The Ultimate “RRSPs and the IRS” Essay
“Is This Your Final Answer?”
I have titled this essay as my “ultimate” write-up on RRSPs and the IRS. I use the word “ultimate” in its true meaning: the last one. There will be no more coming from me on this topic (unless I change my mind), because the IRS has (finally) solved (more or less) the problems (or some of them) in a (somewhat) complete way (until further notice, of course).1
TL;DR
RRSPs are Canadian retirement accounts. Until late 2014, they were semi-toxic for U.S. tax purposes when owned by U.S. taxpayers who were unaware of the paperwork requirements south of the border. These problems bedevilled countless Canadians living in the United States, as well as U.S. citizens and green card holders living in Canada.
By administrative fiat in late 2014, the U.S. government blew away the problems it had created–problems that cost countless people money and caused high levels of stress.
This is the current state of affairs for U.S. taxpayers and their RRSPs:
- Form 8891. You no longer need to file Form 8891, which was previously required. It is not required for 2014 tax returns. It is not required for future years. If you screwed up and did not file Form 8891 in previous years, you are not required to file Form 8891 to fix that screw-up.
- Forms 3520, 3520-A. RRSPs are permanently exempt from the Form 3520 and Form 3520-A filing requirements, even though they meet the definition of being “foreign trusts” in U.S. tax law.
- Form 8938. Your RRSP is a foreign financial asset to be reported on Form 8938–if you are required to file this form. There are a few semi-nearly-somewhat acceptable ways to fix the problem if you missed the filing deadline for this.
- FinCen Form 114. This is the online successor to the dreaded FBAR form (the form with the comically convoluted designation, Form TD F 90–22.1). Report your RRSP there. Yep, there is a semi-nearly-somewhat-almost acceptable way fix the problem if you did not file this form or if you filed it but did not include your RRSP.
The IRS has not eliminated the stress and agony of waking up to the fact that your RRSP triggers some U.S. tax paperwork, but they have eliminated enough of it so that we can declare victory and go home.
With that overview, let’s look at why all of this is true.
Why There Are Problems At All
Problems with RRSPs happen because they natively behave like pensions in Canada but do not natively behave like pensions in the United States. “Behave like pensions” means that you put money into an RRSP–a contribution. Investment gains (interest, dividends, and capital gain) are not taxed as the RRSP receives them. Instead, everything stays inside the RRSP. You pay income tax only when you take money out of the RRSP–a distribution.
Canadian law ensures that an RRSP achieves that tax result for Canadian income tax purposes. In the United States, however, an RRSP cannot achieve the same result because the legal structure of an RRSP does not satisfy the definition of a “qualified plan”–the technical description of an account that behaves in the way I described. The critical reason is simple:in order for a retirement plan to be a “qualified plan” all of the money in the plan must sit in a special trust organized under U.S. law. RRSPs, of course, are organized under Canadian law.
In order to make an RRSP behave (in the United States) as a qualified plan, external intervention is required. That external intervention comes in the form of special rules in the income tax treaty between the United States and Canada. In it, the two countries agree to a simple idea: “If you treat something like a pension, we will, too”.
Making that simple idea work was a task that fell to IRS attorneys. As you might guess, they found a number of places where existing tax law conflicted with the simple idea, or where the the simple idea became fiendishly difficult to implement. The IRS issued a series of rulings and announcements in an attempt to fix the problems they saw, and this rush of effort culminated with the creation of Form 8891. All of this happened in the 2002–2003 time period. And then it stopped.
American citizens and residents are taxed on their worldwide income. This means that a U.S. citizen or green card holder living in Canada would be taxed as a resident of Canada and a resident of the United States simultaneously. The RRSP would work perfectly well for Canadian tax purposes, but (under U.S. tax law) astonishingly poorly on the U.S. income tax returns.
Similarly, Canadians living south of the border would become U.S. resident taxpayers, and suddenly the U.S. government would be looking at their RRSPs through Internal Revenue Code-colored goggles.
For both sets of people, the problems were economic, of course–what was not taxable in Canada was taxable in the United States, making retirement savings terribly difficult for the people affected.
But the bigger problem was–and continues to be–simple lack of awareness of the rules. Most ordinary people simply did not know of the arcane U.S. tax rules and the obscure tax forms that were required for their RRSPs. When they found out, they were horrified, because the U.S. tax system threatened penalties that could completely wipe out their retirement savings–simply for failing to file a form or two.
With that background, let’s look at the four problems that RRSP owners had–problems entirely created by a broken set of tax laws clumsily administered. We will then look at how the IRS fixed the broken stuff bestowed on taxpayer by Congress, our intrepid diplomats who negotiated the income tax treaty, and by the IRS itself.
Broken Stuff 1 – Unreported Income
You have an RRSP with money in it. It grows in value from interest, dividends, and capital gains. The increase in value would not be taxed in Canada, of course. But due to the peculiarities of U.S. income tax law, that increase in value–the interest, dividends, and capital gains earned inside the RRSP–would be taxable income in the United States.
Almost no one, of course, is aware of this. So any U.S. taxpayer with an RRSP would have unreported income, and you know how happy the IRS is when they find out you haven’t reported all of the income you should have reported.
Broken Stuff 2 – Your RRSP is a Foreign Grantor Trust
Everyone knows that The Bogeyman uses foreign trusts. Communists used foreign trusts to spread Godless communism and lure the flower of American youth into the den of iniquity (1960s). Drug lords used foreign trusts to hide the money from forcing Americans to buy cocaine against their will (1970s and 1980s). The commies came back (Nicaragua and the Contras), and you know they were using foreign trusts, too. Then of course we have the current Bogeyman–terrorists. I’m pretty sure “How to use a foreign trust” is in the Al Qaeda HR Manual, in Chapter 2 or Chapter 3 somewhere. Probably. I think. Maybe.
If you are reading this essay thirty years from now, look around and see who the Bogeyman is for your time, and ask yourself whether your favorite politicians are waving a Bogeyman at you to generate a Culture of Fear (warning: Thievery Corporation on YouTube) for purposes that don’t necessarily make your life better and in fact they probably make your life markedly worse.
But I digress.
The IRS is allergic to foreign trusts. And if you look at an RRSP, then look at the definition of a foreign trust in the Internal Revenue Code and Treasury Regulations, you will conclude that an RRSP is a foreign trust. Yep. Commies, Pablo Escobar, bloated plutocrats cruising the Mediterranean on their yachts, and that retired Canadian schoolteacher in Saskatchewan with an RRSP are all using foreign trusts for tax evasion and worse.
The upshot? If you have an RRSP, you have an obligation to file Form 3520 and Form 3520-A, or risk amputation-level penalties if you are late or forget to file them.
Broken Stuff 3 – FBARs (and later Form 8938)
RRSPs are accounts at a financial institution outside the United States. They were (and still are) classically required to be reported to the United States government on Form FinCen 114 (the current incarnation of the unlamented Form TD F 90–22.1), and starting in 2011 they were part of the things to be reported on Form 8938.
Penalties here, as you might guess, could in size from a decent but not extravagant used car to total bankruptcy. Because why not? You’re a retired schoolteacher living in Saskatchewan. You should have known better.
Broken Stuff 4 – The Old Way To Fix The Problem Was Broken
The final problem was that the official way to fix the problem was, itself, broken.
The approved method for fixing these problems (according to the IRS) was to apply for a Private Letter Ruling. Our office processed many of these things, all successfully. This “solution”, however, was no real solution. Successfully getting a Private Letter Ruling from the IRS Commissioner to fix your problems sounds like you are home free, right? Well, no. You would still be left with penalty risks for not reporting your RRSPs on the FBAR form–Form TD F 90–22.1.
The approved method for fixing RRSP problems was also expensive. The filing fee, once reasonable (a few hundred dollars) is currently $6,900. Because why not? That’s not counting the legal fees to do the work in putting together the application.
Spoiler alert: the old way of fixing problems is still there, as broken as ever, and is offered up for you to use if you want it. You would be a fool to use the old “apply for a Private Letter Ruling” system. Don’t do it.
Broken Stuff: Conclusion
The bad old days for RRSPs were a mess. Things are mostly better now.
How The IRS Fixed The Broken Stuff
The IRS fixed the RRSP problems itself. No Congress, no treaty, just soul-searching, decisions, and prose. And, I will bet, endless meetings and internal memoranda.
FinCen Form 114 and Form 8938
A set of procedures attempts to give taxpayers the ability to file obscure tax forms late without suffering financial calamity through oversized penalties. These procedures offer a way for taxpayers to file FinCen Form 114 and Form 8938 late without incurring penalties and without risking heart attacks from fear and stress. That solves “Broken Stuff 3”.
These procedures are not formally adopted in the way that tax lawyers like to see; they are found in a bunch of web pages on irs.gov. Periodically the pages are updated with new stuff and the rules change. This is your new “shoot from the hip” Uncle Sam. I hope you like him.
Unreported Income, Foreign Trust
In late 2014 the IRS published Revenue Procedure 2014–55. It gives solutions to the unreported income problem (“Broken Stuff 1”) and the “your RRSP is a foreign trust” problem (“Broken Stuff 2”).
A Revenue Procedure is a formally-adopted administrative position, carrying a good deal more weight than web pages with stuff on them. You should expect the policy announced in Revenue Procedure 2014–55 to be around for a long time, and to evolve slowly–after deliberation.
No Need for Private Letter Rulings
Collectively, these two actions by the IRS made their existing “fix it” system irrelevant (“Broken Stuff 4”). Good news. The system of applying for a Private Letter Ruling was expensive, slow, and did not completely solve the problems anyway.
From the IRS side, too, it is good news. These Private Letter Ruling applications burned up thousands of hours of IRS attorney time on zero risk, zero revenue paper-pushing. Perfectly good government attorney brains were wasted on trivia. No more.
Let’s Declare a Moral Victory and Go Home
The IRS mostly succeeded. As you read through here you will find me questioning some points, but for 98% of U.S. taxpayers with RRSPs, risks are eliminated and the correct cleanup strategy will be obvious. I leave 2% as undefined because every system has randomness built into it. You, indeed, might be special.
We are close enough. Let’s declare victory and go home.
Fixing Broken Stuff 1 – The Unreported Income Problem
Let’s start with the unreported income problem. An RRSP is an entity that matches the U.S. tax definition of a “foreign trust” and specifically it matches the definition of the type of trust that passes all of its income through to its owner every year–a foreign grantor trust. Unless the RRSP owner wields the mighty axe of the income tax treaty to defeat this problem, there is income missing from the owner’s U.S. income tax return.
And of course normal people did not know about the treaty, or indeed about this unreported income problem. By the time they woke up to the problem, it was years late and the deadline for claiming the treaty benefits to protect their RRSP had long passed. They could not go back and fix the problem.
Revenue Procedure 2014–55 Fixes The Problem For Some People
The IRS neatly fixed this problem in October, 2014 by publishing Revenue Procedure 2014–55. The solution was found by creating a moment of fiction. The IRS declared that anyone who is an “eligible individual” will be treated as if he or she made the necessary treaty election at the earliest necessary date:
An eligible individual who did not previously make an election under Article XVIII (7) of the Convention to defer current U.S. income taxation on the undistributed income of a Canadian retirement plan will be treated as having made the election in the first year in which the individual would have been entitled to elect the benefits under Article XVIII (7) with respect to the plan.2
By pretending that you made the election under the treaty, we then can pretend that you did not have any unreported income from your RRSP. Problem solved.
The “Eligible Individuals” Problem
Only “eligible individuals” are allowed to use the simple, easy, and logical “let’s pretend” of Revenue Procedure 2014–55.3 Who are these favored souls, who, like the 144,000 in the Book of Revelations Chapters 7 and 14, will gain entrance to heaven?
An “eligible individual” is a beneficiary of a Canadian retirement plan who:
A) Is or at any time was a U.S. citizen or resident (within the meaning of section 7701 (b) (1) (A)) while a beneficiary of the plan;
B) Has satisfied any requirement for filing a U.S. Federal income tax return for each taxable year during which the individual was a U.S. citizen or resident;
C) Has not reported as gross income on a U.S. Federal income tax return the earnings that accrued in, but were not distributed by, the plan during any taxable year in which the individual was a U.S. citizen or resident; and
D) Has reported any and all distributions received from the plan as if the individual had made an election under Article XVIII (7) of the Convention for all years during which the individual was a U.S. citizen or resident.4
“An Eligible Individual Is A Beneficiary … ”
The first arm of the definition5 is a problem. It states, in the present tense, that in order to use the special rules of Rev. Proc. 2014–55, you must be a beneficiary of an RRSP right now. If your RRSP is closed, you are not now a beneficiary. It seems to me that the plain language in Rev. Proc. 2014–55, Section 4.01 says:
- Only eligible individuals can use this Revenue Procedure; and
- You are an eligible individual if you are a beneficiary of a retirement plan now; and
- You satisfy four other requirements.
If we knock out the second element, I don’t think you can use Rev. Proc. 2014–55 to solve your RRSP paperwork problems. Conclusion: if you are trying to clean up the past after you have closed out your RRSP, you are out of luck.
“Has Satisfied Any Requirement To File An … Income Tax Return”
You can only be an eligible individual if, among other things, you filed U.S. tax returns for time periods that you had a legal requirement to file.6
The language is curious (the phrase “any requirement to file” is a clanger to my ear), but not fatal. The intention was probably to express the following thought (my words, not the government’s):
You are an eligible individual if the IRS can find a tax return in the system for every year that you were a U.S. citizen or resident (for tax purposes).
The trigger for the filing requirement, in other words, was personal status (citizenship or residence) rather than some other trigger, such as receipt of U.S. source taxable income.
That is unnecessarily restrictive. It cuts off from relief a large number of people who probably need help the most. I’m talking about people who never filed a U.S. tax return. I have met these people in Canada, and I have talked to many on the phone or by email. You were born in Detroit and when you were 8 days old your parents took you back home to Canada, where you have lived a normal life for the last 50 years. I know people like that.
I am not sure why the IRS excluded these people from relief using the rules in Rev. Proc. 2014–55. Let’s be charitable and say this was inadvertent, and can be clarified by the government (if we are lucky) or by a bit of reasoning.
Here is my interpretation. I think that this particular requirement does not say when you were to have satisfied the filing requirements. The requirement is that you did something (filed a tax return); when you did it is not a specified requirement. I would take the position that someone who wakes up and files a bunch of remedial tax returns would be able to say “Yes, I satisfied my filing requirements” (albeit years late). As long as the “fix-it” methodology for your RRSPs includes the fact that your tax returns on file, you can do this late.
This is just my interpretation. You can’t take that to the bank.
Behaved Consistently With the Treaty: Investment Earnings
The other two requirements limit the easy solution to people who “acted as if”. On their US. tax returns, they did not report the income accruing inside their RRSPs as taxable income on their U.S. income tax returns.7 There are a few people (not many) who were alerted to the “RRSP is a foreign trust” problem and sincerely tried to do the right thing. They reported the internal investment returns on their U.S. income tax returns begrudgingly.
In return for following the law correctly, they get shut out of the Rev. Proc. 2014–55 “let’s pretend” solution for RRSPs. There are probably so few of these that the U.S. government can write them off as collateral damage in the War on American Taxpayers Abroad. From a broader perspective, however, damaging people who sincerely follow the law to their detriment is terrific antimarketing for the U.S. tax system, which after all is built on the foundation of taxpayers voluntarily8 telling the truth.
Behaved Consistently With the Treaty: Distributions
For people who received RRSP distributions, they, too, must have behaved consistently with the income tax treaty in reporting the distribution and paying income tax. If they received distributions from their RRSPs, they reported those distributions on their U.S. income tax returns the way the income tax treaty says they should have.9
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.10
If we substitute “Canada” and “United States” in the correct places, and if we throw a few other simplicity bombs on the paragraph, the rule reads:
Pensions and annuities arising in Canada and paid to a resident of the United States may be taxed in the United States, but the amount of any such pension that would be excluded from taxable income in Canada if the recipient were a resident of Canada shall be exempt from taxation in the United States.
The recipient’s home country gets to tax the pension.
However, RRSP distributions to a U.S. taxpayer are taxable by both Canada and the United States under their respective local tax laws.The treaty anticipates this, and limits Canada’s tax bite to 15%.
- 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[.]11
Again, let’s wave the magic wand of simplicity and rewrite this:
Pensions may also be taxed in Canada and according to the laws of Canada; but if a resident of the United States is the beneficial owner of a periodic pension payment, the tax so charged [by Canada] shall not exceed 15 per cent of the gross amount of such payment[.]
Canada can tax RRSP distributions paid to a U.S. resident, but at a maximum rate of 15%.
Back to Rev. Proc. 2014–55. Your RRSP can qualify for the easy “let’s pretend” solution if you (a U.S. taxpayer) paid tax on your RRSP in Canada at a maximum rate of 15%, and you also paid U.S. income tax on the RRSP distribution.
If this did not happen, you cannot be an “eligible individual” and therefore the easy rule of Revenue Procedure 2014–55 will not apply.
Eligible Individual: Conclusion
It’s a mess. An individual taxpayer will need to figure out if he/she is an eligible individual and hope that the definition applies. Here are the things that I think are knockout punches, disqualifying you:
- Your RRSP is closed. You are no longer a beneficiary, but you feel as though you must fix the past.12
- You have not filed U.S. income tax returns for years in which you were a U.S. citizen or U.S. tax resident (by having a green card, by spending too many days in the USA, or by making an election to be a U.S. taxpayer with your spouse on a joint U.S. income tax return), and you are not willing to go back and fix that nonfiling problem.13
- In a sincere (and correct) attempt to follow the law as it then existed way back when, you reported income accrued inside your RRSP as taxable income on your U.S. income tax return because you (correctly) determined that your RRSP was a foreign grantor trust.14
- If you live in the United States and you received an RRSP distribution, you paid more than 15% tax on that distribution to the Canadian government, and you reported the distribution for income tax purposes in the United States.15
There is another disqualification knock-out punch. If you previously made a treaty election you cannot use the Rev. Proc. 2014–55 method. That is no particular problem because you already have the protection from tax that you are seeking.
There is a comment section on this page. Please use it and prove me wrong. I am no longer in the business of fixing RRSP problems, so this is just my attempt to do a complete brain dump to Save the Planet, and I want to be sure that what I say is right. There is no better way to be right than to test your ideas in public against skeptical brains.
Unreported Income: If You Are an Eligible Individual and Never Claimed Treaty Benefits
If you are an eligible individual and you never filed an election to make your RRSP earnings protected by the treaty,16 the government has solved the problem of unreported income. Remember that without the income tax treaty you are treated as if you earned all of the income generated inside your RRSP and you are supposed to report it on your Federal income tax return.
You are treated as if you made a treaty election that protects the accrued but undistributed income inside the RRSP from U.S. income taxation.17 This is effective for all tax years starting with January 1, 1996.18 As a result, for all years from 1996 forward, you will not be required to report RRSP internal investment income on your U.S. income tax return.
Unreported Income: If You Claimed Treaty Benefits In a Prior Year
This applies to you whether you are an “eligible individual” (as defined in Revenue Procedure 2014–55) or not.This is because the result I am about to describe is derived from the operations of Form 8891, not from the way Revenue Procedure 2014–55 is written.
If you claimed treaty benefits in the past (you filed Form 8891 for your RRSP), you are protected.Go look at Form 8891, Line 6a through Line 6c.Note that Line 6c says “If you have not previously made the election described on line 6a above, you can make an irrevocable election for this year and subsequent years by checking this box”.
This means that if you ever filed Form 8891, you must have made the election. And having made the election by checking the box on Line 6c, you made an irrevocable election for that year and all subsequent years.
Unreported Income: Really, Who Cares?
If you somehow fit within the scope of Rev. Proc. 2014–55 as an eligible individual, you can pretend that you made the treaty election. If not, however, what do you do? Here are your choices.
- Do nothing. Everything the IRS has done since 2002 or so has shown me that RRSPs are an annoyance and a resource drain to the Service. They have a zero enforcement budget (he said, euphemistically) for this particular compliance issue.Carry on. Form 8891 is disappearing. Your RRSP distributions will be taxed properly when they are made. No harm, no foul. (Disclaimer: not legal advice, etc. etc.) If the IRS audits you, the tax liability is going to be small, probably less than the accounting fees and legal fees needed to fix the problem the way the IRS wants things to be fixed.
- Apply for a Private Letter Ruling. This is the recommended solution in Revenue Procedure 2014–55.19 Don’t do this. It is a colossal waste of time and money. The only thing it does is allow you to make a late election under the treaty to make your RRSP be treated like a pension, so that accrued and undistributed income is not taxed currently to you.It does nothing else for you. Here’s a clue to a possible strategy.Claim that by filing your income tax return and omitting the RRSP’s accrued and unreported income, you took a treaty-based return position (jargon alert). Hire your favorite tax advisor to take a look at that idea. (Disclaimer: not legal advice, etc. etc.)
I think we have adequately disposed of Broken Stuff 1. Unreported income from accrued and undistributed income in your RRSP is not something to worry about.
Fixing Broken Stuff 2 – the Foreign Trust Forms
Your RRSP is a foreign trust. U.S. taxpayers are required to file Form 3520 to report transactions with foreign trusts–contributions and distributions. The penalties are horrific.
A trustee of a foreign trust is required to file Form 3520-A. Again, the penalties are horrific (5% of the balance of the trust, every year.)
For everyone–eligible individual or not–the requirements for filing Form 3520 are waived. There is no requirement to file this form to report contributions to or distributions from an RRSP.20
The RRSP custodian is not required to file Form 3520-A. Ever.21That was easy.
Fixing Broken Stuff 3 – FinCen Form 114, Form 8938
The requirement to report your RRSP on Form 8938 will continue.22 FinCen Form 114 is the successor to the paper FBAR–Form TD F 90–22.1. Your RRSP is reported there.23
The problem of what to do if you missed prior years’ form filing continues. The path to getting this cleaned up lies in the Streamlined Procedures. There is a set of rules for American taxpayers living outside the United States, a different set of rules for taxpayers living in the United States, a process for filing late FBARS (FinCen Form 114), and a process for filing late informational forms such as Form 8938.
These procedures are magnificent at first glance but you soon will become confused. Never mind. Read the rules carefully. Your biggest risk is the “dog ate my homework” certification you have to give the IRS as part of any “fix-it” you do through these processes. Essentially you are saying “Dear IRS, here are the bullets. Please don’t shoot me.” If they don’t like your reason for missing the deadlines for filing these forms, you can be sent to audit and penalties can be imposed.
Get some advice from someone and plow forward with your life. Decide if you need to file these forms, and if you do, this is probably the least-bad way to do it.
I wish the IRS wouldn’t put a little turd of gratuitous, unnecessary risk and stress on every little rosebud they plant in the garden of taxation. But that’s wishful thinking. If things were different, they just wouldn’t be the same.
There is one other option for fixing the problem of late-filed FBARs and Form 8938–the Offshore Voluntary Disclosure Program. Oh, FFS. No. Just no.
If you’re a normal person with RRSPs and the normal kit of normal person tax stuff, stay away from the Offshore Voluntary Disclosure Program. This is something to consider only if the stakes (money or freedom) are high. That’s probably not you, and there is no way an RRSP alone will raise the stakes high enough to put you at risk of IRS-induced bankruptcy or loss of liberty. (Disclaimer: not legal advice, etc. etc.)
Fixing Broken Stuff 4 – The Private Letter Ruling Process
My theory is that you should never use the Private Letter Ruling process to fix an RRSP problem. It is too expensive, and it solves the smallest tax problem of all of them–the unreported income problem raised by the failure to file a Form 8891 long, long ago.
I think we can say that the IRS has successfully solved the problem of being overloaded by Private Letter Ruling applications for RRSPs. The alternatives discussed here are adequate to the task of solving most (if not all) RRSP-driven U.S. tax problems.
Form 8891: It’s Dead, Jim
Here are the new filing rules for Form 8891 for everyone–eligible individual or not.24
Dead For 2015 and Later
The first thing to know is that Form 8891 is obsolete and will not be in use at all for the 2015 tax year forward. It is gone after December 31, 2014 for everyone and every purpose.25
Forbidden for 2014
The Instructions to the 2014 Form 8938 specifically tell you not to use Form 8891 in 2014. (Thanks to Richard in the comments below for this.)
State Tax Problems Remain
Federal tax complexities for RRSPs are largely banished, but State income tax may remain a problem for RRSP owners. States sometimes cheerfully choose to ignore Federal law. /cough/ California /cough/ is a notorious and flagrant offender. “Federal income tax treaties? F— off”26 is the Standard Operating Procedure in Sacramento, and this philosophy specifically applies to California taxation of RRSPs (warning: PDF).
Conclusion
That’s it for me and RRSPs. Thanks for reading. Please comment and tell me if I’m wrong, if I wrote something that is as understandable as a bag of doorknobs, or if a particular topic needs to be added or amplified. I will get this as good as I can, so it will remain in place and I can focus on other stuff.
Phil.
- Parentheticals FTW. ↩
- Rev. Proc. 2014–55, Section 4.02. ↩
- Rev. Proc. 2014–55, Section 4.01. ↩
- Rev. Proc. 2014–55, Section 4.01. ↩
- Rev. Proc. 2014–55, Section 4.01. ↩
- Rev. Proc. 2014–55, Section 4.01(B). ↩
- Rev. Proc. 2014–55, Section 4.01(C). ↩
- There is that word again. When the government says “voluntary” it does not mean what you and I think it means. ↩
- Rev. Proc. 2014–55, Section 4.01(D). ↩
- Canada/USA Income Tax Treaty, Article XVIII(1). ↩
- USA/Canada Income Tax Treaty, Article XVIII, Section 2(a). ↩
- Rev. Proc. 2014–55, Section 4.01. ↩
- Rev. Proc. 2014–55, Section 4.01(B). ↩
- Rev. Proc. 2014–55, Section 4.01(C). ↩
- Rev. Proc. 2014–55, Section 4.01(D). ↩
- Rev. Proc. 2014–55, Section 4.02. This means you never filed Form 8891 and you never filed one of the statements in the predecessor procedures that the IRS had before it published Form 8891. ↩
- Rev. Proc. 2014–55, Section 4.02. ↩
- Rev. Proc. 2014–55, Section 9. ↩
- Rev. Proc. 2014–55, Section 4.04. ↩
- Rev. Proc. 2014–55, Section 5.01. ↩
- Rev. Proc. 2014–55, Section 5.01. ↩
- Rev. Proc. 2014–55, Section 5.01. ↩
- Rev. Proc. 2014–55, Section 5.01. ↩
- Rev. Proc. 2014–55, Section 5.01. ↩
- Rev. Proc. 2014–55, Section 5.02. ↩
- Appeal of M.T. de Mey van Streefkerk, 85-SBE–135, Nov. 6, 1985. ↩
The FBAR form wants you to prepare the form using the unintelligent, non-intuitive, and wildly misleading way. Highest balance for every account. The good thing about this is that after a few efforts the examining agent will start to distrust the aggregate highest balance on an FBAR because it is self-evidently wrong — because of the over-counting you describe. That means they distrust their own data. Yay.
Hi Phil,
Quick question (famous last words…). Some of my accounts are connected and money gets transferred back and forth. As a result, if I report the highest balance for each of these accounts at any point in the year it makes it appear I have far more money than I actually do. It’s the same money showing up in different accounts. If I was trying to get approved for a loan and prove I had $25,000 I couldn’t open up 5 accounts and transfer the same $5000 to each account and say look I have $25,000. So does the Fbar care about the actual true total amount or do I just report the highest balance in the year (because technically that amount was in that account) and make it look like I’m three times richer than I actually am?
Phil, I am starting the Streamlined Domestic Offshore Disclosure process. I’ve been reading IRS doc for the last 5 days trying to make sense of everything. Luckily, I came across your blog. Thank you for clear and easy to understand explanations. I might just get some sleep tonight.
I have a question on income distributions in my Canadian RRSP. “Income Distribution” was the actual wording in my statement with the gross amount, unit price, additional units for each distribution was listed as individual transactions . The income distributions were actually automatically re-invested back into the plan as additional shares. Since I did not get any money from the monthly distributions, the statement also do not state any Cap and/or income gain and realized Gain was left blank, I tend to think it is not a real distribution and should not have to pay tax on it. However, after 2 days of research without any clear answer, I am ready to throw in the towel and just claim it as interest and pay the tax and penalties. Am I wrong and possibly getting myself into more trouble later on by doing this?
@Adam,
You are correct in your thinking. I am not saying the conclusion is right or wrong — I don’t know enough about your situation — but the approach you are taking is the way I approach questions like this. Therefore, you are correct in your thinking! 🙂
There are plenty of times when it is worth paying the 5% to get closure. If the numbers are small enough in your case (this is a judgment call for you personally) I think you are right to buy peace of mind. Thereafter, you cannot be buffaloed by the IRS’s fear-based marketing. You will be a free man.
We are a Nation of Laws(TM) — quite unlike those countries where law enforcement is based on capricious application of informal and unwritten understandings hidden deep inside the bowels of bureaucracy. Heh. As if.
Phil, Thank you for this summary. If a US taxpayer with an RRSP (only foreign account/asset they have), who never made a 8891 election and never filed 8938 or FBARs wanted to get their ducks in a row – as I review the US Taxpayer Streamlined Domestic Offshore Disclosure Program – it appears that there is a title 26 miscellaneous offshore penalty of 5% due. Whereas participating in the Delinquent FBAR and Delinquent International Information Return programs appear to require nearly all the same information as required under a Offshore Voluntary Disclosure (which provides that RRSP won’t be factored in for penalties), but without the guarantee of no audit or the explanation of reasonable cause. Why not participate in the Offshore Disclosure to ensure you won’t receive a penalty and get closure? It doesn’t appear to be that much more work. Thanks for you input.
Greetings from 30th Street and 7th Avenue in NYC. I will have to get back to you later on that. Time to jump on the subway and head back to my hotel — I am about out of battery. 🙂
Far be it from a Canadian accountant to know these answers–or my accountant.
For Part VI of the 8938 in which I will list my RRSP accounts:
How do I know if the issuer is a a corporation or trust? Both issuers are banks, so I suspect they are corporations. Since theses are Canadian banks, I imagine that the issuer is a foreign person for US tax purposes.
Also, can I check 3d, “no tax it4em reported in Part 111 with respect to this asset” and report no summary information for my RRSPs in Part 111, #2? I have been filing 1040s and the 8891 in previous years.
Thanks so much for your help.
Wow everyone. Silly me. I wrote this post because I thought I could definitively answer all RRSP questions. Hehehe.
We are in the midst of a big push to revamp the website. When we do that we will be promoting this blog post to its own standalone page, with more opportunities to answer all of the questions.
We make no money on RRSP stuff. That is as it should be. RRSPs should be ridiculously easy to handle. Unfortunately, the government begs to differ.
I have RRSPs. I have completed the filings for past years, but I don’t know how to fill out Part VI of 8938 for 2014.
We are not supposed to fill out line 7. Does that mean that we have to fill out line 8 which states that the RRSP is not an interest in a foreign entity? Is the RRSP an issuer or a counterparty? How can I tell? I do know that one of my RRSPs is a corporation. Another is a trust.
Does that mean I should say for c. that they are foreign PERSONS?
Whew! At least I know their address.
Thank you so much for your clear and heartfelt information!
Thank you for your very informative blogs.
I work for an international organization in NY, which has a 401(a) qualified “employees trust” that is a defined benefit plan. (The IRS issued an affirmative determination that it was a 401(a) plan.)
The organization contributes 2/3 and the employee contributes 1/3 to the plan. The employee contribution is reported on a W-2 and is taxable in the year earned. The organization’s contribution is taxable upon distribution subject to Sec 72 annuity rules.
The plan’s assets are held by two US global custodians. The custodians are US corporations based in the US, ie, domestic FIs.
Since it is a 401(a) plan-even though it was technically not created in the US-is it reported on FinCen 114? Also, since only part of it is nonexempt and is not a 402(b) is it a grantor trust subject to 3520 and 3520-a and FinCen114? I have been told no but I am not sure and thought you might have some insight on this. Finally, how far back do information returns need to be filed under streamlined if no tax is owed?
Thank you in advance for any assistance!
@Steve,
True. Another example is expatriation. The exit tax is a Federal-only tax. States don’t care.
Phil.
Regarding California not taxing unrealized gains, this is a good difference from the Federal treatment of PFICs. Not all the state differences are bad.
Thanks Thom. You made my day.
Bravo, Phil!
Thank you for writing such a clear, and delightfully humorous, explanation of the arcane RRSP mess.
It’s the 4th post on the topic I’ve read, and the first that a non-lawyer, non-accountant like me can understand.
What a gift! You’ve made my day!
Everyone rolled over and played dead. Courts have ruled that the FBAR penalty is not excessive. FATCA serves the purposes of your Overlords and it will not go away. Indeed, expect other countries to follow suit. If I were to go Putin a limb I would predict that we are at the dawn of Citizenship-Based Taxation for most of the developed countries. Give it 20 years.
Hi Phil, thanks very much for your blog. I am a U.S. citizen that has lived in Canada for 48 years. I have always filed my 1040’s and made the Tax treaty declaration many years ago. I retired 10 years ago and converted part of my RRSP to a Life Annuity and the remainder to an RRIF. I always report this income as Pension on Line 16a and 16b of the 1040. I use the Canadian Tax Credit on F1116 and have filled out 8891’s in the past and now the 8938. I have always reported a Bank Savings Account on 1040 Schedule B and on the FBAR Fincen 114 but not the annuity or the RRIF distributions. Am I supposed to report these on the Fincen 114 ? If so how do I fix prior years ?
@Phil thank you for the link very helpful information!
Hi, Phil:
First of all, thank you very much for the informative post! I’m one of the Canadians living in the US that didn’t know about the filing requirements for RRSP’s. I didn’t know about any of the forms that were required ( old Form 8891, FinCen Form 114 etc). so I have filed extension this year in order to figure out what I need to do. Now I know I need to file form 8938 since I have Canadian RRSP and the value of my RRSP is more than $75,000 for 2014.
my question is: Do I have to file FBAR as well, even though I will file form 8938? also, do I have to get the previous years of FBAR’s filed? if I filed these forms, will I get into trouble for not filing these in previous years? what is my choice? I would appreciate your advice.
Thanks in advance.
@Thomas,
Look here http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-FBAR-Submission-Procedures for the IRS procedure that I think might work for you.
So what is the semi-nearly-somewhat nearly way to fix it I have not filed FinCen Form 114 for the past 5 years? I have been in US since 2000 and have been filing 8891 every year since 2004… and didn’t realize I need to include RRSP in FinCen until I found out that 8891 become obsolete :(. Is the fix able way is file prior year from (5 years) and pray that IRS wont come after me? Thanks very helpful website.
Phil,
First of all, you taught me a lot, thank you! I’m one of the Canadians living in the US that didn’t know about the filing requirements for RRSP’s. I didn’t know about any of the forms that were required ( Form 8891, FinCen Form 114 etc). I guess that I lucked out with the changes made last October. I’m exempt from filing 8938 since the value of the RRSP is less than $50K for 2014, and I’m married filing jointly. I’m currently in the process of getting the last 6 years of FBAR’s filed, so hopefully that goes well. My only question is where do you claim the RRSP? Is it only on Schedule B Part III, Foreign Accounts and Trusts? If so, that only tells the IRS that you have an account and it is from Canada.
PS I also learned about the expatriate tax here!
Thanks
Terry
I do not remember finding situations where a person was ineligible under a treaty. Maybe it happens, but I have not seen it.
Currency translation–if you are in the weeds and lost on what to do here, find a consistent method and keep using it. You are going to have trouble if you change methods to cherry-pick the best exchange rates all the time. Pick December 31 as your date. Technical answer: I don’t know off the top of my head. 🙂
As I’m doing my first tax return as a US resident, I’ve only recently become aware of this issue but I guess it can’t hurt to try get this on the agenda of a few politicians for future years. Any suggestions of where I might find guidance around how the currency transalation of the pension growth should be handled and whether the growth is treated as a capital gain or ordinary income? Have you any experience of this with Canadian pensions where people were ineligible to claim the treaty exemption? Thanks.
@Chino, I will be happy to help if the IRS gets stinky about the 8938s. 🙂
Phil,
I enjoyed your post.
I have been religiously filing Form 8891, FinCen Form 114 and before that TD F 90-22.1 disclosing all my canadian RRSP accounts. I have not filed Form 8938 in the prior year tax returns because the tax software I used never steered me in this direction and I was not aware of this requirement. I know this sounds like the ‘ the dog ate my homework’ excuse. I was going to file this form with the 2014 return of course. If the IRS come after me for something that I have disclosed all along in form 8891 and in my filings with the Dept of Treasury – form TD F… and FinCen form 114, will you be able to help undo the mess?
Thank you
Chino Srinivasan
I seriously doubt that we will see the Treasury Department provide any kind of blanket guidance for foreign pensions to create solutions such as we see for Canadian RRSPs. It seems that they do this on a country by country basis. Irish politicians need to be prodded to yell at their U.S. counterparts. 🙂
Phil,
Thanks for a very thorough article. I am amazed that the official guidance is so unclear and also by the fact that a US resident or citien could be required to pay US taxes on unidistributed growth in a foreign pension plan even if that person was unemployed for a period of time and therefore had no current income with which to pay the tax. Any advice for a US resident who moved to the US from Ireland in 2014 but has reasonably high savings in an Irish pension plan? Unfortunately, I don’t believe the US-Ireland tax treaty provides for relief on undistributed pension growth. Do you think there is any likelihood of a similar exemption to the Canadian treaty being established in the future for other countries and applied retrospectively and, if so, whether it might be better to take an approach of not considering foreign pension growth as taxable income? If not, are you aware of any guidelines regarding how the FX impact on foreign pension fund growth is calculated? I am hoping it is based off the change in USD value of the pension from the start to the end of the tax year as the other alternative of firstly calculating the growth in the fund in foreign currency (Euro) and converting to USD using an average FX rate for the year would result in a much higher USD amount given the drop in the EURUSD FX rate in 2014. Lastly, if an individual’s pension is invested solely in a managed equities fund which doesn’t make distributiions, do you know whether the growth in the pension funds value would be treated as a capital gain or ordinary income for US tax purposes?
Thanks, James
@HEC,
The withdrawal from an RRSP is taxable income to you for U.S. purposes. It will flow through to Line 16 on Form 1040, and you will claim a foreign tax credit on Form 1116 for the Canadian tax withheld. I am not sure whether your RRSP administrator will issue a 1099-R or not. The bet is on “not”. You’re on your honor to report the income.
For Phil
Under the new rules, how does one report a withdrawal from an RRSP. The RRSP account had been properly reported according to the old rules (8891) in previous years. Do I use a 1099-R ? If so, it looks might arcane.
To my question above- sorry I wrote form as 8898 instead of 8938
For Phil,
First of all thanks a lot for this post. It was very informative. I still however have one question- I am a Canadian citizen living in US for last 5 years. I fall in the category of eligible individual who had filled form 8891 for tax year 2010 and for subsequent tax years we were told by E&Y who did our taxes that we need to report ONLY our RESP- education fund on form 3520-A (since RESP is considered a TRUST) and not our RRSP. My question is going forward for TAX year -2014- quest-1- do I need to fill form 8898 if my RRSP saving are greater than 100,000?
Second question- if I do fill up form 8898, where do I specify that these are my tax sheltered savings and not my income since I haven’t taken out that money yet.
@stickman – Your strategy (ETFs etc.) is the right one. California only cares about actual cash transactions, not unrealized gains. You put those on Schedule CA in order to tell California how much income you realized. As you note, you can choose investment strategies to keep this at a minimum, so it is mostly an annoyance. 🙂
Phil,
Thank-you for the quick reply. Although it’s a pain to calculate these internal dividends or distributions the net California tax owed by most filers will be negligible so long as they do not trade any of the holdings in the RRSP (which would generate a realized capital gain) and it would be preferable to hold index funds or etf’s to limit any internal dividends or distributions. Your explanation makes sense to me – I had seen on other forums/boards on the net where people claimed that RRSP holders in California had to pay tax on unrealized capital gains (paper capital gains from increased stock or fund appreciation that has not been realized and will not be realized until the stock or fund is sold) – that made no sense to me.
@stickman,
California could give two flicks of a horse’s . . . tail for Federal tax law and the solution to the RRSP problem. You are correct — California wants to tax the internal dividends etc even if there is no distribution to the RRSP holder.
Hi Phil:
Your website and blog are very helpful. I have the following question: are California taxes due on unrealized gains in a Canada RRSP account ? If the holdings in the account remain untouched are the only California taxes due on dividends or distributions generated by the fund itself for the tax year in question ?
Re the e-file for 8938. At least with the FreeFile Fillable Forms for 2014, there are three major limitations on this form: 1. You can only file one copy with your return, even a joint 1040. 2. You can only report details for one foreign asset on that one copy. And 3. it does not have continuation pages. So for those of us with more than one (e.g. Canadian spouses in the US permanently, each with an individual RRSP), my reading is that we *still* have to do paper filing. This is crushingly disappointing, as it really looked like it would finally be possible. (The annoying thing is that one of those is only worth ~$500. I guess it’s time to close it out and pay the tax and Canadian penalties, to leave just one, unless doing so would create even worse headaches.)
If anyone knows of a (legit) way to make two accounts work with the current limitations, I would love to hear about it.
California will never align itself with tax treaties. This flies directly in the face of the Culture of Californian Exceptionalism. 🙂
An RRSP that just sits there is not likely to generate enormous California tax costs. I personally would suggest filing Schedule CA to report the income on the California tax return. The marginal cost is low and the sleep-at-night benefit is worthwhile.
That said, the probability of RRSP visibility is negligible now that nothing is reported to the IRS on Form 8891. He said, gazing skyward and whistling a tune to himself.
Thanks for the clear writeup Phil, much appreciated by those of us in this boat of absurdity!
Do you have a recommendation for how to deal with nonsensical states such as California? Wait patiently for them to align with international tax treaties / reality? File each year as they request and pay the “best state in the union” use fee, and screw oneself further later in case the cleanup is similar to the fed one which screws you if you reported in the past? Move back home, or to a better state?
@anotherbrick,
Yep. Even though the IRS has done away with the Form 8891 (finally!) your basic point remains true. There are other things that Americans abroad must file that bork the e-file systems, forcing them to go back to paper.
/Phil.
You forgot to mention the other horror show even for those of us who were doing it correctly… 8891 forced paper filing instead of e-filing, at least for the e-file systems I am aware of, which is big fat pain when you live in another country. I am really hoping to e-file now in 2015.
Thanks for the clarification. I will update the post. You have improved the quality of information available to the world and so many thanks for that.
Phil
Just to clarify Cdn taxation of RRSPs for US residents, the 15% rate aplies ONLY to periodic pension payments. Periodic is defined in the ITCIA Section 5.
In essence this requires the payouts to be (a) NOT from an RRSP and (b) be less than twice the minimum prescribed annual payout or 10% of the account value (at start of year), which ever is greater.
So, an RRSP payout, regardless of how small or the age of the beneficiary, will always be withheld at the 25% non-resident rate. An RRSP would need to be converted to a RRIF or other Income fund, and paid out at less than 10% per year, to be considered “periodic” and thus benefit from the 15% withholding rate.
Thanks Richard. I will fix this now.
Phil,
Good comprehensive post! But the discussion of Form 8891 needs to be modified in light of the new instructions for Form 8938 that just came out. These instructions appear to say that 8891 *cannot* be used for 2014 under any circumstances, even though there’s still a reference to it on 8938.
The only reason that Canadian RRSPs have treaty protection is because a lot of U.S/Canadian taxpayers woke up and started yelling at the Canadian banks to give them Form 3520-A forms. Banks have political clout, so diplomacy happened and the treaty was amended to solve the problem. Also, the IRS started fielding a metric tonne of calls from irate/distraught taxpayers, so they got hit over the head with the Cluestick, too.
This has not yet happened with Australia. Ultimately the only solution is a diplomatic solution–amending the income tax treaty between the two countries. The U.S. could care less, so the impetus must come from the Australian side.
I am told that in the early 2000’s there was internal discussion at the IRS and Treasury Department to find a Keep It Simple solution for superannuations, but the idea was shot down by some Poohbah or another in the Treasury Department. That’s why the solution (that took a couple of decades to incubate) is Canadian only.
Short answer: USA and its tax people know it’s a problem. Probability of a fix: nil. Recommended solution: ask the Australian ambassador to start yelling. Keep yelling for five or six years.
Any idea if we’ll see something like this for Australian Superannuation accounts? These are essentially the same situation, except that by Australian law, Australians cannot close Superannuation accounts until age 60 — they can’t even move the money to the US if they want to (unlike RRSPs, which can be closed at any time).
Good news for Canadians, then.
Nothing at all, though, for residents and/or citizens of any of the other approx 68 countries with which the US has a tax treaty .