This item explains the evolution of the IRS reporting requirements for Canadian registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs).
An RRSP is a retirement savings plan that a taxpayer establishes, the Canada Revenue Agency registers, and the taxpayer and his or her spouse or common law partner contribute to. Under Canadian tax law, the contributions to the RRSP are deductible on a Canadian tax return and thus reduce Canadian tax liability. Under Canadian tax law, any income earned in the RRSP is usually exempt from tax as long as the funds remain in the plan; a taxpayer generally has to pay Canadian tax when he or she receives payments from the plan (see Income Tax Act, R.S.C. 1985, ch. 1 (5th supp.), Section 146(1)).
An RRIF is an arrangement between a taxpayer and a carrier (an insurance company, trust company, or bank) that Revenue Canada registers. The taxpayer transfers property to the carrier from an RRSP, for example, and the carrier makes payments to the taxpayer. The minimum amount must be paid to the taxpayer in the year following the year the RRIF is entered into. Earnings in an RRIF are tax-free, and amounts paid out of an RRIF are taxable upon receipt (see Income Tax Act, R.S.C. 1985, ch. 1 (5th supp.), Section 146.3(1)).
U.S. Tax Treatment of RRSPs and RRIFs
RRSPs and RRIFs are not treated as pension plans under U.S. tax laws. Rev. Proc. 89-45 states:
Canadian [RRSPs] are provided certain income tax benefits for Canadian tax purposes; however, these plans do not meet the requirements for qualification as individual retirement accounts under section 408(a). . . . As a result, the earnings of such a plan are includable currently in the gross income of the beneficiary of the plan for United States income tax purposes.
Thus, there could be a mismatch of the recognition of income for U.S. and Canadian income tax purposes, i.e., the possibility of double-taxation. However, there is an election provision in the United States—Canada tax treaty to mitigate this issue, which is discussed below.
RRSPs and RRIFs for U.S. Reporting Purposes
For U.S. tax purposes, RRSPs and RRIFs are foreign grantor trusts, as the contributor can obtain all the money back that he or she contributed. This means that absent an exception, a U.S. taxpayer with one would be required to file a Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner, and Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, annually.
Changes Made by Rev. Proc. 2002-23 and Notice 2003-75
Rev. Proc. 2002-23 superseded Rev. Proc. 89-45 and included Article XVIII(7) of the treaty, which was added by the treaty protocol that was signed on March 17, 1995, and expanded and replaced Article XXIX(5).
Article XVIII(7) of the Convention provides, effective for tax years beginning on or after Jan. 1, 1996, that:
1. A natural person who is a citizen or resident of either the United States or Canada and
2. Is a beneficiary of a trust, company, organization, or other arrangement that is a resident of the other country and that is generally exempt from income taxation in the other country (a plan), and that is operated exclusively to provide pension, retirement, or employee benefits,
3. May elect to defer taxation in the person's country of citizenship or residence, under rules established by the competent authority of that country, 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 therefore.
Rev. Proc. 2002-23 provided interim rules for making the election provided for by the treaty to defer the income from RRSPs and RRIFs until a distribution was made from the plan. It also prescribed the statements that had to be attached to a current Form 1040, U.S. Individual Income Tax Return, and all subsequent Forms 1040 that the taxpayer wanted the election to be effective for until the IRS issued Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.
Notice 2003-75 advised that the IRS had developed a new simplified reporting regime for taxpayers holding interests in Canadian RRSPs and RRIFs, which was effective for tax years beginning after Dec. 31, 2002. This new regime was in lieu of the filing obligations under Sec. 6048 (Form 3520 and Form 3520-A) that otherwise apply to U.S. citizens and resident aliens who hold interests in RRSPs and RRIFs and to the custodians of those plans. The simplified reporting regime was designed to permit taxpayers to meet their reporting obligations by completing Form 8891. By attaching it to Form 1040, the taxpayer was making the election under the treaty to treat an RRSP or RRIF as a pension for both U.S. and Canadian tax purposes and was relieved of the Form 3520-A and Form 3520 filing requirements. Note that if taxpayers did not make this election and actually included the income and gains from the RRSP and RRIF on their Form 1040, they would still be required to file Form 3520-A and Form 3520 annually.
Further Evolution of U.S. Reporting of RRSPs and RRIFs
Taxpayers still seemed unaware that they had to make an affirmative election by attaching a Form 8891 initially and each year. Then, in the late 2000s, when the IRS introduced its first Offshore Voluntary Disclosure Program (OVDP), many U.S. citizens or residents suddenly became aware that they had been taking the position on their Forms 1040 that their RRSPs and RRIFs were tax-deferred for U.S. tax purposes, but they had not attached the Form 8891 annually and/or had not made the initial election. Thus, the income from their RRSPs and/or RRIFs should have been reported as income on their Forms 1040, and they should have been filing forms 3520-A and 3520 annually. This meant that they would have been subject to OVDP penalties, as they had omitted foreign income from their U.S. taxable income.
At that time, the only avenue to make a retrospective election under the treaty was to apply for a private letter ruling, which certain taxpayers did, but that is an expensive administrative process.
Rev. Proc. 2014-55 to the Rescue
Rev. Proc. 2014-55 provides that an eligible individual who did not previously make an election under Article XVIII(7) of the treaty but who would have been eligible to make one is deemed to have made the election in the first year in which he or she was entitled to do so. So, a taxpayer who is a U.S. citizen or U.S. resident and has an RRSP and/or RRIF but has never included any income on a Form 1040 from it is deemed to have made the election. In addition, Rev. Proc. 2014-55 eliminated the need to file Form 8891 annually, as of Dec. 31, 2014.
Rev. Proc. 2014-55 provides the following example, which summarizes the IRS's current position on RRSPs and RRIFs:
Taxpayer is a U.S. citizen and a resident of Canada who established an RRSP in 2004 and filed Form 1040, U.S. Individual Income Tax Return, for 2004 and all subsequent taxable years. Taxpayer did not attach to any Form 1040 a Form 8891 with respect to the RRSP and did not make an election under the procedures set forth in Revenue Procedure 2002-23. Taxpayer also did not include as gross income on any Form 1040 any earnings that accrued in the RRSP during 2004 and subsequent taxable years. Taxpayer has not received any distributions from the RRSP. Pursuant to . . . this revenue procedure, Taxpayer is an eligible individual and . . . will be treated as having made an election under Article XVIII(7) of the Convention to defer current U.S. income taxation on the undistributed income for 2004 and all subsequent taxable years through the taxable year in which there is a final distribution from the RRSP. When Taxpayer receives distributions from the RRSP, the entire amount of each distribution will be subject to U.S. Federal income tax. In addition, Taxpayer is not required to report his interest in the RRSP on Form 8891, Form 3520, or Form 3520-A. However, Taxpayer may need to report his interest in the RRSP under section 6038D [on Form 8938, Statement of Specified Foreign Financial Assets] or under another provision of U.S. law, including the requirement to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), imposed by 31 U.S.C. § 5314 and the regulations thereunder.
Note that frequently asked questions and answers Nos. 8, 9, 10, 11, and 12 of the IRS's Streamlined Filing Compliance Procedures for U.S. taxpayers residing in the United States should also be referred to if a taxpayer has RRSPs and RRIFs and is considering using these procedures to become compliant with the various income-reporting requirements.
How the Individual States View RRSPs and RRIFs
The treaty applies only to U.S. federal tax statutes; it does not apply at the state level. Therefore, practitioners need to make sure that taxpayers are disclosing RRSPs and RRIFs correctly not only at the federal level but also at the state level. For example, California Franchise Tax Board Information Letter No. 2003-0040 said the state does not recognize the election to defer the income on RRSPs. California considers these accounts similar to a savings account and taxes the income and gains as they accrue.
In summary, the IRS has finally simplified the reporting requirements for taxpayers who want to treat RRSPs and RRIFs as pensions for U.S. tax purposes and defer the inclusion of income on their Forms 1040 until they receive a distribution. However, states don't necessarily follow that position, so taxpayers and their advisers need to review this on a state-by-state basis. Finally, it is important to note that RRSPs and RRIFs may need to be reported on Form 8938 and/or FinCEN Form 114 annually.
Anthony Bakale is with Cohen & Company Ltd. in Cleveland.
For additional information about these items, contact Mr. Bakale at 216-774-1147 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with Cohen & Company Ltd.