I hear from people every week who think their tax problem is the end of the world. It usually isn't. I'm Darrin Mish. I've resolved over $100 million in tax debt for clients. Here's what you should know.
The Cross-Border Pension That Got Easier
Canadian Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) are the foundation of Canadian retirement saving. For U.S. taxpayers with Canadian connections – dual citizens, U.S. citizens working in Canada, Canadians who moved to the U.S. – the U.S. tax treatment of RRSPs used to be one of the most complicated pieces of cross-border tax compliance.
The good news is that the IRS substantially simplified the rules in 2014. The basic mechanics now work well for most cross-border taxpayers. The catch is that the simplification depends on the taxpayer making the right election and meeting the qualifications.
How RRSPs Work Under Canadian Law
An RRSP is a tax-deferred retirement account under Canadian law. Contributions are deductible against Canadian taxable income up to annual limits. Investment earnings inside the RRSP are not taxed by Canada until withdrawal. Withdrawals are taxed as ordinary income.
RRIFs are the post-retirement form of RRSP. At age 71, RRSPs must be converted to RRIFs or annuities. RRIFs require minimum annual withdrawals.
The Canadian tax system treats RRSPs and RRIFs similarly to U.S. IRAs – tax-deferred during accumulation, taxable on distribution.
The Pre-2014 U.S. Problem
Before the IRS issued Rev. Proc. 2014-55, U.S. taxpayers with RRSPs had to file Form 8891 each year to elect treaty-based deferral of U.S. tax on RRSP earnings. The election had to be made annually. Missing the form created an exposure for current taxation of RRSP earnings.
The rule produced poor outcomes. Many U.S. taxpayers had RRSPs they did not know about (left behind from prior Canadian employment, inherited from relatives, opened by parents). Failures to file Form 8891 were widespread. Penalty exposure was significant.
Rev. Proc. 2014-55 – The Fix
In 2014, the IRS issued Revenue Procedure 2014-55, which eliminated the Form 8891 requirement and provided automatic treaty-based deferral for U.S. taxpayers with RRSPs and RRIFs.
Under Rev. Proc. 2014-55, U.S. taxpayers with RRSPs are automatically treated as having elected treaty-based deferral under Article XVIII of the U.S.-Canada tax treaty. The treaty election is made by default, without affirmative action by the taxpayer.
The effect: income earned inside the RRSP is not currently taxed by the U.S. RRSPs accumulate on a tax-deferred basis for U.S. purposes, similar to how IRAs accumulate.
Rev. Proc. 2014-55 applies retroactively for taxpayers who never filed Form 8891 in prior years and were otherwise compliant. The relief was a fix to an over-broad pre-existing rule.
Withdrawals From RRSPs – The U.S. Tax Treatment
When an RRSP is distributed to the U.S. taxpayer, the distribution is U.S. taxable income. The treatment depends on whether the distribution is to a U.S. resident or to a Canadian resident.
For U.S. residents (who are also U.S. persons), the distribution is reported on the U.S. tax return as pension income, taxable at ordinary income rates. The Canadian tax withheld at distribution (15 percent under the treaty, 25 percent if no treaty applies) is creditable against U.S. tax under IRC Section 901.
For Canadian residents who are U.S. citizens, the distribution is taxable in Canada under Canadian rules. The U.S. tax treatment depends on whether the taxpayer is also a U.S. resident or only a U.S. citizen abroad. U.S. citizens abroad may have the distribution covered by the foreign earned income exclusion or the foreign tax credit.
The Basis Recovery Question
One nuance of RRSP distributions to U.S. residents: the U.S. system may treat some of the distribution as a return of basis rather than taxable income.
U.S. basis in an RRSP includes after-tax contributions made by the U.S. taxpayer (not deducted on the U.S. return) and any RRSP earnings that were previously taxed by the U.S. (rare under current law given Rev. Proc. 2014-55 deferral).
For most RRSPs accumulated entirely by Canadian residents who later moved to the U.S., the U.S. basis is minimal or zero – because the contributions were not on U.S. returns. The full distribution is U.S. taxable income.
For RRSPs where U.S. taxpayers made contributions during U.S. residency, the basis may be substantial. Tracking is required to support the basis recovery position.
FBAR and Form 8938 Still Apply
Rev. Proc. 2014-55 addressed the Form 8891 issue but did not eliminate other reporting obligations.
FBAR (FinCEN Form 114) is required if the aggregate balance of foreign financial accounts (including the RRSP) exceeded $10,000 at any point during the year. Most RRSPs of any size will exceed this threshold.
Form 8938 (FATCA) is required if the specified foreign financial asset threshold is met. RRSPs count as specified foreign financial assets.
For most U.S. taxpayers with RRSPs, both FBAR and Form 8938 are required each year.
The Form 3520 and 3520-A Question
RRSPs are structured as trusts under Canadian law. The classic U.S. foreign trust analysis would suggest Form 3520 and 3520-A reporting requirements.
Rev. Proc. 2020-17 created an exemption from Form 3520 and 3520-A for certain tax-favored foreign retirement trusts. Most RRSPs meet the conditions for the exemption: tax-favored treatment in Canada, defined contribution limits, an information reporting framework in Canada.
The practical result: most U.S. taxpayers with RRSPs do not file Form 3520 or 3520-A. The reporting obligations come down to FBAR, Form 8938, and income tax reporting on distributions.
RRSPs Inside Other Structures
Some Canadian financial structures involve RRSPs held inside other arrangements that complicate the U.S. analysis.
Group RRSPs (sponsored by Canadian employers) generally follow the same rules as individual RRSPs.
Spousal RRSPs (where one spouse contributes to the other spouse’s RRSP) have specific U.S. treatment that may differ from individual RRSPs. The Canadian attribution rules do not necessarily carry over to U.S. analysis.
Locked-in retirement accounts (LIRAs), locked-in retirement income funds (LRIFs), and similar provincial vehicles can have different U.S. treatment depending on the specific structure and the provincial rules.
RRSP investments in Canadian mutual funds and ETFs raise the PFIC question. Canadian mutual funds and ETFs are PFICs under U.S. tax law.
The PFIC Issue Within RRSPs
Canadian mutual funds and ETFs held inside an RRSP are PFICs. The PFIC reporting under Form 8621 would normally apply.
The Rev. Proc. 2014-55 deferral generally suspends current taxation of PFIC income inside the RRSP. The IRS position is that the deferral covers PFIC mark-to-market and excess distribution amounts inside the deferral-protected account.
This is a practitioner-driven position based on the language of Rev. Proc. 2014-55 and the underlying treaty article. It is not specifically articulated by the IRS in formal guidance. For substantial RRSP positions in PFICs, getting specific advice on this point is worth doing.
If You Have an RRSP
Three steps for U.S. taxpayers with RRSPs.
First, confirm Rev. Proc. 2014-55 deferral applies. The automatic treatment requires that the taxpayer be a U.S. resident at relevant times and that the RRSP is a recognized RRSP under Canadian law. Most situations qualify.
Second, report FBAR and Form 8938 each year. The deferral does not eliminate these reporting obligations.
Third, plan for distributions. The tax timing of distributions can be planned around lower-income years, foreign tax credit availability, and other factors.
If Prior Years Are Behind
If you have an RRSP and have not been filing FBAR or Form 8938, the disclosure programs handle the catch-up.
The Streamlined Filing Compliance Procedures cover non-willful failures with the standard penalty structure.
The Delinquent FBAR Submission Procedures cover taxpayers whose only failure was missed FBARs.
The Delinquent International Information Return Submission Procedures cover Form 8938 catch-up filings.
Get the RRSP Reporting Right
After 32 years of cross-border tax work, the RRSP situation is one of the cleaner areas in international tax now – thanks to the IRS guidance issued over the past decade. Contact the Law Offices of Darrin T. Mish, P.A. at (813) 229-7100. We confirm the deferral, file the parallel forms, and clean up prior years where the reporting was missed.