How Canadian RRSP’s are Taxed In The U.S.?

When Canadians relocate to the US and become US tax residents, what happens to their RRSPs? There is a lot of confusion about how the IRS and state revenue agencies treat these accounts. TN Visa holders are especially affected when they move to the US.

What is an RRSP?

An RRSP is short for “Registered Retirement Savings Plan.” It is a government-regulated retirement savings account that an individual establishes, into which the individual or their spouse (or common-law partner) contributes toward their retirement.

RRSPs are designed to help Canadians save for retirement in a tax-efficient manner, as contributions made to an RRSP are tax-deductible. This means individuals can subtract the amount they contribute to their RRSP from their taxable income for the year, reducing the amount of income tax they have to pay for that year.

Canadian RRSP’s are not IRA’s (and vice versa)

The US tax code views a Canadian RRSP as a savings account, not a retirement vehicle such as a US IRA.

At first glance, this is perplexing to a new US resident from Canada as RRSP’s function almost the same as the various IRA investments available to US residents.

However, the similarity is not the focus. With most International Taxation, the fact that the account is foreign is the starting point for the different treatment, not the schematics of its function.

Because the IRS does not view RRSP’s as IRA’s, one cannot rollover RRSP’s into IRA’s and vice versa. To minimize RRSP taxes (the tax on RRSP withdrawals), careful planning is required.

Canadian RRSP Earnings are taxable

Since the IRS and US state revenue agencies do not view RRSP’s as IRA’s, all of the yearly earnings in an individual’s Canadian RSP accounts are taxable and are required to be reported annually. For all those asking, “Are RRSPs taxed?” Unfortunately, they are.

Additionally, when individuals holding RRSP’s work as a nonresident in certain states, the RRSP earnings must be included in the worldwide income used to determine the ratio of in-state earnings to worldwide earnings. This is especially true in California which is not the friendliest state for Canadian retirement account holders.

Not sure which US states are tax-friendly for Canadian RRSP holders? TN Visa Expert can help you with the information you need, including how the state’s tax laws affect Canadian TN visa retirement accounts.  

Withdrawal Cost of the Canadian RRSP

Another peculiar aspect of RRSPs in the US is that the “basis” an account owner has in an RRSP is the fair market value of all the accounts on the day that they enter the US.

“Basis” is a term used to describe one’s investment in an asset. For example, if one buys stock for $200 and sells it for $400, they have “basis” of $200 and are taxed on the difference between the sales price and their basis. 

By the Canadian RRSP withdrawal rules, withdraws from RRSP’s are generally taxable by Canada Revenue in full as there is zero “basis” in the accounts. This is due to the fact that the contributor received a tax deduction for the original contribution.

When one enters the US and withdraws from an RRSP, they are fully taxable in Canada but only partially taxable in the US. For example, if one entered the US with RRSP’s totaling 10K and immediately withdrew the entire amount, they would be taxable in Canada on the 10K withdrawn and have no tax to pay to the US.

How the Tax Treaty Helps You

Fortunately, the US and Canada have a treaty that helps mitigate the potentially unfair treatment of RRSP’s in the US. The treaty allows owners of RRSP’s to do the following:

1) Defer earnings in the RRSP until actual distribution

Under the tax treaty, earnings in an RRSP Canada account (such as interest, dividends, or capital gains) are not taxed by the US until they are withdrawn from the RRSP. This allows Canadians with RRSP accounts who work in the US to benefit from tax-deferred growth within their RRSP accounts, similar to how US citizens benefit from tax-deferred growth within US retirement accounts like IRAs.

However, deferring earnings in the RRSP until actual distribution is not automatic. A taxpayer must state this desire on the appropriate form for each account that they own.

It’s also important to note that not all states follow the US-Canada tax treaty. A particular example is California (have we said this before?). Since US state tax regimes function completely separate from the Federal IRS, it is their right to do otherwise despite the fact that the majority of states follow the treaty.

2) Deduct IRA contributions on the Canadian return

Under the US-Canada tax treaty, contributions made by a Canadian resident who is also subject to US taxation to an IRA may be deductible on their Canadian tax return. This means the individual can subtract the amount contributed to the IRA from their taxable income for Canadian tax purposes, potentially reducing their taxable income and providing some tax relief. 

This works in a situation where a Canadian resident is working in the US as a nonresident or a US Resident working in Canada as a nonresident. The same deduction enjoyed in the nonresident nation is extended to the resident nation.

How to report Canadian RRSP on US Tax Returns

Wondering how to report RRSP on US tax return? In the next sections, we will explore how Canadians in the US with tax status as nonresidents or residents can report Canadian RRSPs on US Tax returns.

RRSP in US: Tax Reporting for Non-Residents:

Those individuals who are US nonresidents for tax purposes have a different filing requirement from that of a US tax resident. Generally, a nonresident is only taxable on income earned within the US. Any earnings within RRSPs do not have to re-reported to the IRS if the individual is a nonresident.

However, a number of states require a nonresident alien to report global income on the state tax return. In states like California, this includes any earnings within RRSPs.

For example, suppose that a Canadian tax resident on a TN Visa works a temporary assignment in California and earns $20,000, works in Canada and earns $20,000, and earns $2,000 of income within their RRSP’s.

California will require the individual to report $42,000 of global income (assuming exchange rate parity). California will calculate the tax on all $42,000 of earnings. The actual tax will be 20/42 of the tax of $42,000.

But if California did not require the reporting of the income in the RRSPs, then the tax would be 20/40 of the tax on $40,000. This ratio is also applied to the standard deduction or itemized deductions that the taxpayer claims.

RRSP in US: Tax Reporting for Residents:

US tax residents have more complicated filing requirements than nonresidents.

It may be good to stop here and clarify what is meant by a US tax resident. A US citizen and a green card holder are automatically US tax residents. For TN Visa holders, the tax residence is determined by a number of factors, including the number of days spent in the US and whether the United States-Canadian tax treaty modifies this determination in favor of one nation over the other.

Tax treaties trump domestic law. So, while the Canadian TN Visa holder may live in the US for an entire year and satisfy the 183-day substantial presence test, if the tax treaty determines that the individual is a Canadian resident, then the treaty prevails.

Determination of residence can fill an entire article, but this information is sufficient for our purposes. One important thing to keep in mind is that immigration status does not correlate with tax residency status.

If a US tax resident holds Canadian RRSPs, there are potentially three forms that are required to be filed:

1. IRS Form 1040

Form 1040 is the main US income tax return form. Regardless of the value of the account, all earnings in RRSPs and RRIFs must be reported to the IRS on the annual tax return. This form also requires the reporting of the year in value as well as any distributions taken from the account.

Remember that the US-Canada tax treaty allows US citizens to defer taxation on income accruing in their RRSPs. In the past, individuals had to elect for tax deferment by filing a separate form (IRS Form 8891) with their annual US tax returns.

However, the 8891 form was discontinued from the tax year 2015. For those asking, “Is form 8891 no longer required?” It no longer is.

Now, taxpayers with RRSPs may report their RRSP contributions, earnings, and distributions directly on the Form 1040.

Also, since filing Form 8891 to elect for tax deferment has been discontinued, US taxpayers with RRSPs or RRIFs now automatically qualify for tax deferrals. As long as they file their US income tax returns properly, eligible individuals are treated as having made the election for tax deferment.

However, as mentioned earlier, some states still tax earnings within the RRSPs, so these elections may have no force at the state level.

2. RRSP FBAR/TDF – required for accounts greater than $10,000 in aggregate

An FBAR (Foreign Bank Account Report) is required for anyone holding more than $10,000 in foreign accounts on an aggregate basis. The value of each individual account does not determine the filing requirement. If the individual has more than $10,000 spread through different accounts (hence the term “aggregate”), an FBAR is required.

Additionally, the $10,000 is not based on the year-end amounts. It is based on the maximum value of accounts during the course of the calendar year. This form is not sent to the IRS. It is sent to the U.S. Treasury office in Detroit and is due on June 1 of every year.

3. RRSP Form 8938 – required for larger accounts

Form 8938, Statement of Foreign Financial Assets, is the newest reporting requirement. The threshold for filing form 8938 RRSP depends upon the filing status of the individual, the value of their accounts at year, maximum value during the year, and whether the taxpayer is living permanently in a foreign country.

Individuals can hold other foreign assets besides RRSPs and trigger this requirement. For those who have already reported their RRSPs on their income tax returns form and meet the threshold for filing form 8938, the form is still required.

Sound like a lot? The IRS has become very aggressive in pursuing US tax residents who hold funds in other countries. Since a US tax resident is taxable on worldwide earnings regardless of source, locating these funds is imperative to effective tax collection.

What are Your Next Steps?

Do you have questions about your RRSP and taxes? Especially if you have crossed the border into the US from Canada, find what you need to do about your RRSPs.

Contact one of our trusted Cross Border Tax Professionals. It’s free to ask your questions.Click here for a list of US-Canada Tax Accountants

Eric Nghiem

Tax Specialist – U.S., Canada,
International

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