U.S. Tax Treatment of Canadian Registered Retirement Savings Plans and Registered Retirement Income Funds

by John Anthony Castro, J.D., LL.M.

Canada

Executive Summary

Income and gains within a Canadian Registered Retirement Savings Plan or a Registered Retirement Income Fund in Canada are exempt from U.S. tax during the growth phase prior to retirement pursuant to Article 18 of the U.S.-Canada Income Tax Treaty if and only if there is adequate disclosure on your U.S. federal income tax return. In other words, there is no tax until the Canadian Registered Retirement Savings Plans and Registered Retirement Income Fund annuitizes at retirement and begins actually paying benefits.

Contact our firm today to schedule a free consultation by clicking here to submit your information online and be contacted by our firm. We can handle the preparation and submission of your U.S. federal income tax return to ensure your Canadian Registered Retirement Savings Plans and Registered Retirement Income Fund is not exposed to U.S. income tax.

Interpretation of International Treaty Law

If both the U.S. and another country are members of the OECD, U.S. courts will generally defer to OECD commentary to determine the prevailing international interpretation of terms, which is published every few years.[1] Both the United States and Canada joined the OECD in 1961.

Therefore, U.S. courts are legally bound to defer to the OECD with regard to the definition of treaty terms, which promotes international consistency.

U.S. Tax Treatment of Canadian RRSPs and RRIFs

Article 18, Paragraph 7, explicitly states that income and gains within any U.S. or Canadian retirement plan (RRSP, RRIF, TFSA, RESP, and RDSP) is exempt from taxation in both countries during the growth phase prior to retirement.[2] Other firms that have stated differently on their websites are completely and utterly wrong.[3] All plans are covered by the treaty.

Article 18, Paragraph 1, of the U.S.-Canada Income Tax Treaty provides that non-exempt pension distributions are primarily taxable in the taxpayer’s country of residence, but it also provides that the source country can impose tax up to 15%.

Moreover, if the source country’s domestic laws provide that the distribution would be exempt from tax, the country of residence is required to honor that exemption; this is called the Reciprocal Pension Exemption since each country agrees to reciprocate when the other exempts particular pension distributions from tax. For example, an American living in Canada would owe no tax to Canada on the receipt of a distribution from a Roth IRA in the U.S. since Roth IRA distributions are exempt from tax in the U.S. Likewise, a Canadian national living in the U.S. would owe no tax in the U.S. on the receipt of a distribution from a pension amount that would be tax-free if that person were a tax resident of Canada. Basically, both countries agree to honor each other's pension exemptions.

Furthermore, Article 18, Paragraphs 8 through 14, provide for a Reciprocal Retirement Contribution Deduction. In other words, if an American contributes to a Canadian Registered Retirement Savings Plan (RRSP) and Registered Retirement Income Fund (RRIF), that contribution will be deductible in computing U.S. gross income subject to limits on retirement plan contributions under the Internal Revenue Code.

Moreover, it is also critical to note that Canadian RRSPs and RRIFs are no longer subject to reporting on IRS Forms 8891, 3520, or 3520-A.[4]

Lastly, as a final note for Canadian nationals, Article 18, Paragraph 5(b), of the U.S.-Canada Income Tax Treaty provides for total exemption from U.S. tax for a Canadian Pension Plan (CPP) or Quebec Pension Plan (QPP), which are social security pensions.

State Income Taxation

State tax law typically defers to Internal Revenue Code section 61 for the definition of “gross income.” Code section 894(a)(1) mandates that all “provisions of [the Internal Revenue Code] shall be applied to any taxpayer with due regard to any treaty obligation of the United States which applies to such taxpayer.” By operation of Code section 894(a)(1), Code section 61 is modified to the extent there is an applicable income tax treaty. Therefore, if and when state law defers to Code section 61 for the definition of gross income, which is itself limited by any applicable income tax treaty in accordance with Code section 894(a)(1), any income excluded from an individual U.S. federal income tax return pursuant to an applicable income tax treaty is excludible for state income tax purposes.[5]

Not all state tax authorities agree, but our firm can and will litigate the matter in federal court should any state tax authority impose tax on our clients.

Conclusion

During the pre-retirement growth phase, income and gains within a Canadian Registered Retirement Savings Plans and Registered Retirement Income Fund in Canada are exempt from U.S. tax pursuant to the U.S.-Canada Income Tax Treaty. In other words, there is no tax until the Canadian RRSP or RRIF annuitizes at retirement and begins paying benefits.

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Contact Our Firm

Contact our firm today to schedule a free consultation by clicking here to submit your information online and be contacted by our firm. We can handle the preparation and submission of your U.S. federal income tax return to ensure your Canadian Registered Retirement Savings Plan or Registered Retirement Income Fund is not exposed to U.S. income tax.


About the Author

John Anthony Castro, J.D., LL.M., is the Managing Partner of Castro & Co., the author of International Taxation in Plain English as well as International Estate Planning in Plain English, an esteemed graduate of Georgetown University Law Center in Washington DC, an OPM Fellow at Harvard Business School, and an internationally recognized tax attorney with offices in New York, Los Angeles, Miami, Chicago, Dallas, and Washington DC.

To provide feedback on this article or suggest an idea for a future article, please contact Tiffany Michelle Hunt, J.D., LL.M., Director of Tax Planning at Castro & Co., at T.Hunt@CastroAndCo.com.


Bluebook Citation: John Anthony Castro, U.S. Tax Treatment of Canadian Registered Retirement Savings Plans and Registered Retirement Income Funds, Castro Int’l Tax Blog (Dec. 9, 2019) url.


[1] See Podd v. C.I.R., 76 T.C.M. 906 (1998) (citing U.S. v. A.L. Burbank & Co., 525 F.2d 9, 15 (2d Cir. 1975); North W. Life Assurance Co. of Canada v. C.I.R., 107 T.C. 363 (1996); Taisei Fire & Marine Ins. Co. v. C.I.R., 104 T.C. 535, 546 (1995) (construing the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Mar. 8, 1971, U.S.-Japan, 23 U.S.T. 969, with reference to the Model Treaty and its commentary)).

[2] U.S.-Canada Income Tax Treaty, Article XVIII, Paragraph 7.

[3] One website incorrectly concludes that TFSA is not covered by the treaty since it was enacted into law after the treaty despite the fact that Article 18, Paragraph 3(b), of the U.S.-Canada Income Tax Treaty explicitly states that “the term pensions also includes… a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007.” Please avoid the “Efficient Market Canada” website as they are pushing false and inaccurate tax information.

[4] See Rev. Proc. 2014-55. It is important to note that Castro & Co. has long held the position that a treaty exemption implicitly overrides domestic reporting requirements while other firms never advocated for their clients.

[5] Where federal and state statutes and regulations are substantially identical, the interpretation and effect given to the, by federal courts are highly persuasive. See Rihn v. Franchise Tax Bd., 131 Cal. App. 2d 356, 280 P.2d 893 (1955). For example, because California tax law defers to federal law for the definition of gross income, it is appropriate for state courts to look to federal law as well as state law. In re Shelley, 184 B.R. 356 (B.A.P. 9th Cir. 1995), aff’d, 109 F.3d 639 (9th Cir. 1997). Because California income tax law is largely based on federal income tax law, any increase or decrease in an individual’s federal tax liability will generally have a corresponding increase or decrease in state tax liability. See Goldman v. California Franchise Tax Bd., 202 Cal. App. 4th 1193, 136 Cal. Rptr. 3d 373 (2012).

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