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December 9, 2014 - Phil Hodgen

RRSPs and the certification test–a solved problem

This Week

This week’s question comes from reader M, who has an RRSP question. My keen analytical mind tells me she lives in Canada.  🙂  (For those of you who are not Canadian, an RRSP is a self-funded retirement savings plan much like the IRA in the United States).

This question is particularly apt because I was in Toronto last weekend attending a session organized by John Richardson at the University of Toronto.  St. Michael’s College, specifically. Carr Hall, Room 405, precisely. An RRSP question popped up.

So let’s do an RRSP question this week, because (unbelievable but true) RRSPs and U.S. tax law are now a topic that can be placed in the “Officially and Sanely Solved” category of tax questions. I know! I know! Boggles the mind, doesn’t it?

M asks:

Hi Phil,

My question for you regarding expatriation is this:

I have been FBAR compliant since 8 years, but have only filed forms 8891 for RRSPs since 3 years (including 2013). I am ready and willing to give up US citizenship, but I have no idea of how to proceed since I am not 5 years tax and information forms filing compliant.  I assume my choice is to wait 2 more years, then visit the US Consulate to start the paperwork to expatriate.   Any help would be greatly appreciated.

Short Answer

Short answer:  M, nothing to worry about.  Renounce citizenship whenever you want, and the lack of Form 8891 in earlier years will be no problem at all for you.

The Problem:  the Certification Test

Form 8891 is a special tax form to be used by a U.S. taxpayer who owns a Canadian Registered Retirement Savings Plan—RRSP.

The problem that M faces is the certification test.  Look at the bottom of page 2 of Form 8854.  Question 6 asks you to check a box to answer “yes” or “no” to this question:

Do you certify under penalties of perjury that you have complied with all of your tax obligations for the 5 preceding tax years (see instructions)?

M has filed Form 8891 for three of the previous five years.  She was required to file Form 8891 for all five of the years before her planned year of renunciation.

This means she would be required to check the “no” box.

A person who renounces U.S. citizenship is an “expatriate”.  See Internal Revenue Code Section 877A(g)(2)(A).

A “covered expatriate” is someone who satisfies one of three criteria.  See Internal Revenue Code Section 877A(g)(1)(A), which says:

The term “covered expatriate” means an expatriate who meets the requirements of subparagraph (A), (B), or (C) of section 877(a)(2).

When we follow the cross-reference to Internal Revenue Code Section 877(a)(2), we find that two of the three criteria are financial in nature.  The third, however, is not.  Internal Revenue Code Section 877(a)(2)(C) places an expatriate into the “covered expatriate” category if prior year tax paperwork is faulty, or prior year taxes have not been paid.  Covered expatriate status will result for an expatriate if:

. . . such individual fails to certify under penalty of perjury that he has met the requirements of this title for the 5 preceding taxable years or fails to submit such evidence of such compliance as the Secretary may require.

M reports that she should have—but did not—file Form 8891 for two of those five years.  As a result, she is tripped up by Internal Revenue Code Section 877(a)(2)(C).  That, courtesy of Internal Revenue Code Section 877A(g)(1)(A), makes her a covered expatriate.

As a covered expatriate, she suffers the full brunt of the U.S. income tax system that applies to citizens who renounce their citizenship:

  • The mark-to-market system of taxation that makes M pretend that she sold everything she owns (except some stuff) and then makes M pay real (not pretend) tax to the Internal Revenue Service on the capital gain (but not all of it).
  • Pension plans get taxed in special (in a not-good) way by the IRS.
  • If M has U.S. tax-free accounts like IRAs, they get taxed all at once.
  • If M is a beneficiary of a trust, she has fun (in the tax sense) ahead of her (for certain defined values of fun, by which I mean not very much fun at all).

Obviously, M would like to avoid all of that.  So it is in her definite best interest to answer that Question 6 at the bottom of Page 2 of Form 8854 with a happy checkmark in the “yes” box.

Yay, IRS

And M, you can do that.  You can answer Question 6 with a “yes” and you are telling the truth.  You do not have to do any remedial paperwork.  

This result is courtesy of the vast beneficence of the IRS.  

In October, 2014 the IRS published an edict (I love that word) (“edict” is not a word used in tax law) (when I think of “edicts” I think of 16th Century Popes announcing yet another Memo from God on a piece of parchment that, in one form or another, inevitably funds the construction of yet another Papal palace, or buys some very nice papal undergarments) (did I ever tell you that my sister’s friend from college, who now lives in Milan, wrote her thesis on that very topic–papal undergarments) (hello, Star!) . . .

But I digress.

Where was I? Oh, yes.

Revenue Procedure 2014-55—read the IRS summary or you will find the link to the full Revenue Procedure at the bottom of that page.

In plain English, the IRS is telling you, M, that if you didn’t file Form 8891 in the past, don’t worry about it.  The money quote from the IRS web page:

 The IRS is eliminating Form 8891, and taxpayers are no longer required to file this form for any year, past or present.

This means, M, that you do not need to file Form 8891 for those two years for which the form is missing.  The requirement is gone and your failure to file Form 8891 is treated as full and complete fulfillment of the requirements. You (who did not file for some of the years) are in the same position as someone who filed Form 8891 religiously, year after year. Yes, it is all very much Prodigal Son-ish, isn't it?

But Wait–There’s A Catch

And with tax law there always is a catch.

The IRS consigned (after more than a decade of useless and unnecessary fear, agony, and expense) dear old Form 8891 to oblivion.  But all of the other fun forms still exist.

Watch out for Form 8938.  This form should report the existence of the RRSP.  It has applied since the 2011 tax year, so that’s three years of forms I hope you filed.  Ordinarily you would report an RRSP by attaching Form 8891 to your tax return and noting that fact on Form 8938, Part IV, Line 6.  But for 2014, lots of luck.  There is no Form 8891 so the short-cut method of reporting your RRSP won’t apply.

Watch out for Ye Olde FBAR.  FinCen Form 114.  Put your RRSP on that there form without fail.

Then the magic question for which I do not have a definitive answer.  Your RRSP has mutual funds inside it.  Do you file Form 8621?  Is it required?  Well maybe.  Maybe not.  (I’m in the “not” camp.)  (Foreign mutual funds are Passive Foreign Investment Companies.  These are reported on Form 8621).  (This is not advice to you, M, or anyone reading this.)

Mostly Good News, And Let’s Be Kind

But it’s mostly good news.  The Canada/USA income tax treaty was amended in 1995 to give protection to RRSPs from U.S. tax and it only took 19 years to get the paperwork sorted out.

It’s easy to mock the IRS and the assorted Federal bureaucrats for stunts like this.  And it’s mostly wrong to do so.  We on the outside of the system are unconstrained and our options to fix things are unfettered compared to the people who work inside the system.  Stuff that you and I would look at and solve quickly and cleanly (just as Rev. Proc. 2014-55 did) cannot be done inside the system.

The reason for this is that J. Random IRS Person who is coming up with a solution to a problem cannot simply implement it.  The solution must be considered in the totality of the entire tax system.  A tax rule cannot be written until it has been considered from every angle to ensure that it does not do violence to the Internal Revenue Code in some unforeseen way.  

And it is extraordinarily easy for a rule change over here (Phil gestures to the left) to cause unanticipated collateral effects over there (Phil gestures to the right).  It happens all the time.  Tax lawyers exist on the planet to find these anomalies and exploit them with glee.

Thus, I have absolutely no doubt in my mind that someone, a couple decades ago, sat in a meeting somewhere in IRS headquarters and said “RRSPs cannot possibly be abused for tax avoidance purposes, so let’s skip the paperwork entirely.”  (In fact, I can guess that person’s name.)

That excellent idea, implemented 19 years after the treaty was amended, had potential repercussions throughout the Tax Borg. Even if everyone else around the table agreed with that suggestion, it could not be implemented without careful discussions.  What does this do to treaty interpretation?  What about future treaty negotiations?  What about foreign trust reporting requirements?  Withholding rules?  What are the implications for qualified plans cross-border?  And what if the Canadians change their domestic tax rules governing RRSPs?  What then?

It’s all too easy to mock the government.  I do it all the time. I did not really understand this point until I was reading a designer’s side-by-side comparison of Apple Maps and Google Maps and why designers inside those two companies are so constrained in their design decisions.  I immediately understood that the IRS and its people operate under similar constraints. I’m wrong. Sorry, IRS people.

Expatriation