June 11, 2010 - Phil Hodgen

RRSP puzzler number 1 — what are the penalties?

This post is a multi-purpose post.  It is simultaneously:

  • A plea to the universe for help in answering a rather technical question;
  • A demonstration of the needless complexity of the U.S. tax system (sheesh, as if you need yet another example of this self-obvious point);
  • A cleverly-disguised and exceedingly polite rant by mygoodself; and
  • A shameless opportunity for me to pimp my soon-to-be-completed ebook that has a current working title of “RRSPs in the USA.”

RRSPs are . . .

RRSPs are Canadian retirement plans.  For U.S. taxpayers, think of an IRA.  For readers in the U.K., think of ISAs.  For readers in Australia, think superannuation accounts.  Etc.

You make a contribution, and get a tax deduction.  The money grows inside the account tax-free until you retire.  You pull the money out at retirement and have taxable income when you receive the money.

RRSPs don’t cross borders well

From the U.S. perspective, an RRSP is just a regular taxable account.  It isn’t a “pension plan” in the United States.  This means that all those years while you (a Canadian who has an RRSP) are living in the United States, you should be paying U.S. income tax on the investment earnings inside your RRSP.

(Relatively simple) fix

There is a relatively simple fix.  Form 8891.  It is a simple fix if you are doing it within the deadlines.  It’s a bit more painful in terms of paperwork and expense if you’re late in fixing the problem.  But it can be done, and it works.

(Ha.  How’s that for a tease?  Book coming.  All will be revealed, etc. etc.)

Today’s puzzler — penalties

Today’s puzzler (hat tip, Car Talk) involves penalties.  The IRS loooooooves penalties.  If bureaucracies are kinky, well, let me just say IRS = BDSM.

An RRSP is a foreign trust in the eyes of the Internal Revenue Service.  (Too technical to tell you why in a lowly blog post.  Trust me on this.)

If you have a foreign trust, Section 6048 of the Internal Revenue Code says you have to file whatever the IRS says you have to file.  The IRS has decided that Form 3520 (PDF) and Form 3520-A (PDF) are the forms to use.

What if you do not comply with her command and you don’t file the required forms?  Well, you must be punished.  Of course.  Section 6677 is where you find the penalties for screwing up in the Section 6048 department.

Let’s recap:

  • An RRSP is a foreign trust.
  • You have an RRSP, so you have a foreign trust, in the eyes of the IRS.
  • Section 6048 gives the IRS power to tell you what paperwork to do for a foreign trust.
  • The IRS says “Do Form 3520 and Form 3520-A.”
  • If you don’t do what the IRS says you have to do, you get whacked with the penalty stick at Section 6677 of the Internal Revenue Code.

Simple, right?

IRS does some simplifying

In the early years of the 21st Century the IRS saw the folly of treating RRSP-totin’ Canadians as criminals.  In a series of bureaucratic broadsides the IRS sought to simplify life for our Canadian friends.

Today’s puzzler is about the simplification efforts.

In Notice 2003-75, 2003-50 IRB 1204, Section 1, the IRS says:

This notice describes the new simplified reporting regime that Treasury and the IRS have developed for taxpayers who hold interests in RRSPs and RRIFs.  The new reporting regime, which is effective for taxable years beginning after December 31, 2002, is in lieu of the filing obligations under Section 6048 (Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) and Form 3520-A (Annual Information Return of Foreign Trust with a U.S. Owner)) that otherwise apply to U.S. citizens and resident aliens who hold interests in RRSPs and RRIFs and to the custodians of such plans.

Easy to understand.  “We have this new system.  The old system of Form 3520 and Form 3520-A doesn’t apply to you.”

Then, in Section 3 of Notice 2003-75, the IRS specifically addresses the questions of penalties that will apply:

The new simplified reporting regime, instituted under the authority of section 6001, provides the information needed for tax compliance purposes. Therefore, pursuant to section 6048(d)(4), no reporting will be required under section 6048 with respect to RRSPs and RRIFs that have beneficiaries or annuitants who are subject to the new simplified reporting regime. Accordingly, the associated penalties described in section 6677 do not apply to such RRSPs and RRIFs and their beneficiaries or annuitants. A beneficiary or annuitant of an RRSP or RRIF may, however, be subject to other penalties.

Easy to understand.  “We have this new system.  The old system doesn’t apply.  That means the penalties under the old system won’t apply to you, either.”

Enquiring minds want to know

But that last sentence bugs me.

“A beneficiary or annuitant of an RRSP or RRIF may, however, be subject to other penalties.”

So, I ask The Universe.  What are these “other penalties” of which they speak?  I can’t find any reference to penalties in the instructions to Form 8891, or in Notice 2003-75.  Or, for that matter, in Rev. Proc. 2002-23 (PDF).  So.

Is it possible that the IRS simply took away a penalty regime and failed to replace it with some other penalty regime?  That seems improbable, but you never know.

A better explanation is that the “general” penalty of Section 6651(a) is applied to failure to file Form 8891 (or a late filing):  “5% per month of the tax due on the form, up to a maximum of 25%.”  What does The Universe think of that answer?  Because then the worst that can happen is the “$135 flat minimum” will be the penalty if you are more than 60 days late.

Sorry, no answer (yet)

Sorry.  I don’t have an answer to the puzzler yet.  That’s why I am asking Teh Interwebs.

Another puzzler coming . . .

I have another puzzler coming up, too.  I think I have identified a hole in the doughnut.  “You don’t have to do anything for years 1, 2, 4, 5, 6.  But haha! you have to do something for year 3!”  Wait for it.  Another possible unanticipated thrill for RRSP owners.  Coming soon to on a computer right in front of you.

A bookload of answers

And there is a bookload of answers coming in the ebook I’m working on “RRSPs in the USA”.

  • How to do your current year RRSP filings right.
  • How to do your current year RRSP filings if you’re a tiny bit late.
  • How to do the paperwork if you’re a lot late.
  • How far back in time do you go to clean up your RRSP messes?
  • Etc.

Stand by.  I’m still writing it.  Today’s puzzler will tell you that this is not a surface treatment of the topic.

If there are topics you think should I should include.  I want to make this as complete as possible.