Blog Alert – Investing Strategies for U.S. Citizens Resident in Canada
U.S. persons (U.S. citizens, green-card holders and residents under U.S. tax law) resident in Canada are taxable in both Canada and the U.S. on their worldwide income. This blog summarizes some of the related complexities and potential solutions.
Canadian Mutual Funds and ETFs
U.S. tax law’s Passive Foreign Investment Company, (PFIC) rules apply to most Canadian mutual funds and exchange-traded funds (ETFs) held by U.S. persons. These rules apply to any non-U.S. corporation where either 75% of gross income is passive or average assets are 50% passive assets. These rules may also apply to entities defined as corporations under U.S. tax law including trusts that conduct business activities. They may also apply to non-investment entities, including professional corporations which have U.S. owners.
Capital gains on PFICs and certain distributions by them are pro-rated over their holding period and taxed at the highest marginal income tax rate in each year. Also, interest is charged for tax deferred under its rules. Owners must annually file IRS Form 8621 for each PFIC.
Solutions to adverse U.S. tax rules on PFICs include investing in equities directly rather than through mutual funds and ETFs, making certain elections, alternative ownership strategies, etc.
Registered Retirement Savings Plans (“RRSP”) are Canadian retirement saving plans. Withdrawals from RRSPs are taxable in Canada; however, generally, only incremental income or gains realized in the RRSP will be taxable in the U.S.
Individual Retirement Accounts and 401(k) plans are U.S. retirement savings plans. Contributions to these plans are generally not deductible in Canada. Withdrawals from both plans are taxable in Canada and U.S.
Individuals can hold both Canadian and U.S. pension plans regardless of whether they reside in either country or move from one to another. In limited circumstances, an individual can transfer funds from a U.S. pension plan to a Canadian RRSP without a net tax cost. Generally, individuals resident in Canada should only contribute to Canadian retirement plans.
Education Savings Plans
Canadian Registered Education Savings Plans (RESP) and U.S. 529 Plans are education savings plans in Canada and the U.S., respectively. Both have tax advantages in their own countries, but can have adverse tax consequences in the other jurisdiction.
Income and gains in RESPs are subject to U.S. federal tax where plans have U.S. contributors. Canada treats most U.S. 529 plans as Canadian resident trusts, subjecting them to Canadian tax each year. Canada also requires annual trust returns for Canadian resident plans.
Solutions to the cross-border tax issues of education savings plans include contributions to RESPs by non-U.S. persons or non-Canadian residents contributors and trustee for 529 Plans. For existing plans with lower investment balances, families should perform a cost/benefit analysis to determine if the annual tax and reporting costs degrade the investment benefit.
Other Savings Plans
Tax Free Savings Accounts (“TFSA”) and ROTH Individual Retirement Accounts are savings plans in Canada and the US, respectively, where their earnings are not taxable in the respective country when earned or distributed. Income earned in a TFSA is subject to U.S. federal tax where the owner is a U.S. person. Withdrawals from ROTH IRAs are not taxable for U.S. tax purposes. Withdrawals from a TFSA are not taxable in either Canada or the U.S.
Canada will not tax income and gains in a ROTH IRA where it meets the requirements under the Canada-U.S. tax treaty and filing requirements. U.S. persons owning TFSAs may be able to use other Canadian tax paid on taxable accounts as foreign tax credits to reduce or eliminate U.S. tax on income within the TFSA.
In addition to the topics discussed above, U.S. persons resident in Canada who hold interests in privately-held corporations, limited liability companies (LLCs), real estate investment trusts, and life insurance and annuities may also have cross-border tax issues that arise from their ownership.
For more information, please see our webinar on Investing Strategies for U.S. Citizens Resident in Canada: Tax 101