How Canadian RRSP’s are Taxed In The U.S. — Part 1

Overview

When Canadians relocate to the US and become US tax residents, what should be done with their RRSP’s? A lot of confusion exists on how the IRS and state revenue agencies treat these accounts. TN Visa holders are especially affected when they move to the U.S.

RRSP’s are not IRA’s (and vice versa)

The US tax code views RRSP’s as savings accounts and not retirement vehicles such as the US IRA’s. 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. The similarity is not the focus however. 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 the same as IRA’s, one cannot rollover RRSP’s into IRA’s and vice versa. To minimize the tax on any RRSP withdraws, careful planning is required.

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 the your RRSP accounts are taxable and are required to be reported annually. 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.

“Cost” of the RRSP

Another peculiar aspect of RRSP’s in the US is the fact that the “basis” an owner of an account has in the RRSP’s 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. 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the US with RRSP’s totaling 10K and immediately withdrew the entire amount, they would be taxable in Canada on the 10K withdrawn and have no tax to pay to the US.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
This is not automatic. A taxpayer must state this desire on the appropriate form for each account that they own. Not all states will follow the treaty particularly 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
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.

In the next article, we will explore the various forms involved in reporting RRSP’s in the US.

Cross Border Taxes: Your Next Steps

Do you have questions about your RRSP’s? Find What You need to do to 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