A new revenue procedure makes it easier for taxpayers who hold interests in certain Canadian retirement plans to get favorable U.S. tax treatment.
On October 7, 2014, the IRS made it easier for taxpayers who hold interests in certain popular Canadian retirement plans to get favorable U.S. tax treatment. Rev. Proc. 2014-55. As a result of the change, many Americans and Canadians with either registered retirement savings plans (RRSP’s) and registered retirement income funds (RRIF’s) now automatically qualify for tax deferral similar to that available to participants in U.S. individual retirement accounts (IRA’s) and 401(k) plans. In addition, the IRS is eliminating a special annual reporting requirement that has long applied to taxpayers with these retirement plans.
In general, U.S. citizens and resident aliens will qualify for this special treatment as long as they have filed and continue to file U.S. income tax returns for any year they held an interest in an RRSP or RRIF and include any distributions as income on their U.S. returns.
Under a longstanding provision in the U.S.-Canada Tax Treaty, U.S. citizens and resident aliens can defer tax on income accruing in their RRSP or RRIF until it is distributed. Otherwise, U.S. tax is due each year on this income, even if it is not distributed. In the past, however, taxpayers generally were required to elect-in to get tax deferral by attaching Form 8891 to their return and choosing this tax treaty benefit, something many eligible taxpayers failed to do. Before this change, a primary way to correct this omission and retroactively obtain the treaty benefit was to request a private letter ruling from the IRS, a costly and often time-consuming process.
Many taxpayers with an interest in a RRSP or RRIF also failed to comply with a reporting requirement of the yearly filing of Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, reporting details about each RRSP and RRIF, including contributions made, income earned and distributions made. This requirement applied regardless of whether the taxpayer chose the special tax treatment. In Rev. Proc. 2014-55, the IRS said it is eliminating Form 8891, and taxpayers are no longer required to file this form for any year, past or present.
Taxpayers Still Subject To FBAR and Form 8938 Reporting
Rev. Proc. 2014-55 does not modify any other U.S. reporting requirements that may apply under Code Sec. 6038D or under any other 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. Failure to comply with these reporting requirements can result in steep penalties to the unwitting taxpayer. Failure to file a Foreign Bank Account Report (“FBAR”) may result in civil penalties for negligence, pattern of negligence, non-willful, and willful violations. These penalties range from a high penalty for willful violations, equal to the greater of $100,000 or 50% of the balance in the account at the time of violation, to a low penalty of $500 for negligent violations. For failing to file a correct Schedule B or Form 8938, the taxpayer could face a failure-to-file penalty of $10,000, criminal penalties, and if the failure to file results in underpayment of tax, an accuracy-related penalty equal to 40% of the underpayment of tax and a fraud penalty equal to 75% of the underpayment of tax.
Federal Relief Does Not Extend To State Income Taxation
Such is the case in California. The State Board of Equalization has previously held that tax treaties between the United States and other countries which expressly limit their application to federal income taxes do not prevent California from taxing persons otherwise covered by such treaties.” Appeal of M. T. de Mey van Streefkerk, 85-SBE-135, Nov. 6, 1985. The United States Supreme Court noted that “the tax treaties into which the United States has entered do not generally cover the taxing activities of subnational governmental units such as States … and if the treaty does apply to the States it will be specified in the treaty itself. Container Corp. v. Franchise Tax Board (1983) 463 U.S. 159, 196. Accordingly, the federal election to defer taxation on earnings of the RRSP is inapplicable for California income tax purposes.
Basically, the Franchise Tax Board considers a RRSP to be similar to a savings account. The Franchise Tax Board will treat a taxpayer’s original contributions to the RRSP, made while a Canadian resident, as a capital investment in the RRSP. A California resident must include any earnings from their RRSP in their taxable income and pay taxes on this income in the year earned. After a taxpayer pays tax on these earnings, the earnings will also be treated as capital invested in the RRSP. Therefore, when a taxpayer receives a distribution from their RRSP, the amount consisting of the contributions and the previously taxed earnings is considered a nontaxable return of capital.
What Should You Do?
California taxpayers who have an interest in a Canadian RRSP would benefit from the experienced tax attorneys of the Law Office Of Jeffrey B. Kahn, P.C. representing you to avoid the pitfalls associated with failure to comply with the reporting requirements associated with having an interest in an RRSP.
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