens living in Canada; RESP’s & TFSA’s. Do you have any
plans to approach the IRS with such well developed proposed solutions now or in the future?

These are equally crucial issues for those who were not aware
of how the IRS regards the status of these accounts coupled with the onerous filing requirements, not to mention the massive penalities now set in place for not having filed the required paperwork.

Thanks

Phil Hodgen says:

@G(gee),

Yes I know that there are all of those other accounts in Canada. And other countries have their equivalents of RRSPs, TFSAs, etc. I would LOVE for these things to be sorted out.

When I’m at the meeting next week at the IRS I will ask about these. But I’m guessing that it is a “one at a time” game here. First let’s see if we can solve RRSPs. Then on to the next one. And then the next.

Phil.

Careful Taxpayer says:

Isn’t there another “get out of jail free” paragraph just above the one that you quoted, Phil? 301.6114-1 (c)(1) lists the the exemptions from reporting, with the preamble:

“(c) Reporting requirement waived. (1) Pursuant to the authority contained in section 6114 (b), reporting is waived under this section with respect to any of the following return positions taken by the taxpayer:”

The fourth item on the list is:

“(iv) That a treaty reduces or modifies the taxation of income derived from dependent personal services, pensions, annuities, social security and other public pensions, or income derived by artistes, athletes, students, trainees or teachers;”

The IRS web site at http://www.irs.gov/businesses/small/international/article/0,,id=96438,00.html rephrases this, and your point above, in plain language:

“Exceptions

You do not have to file Form 8833 for any of the following situations:

You claim a reduced rate of withholding tax under a treaty on interest, dividends, rent, royalties, or other fixed or determinable annual or periodic income ordinarily subject to the 30% rate.
You claim a treaty exemption that reduces or modifies the taxation of income from dependent personal services, pensions, annuities, social security and other public pensions, or income of artists, athletes, students, trainees, or teachers. This includes taxable scholarship and fellowship grants.
You claim a reduction or modification of taxation of income under an International Social Security Agreement or a Diplomatic or Consular Agreement.
You are a partner in a partnership or a beneficiary of an estate or trust and the partnership, estate, or trust reports the required information on its return.
The payments or items of income that are otherwise required to be disclosed total no more than $10,000.”

I’m not familiar with Canada (well, I know where it is :-)), so I don’t know if an RRSP has to be treated differently because of the nuances of the RRSP itself and/or the US/Canada tax treaty. I see that the treaty has relatively “weak” pension provisions (e.g. accumulation of value isn’t addressed) versus a treaty like the one for the US/UK, which has very strong (possibly the strongest) pension provisions.

Apologies if this is boneheaded and I’m missing something obvious. I know that there’s a lot of chat on the various expat forums about accountants filing Form 8833 to claim treaty benefits on pensions, when the law and the IRS are unusually clear that you don’t need to do this. It makes sense: why force millions of people to send in a form to claim a benefit when, as you say, it’s really hard to evade taxes using a pension plan!

Careful Taxpayer says:

Ok, sorry, I AM a bonehead. The 2007 protocol to the US Canada tax treaty added this:

“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.”

I guess that the key phrase is “may elect to defer taxation”. My bad.

The US/UK tax treaty (the one that I have tattoed inside my eyelids, or at least it feels like it), has no such language. It explicitly states that

“income earned by the pension scheme may be taxed as income of that individual only when….it is paid to, or for the benefit of, that
individual from the pension scheme”.

Chris says:

Hi,

May I bring up a point that may or may not be related:
Phil, from your experience, out of the people who contacted you for not having filed form 8891, how many also did not declare their RRSP in a FBAR form?
Are these 2 compliance issues often related?
If so, could the problems with the Voluntary Disclosure Program be brought up at the meeting as well? This thing MUST be fixed for people who are not tax evaders.

Thanks

Phil says:

These two points almost always go together. And the scary problem is always the FBAR.

This is a point I will be discussing in Washington DC on Monday with the IRS.

This is a toxic problem for the IRS. If they want to impose huge penalties on retirement savings accounts that have paperwork faults — and are GUARANTEED to be taxed upon distribution — this would be a spectacular act of anti-marketing by the government.

Yet the Commisioner’s policies have promoted the profile of being a bully in offshore account cases and the IRS cannot afford to do anything that relaxes the world’s perception. Otherwise three years of beating up taxpayers goes for naught.

And don’t forget how the government of Canada will react.

I think the government knows they’ve painted themselves in a corner.

Tim says:

I think the current govt in the US is trying to push all of this off until after the next election just like their doing with the Keystone pipeline. Additionally despite the non partisan nature of IRS Commissioner it just happens to be he is leaving in November too. Its already May I have the feeling if they were going to do something this year they would have shown signs of starting to.

In terms of the Government of Canada I have a stack of letters from angry MPs in Ottawa going back months now that I am starting to show to people involved in pushing for this legislation in the US. I have the initial feeling there is a bit of shock Canada and FBAR would at all be related.

Chris says:

Do you also work with immigration attorneys to address the potential immigration issues related to your customers. A lot of people in this situation are either visa or green card holders.
Are we all doomed and risking deportation for having foreign tax issues that can be considered crimes of moral turpitude?

Phil says:

Yes we look at the immigration issues. And I am definitely not an expert at immigration so we work with other lawyers any time it is needed.

Tim says:

Phil,

I have a new post at IBS very relevant to you RRSP project. For those who don’t think we have enough informations sharing between CRA and IRS.

http://isaacbrocksociety.com/2012/05/05/for-those-who-dont-think-we-have-enough-tax-information-sharing-between-canada-and-the-us/

On RRSP alone IRS gets:

RRSP – Periodic payments

RRSP – Refund of premiums

RRSP – Refund of excess amounts

Deferred profit-sharing plans – Lump-sum payments

RRSP – Deemed receipt on deregistration

RRSP – Deemed receipt on death

Roy Berg says:

@ Phil Hodgen –

It’d be great if you could weave into your interaction with IRS (if you don’t already plan to do so) an important nuance to the US taxation of RRSPs that is usually overlooked.

The nuance is this: for US citizens the 2007 Protocol allows: a) a deduction for contributions to an RRSP; and b) deferral of income generated by an RRSP ONLY IF the RRSP is a Qualifying Retirement Plan (Article XVIII(13)). An RRSP is not a Qualifying Retirement Plan if it is an individual plan (Article XVIII(15)(b)).

Thus only employer sponsored (or employer “involved”) RRSPs are afforded deferral for US citizens resident in Canada.

Just my $0.02… Query, would the $0.02 be rounded down to $0.00 now that Canada has gotten rid of the penny?

Phil says:

I will make a note to chat with them about the problem of Americans in Canada — if the opportunity arises.

The problem is not unique to Canada of course. Americans in Australia face similar problems with superannuations.

U.S. international tax laws today are heavily dependent on the 1954 version of the Internal Revenue Code. The Chairman of the House Ways & Means Committee at the time had an intellectual background rooted in a different era.

How different? His father was a Confederate Army colonel. His idea of international commerce is vastly different from today’s world. Steamships and telegraph were the cutting edge tech of his day. Is it any wonder that the tax system struggles to keep up with reality?

Chris says:

Phil,

Are you at liberty to share the outcome of your meeting with your readers?

Phil says:

I am walking to lunch after back to back meetings at the IRS. Office of Associate Chief Counsel (International) then Nina Olsen.

I am going to The Treasury Department after lunch. I will blog tonight.

Hint. I am going to make a call for war stories for people with RRSPs and IRS problems. I will do it here and at IBS. Get ready.

ij says:

Phil,

Just pass this to IRS. I will opt-out from OVDI if RRSP is included in lieu penalty.

FBAR/f8891 on RRSP should be considered as technical error and should not be subjected penalty the same as tax non-compliance.

Phil says:

Let me just say that I have seen this done already. You are not alone.

I will do a full write up tonight. First, Treasury. Then dinner with brother- and sister-in-law. Then blog. :-)

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