U.S. Tax on Canadian Pension Plans (RRSP)

U.S. Tax on Canadian Pension Plans

Pursuant to Article XVIII of Canada-U.S. tax treaty, pensions and annuities from Canadian sources paid to U.S. residents are subject to tax by Canada, but the tax is limited to 15% of the gross amount (if a periodic pension payment) or of the taxable amount (if an annuity). Canadian pensions and annuities paid to U.S. residents may be taxed by the United States, but the amount of any pension included in income for U.S. tax purposes may not be more than the amount that would be included in income in Canada if the recipient were a Canadian resident.

What is pension?

The term pension is defined in the treaty and includes any  payment under a pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances, and payments under a sickness, accident, or disability plan. It includes pensions paid by private employers and the government for services rendered.

Pensions also include payments from individual retirement arrangements (IRAs) in the United States, registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) in Canada.

Pensions do not include social security benefits (i.e. Canada Pension Plan, Old Age Security, Quebec Pension Plan are not considered to be pension).

Specific pension plans and their treatment:

Pension Plan 
RRSP/RRIF/RPP/DPSP

These plans are considered to be a grantor trust in the U.S.

A U.S. Resident is required to include into income any amount accrued in these plans (even if it not distributed). However, from Canadian tax perspective, we only tax amount taken out from these plans. 

This mismatch is addressed under the Canada-U.S. tax treaty. Under the treaty, a beneficiary of these plans may elect to defer U.S. taxation on income earned inside the plan until the amount is withdrawn. 

Prior to 2014, the taxpayer were required to file form 8891 to make an election to defer the U.S. taxation on income earned inside these plans. However, the IRS changed the rules and as such there is no requirement to file the 8891 election if the following conditions are met:

  • The taxpayer is compliant with all the prior year U.S. tax returns, and 
  • has not reported gross income accrued in these plans on the prior year tax returns, and
  • accurately reported any withdrawals from these plans

Individuals who does not meet the criteria above and have previously reported the undistributed income accrued in a Canadian retirement plan  on a U.S. federal income tax return are not eligible individuals, and must continue to report the undistributed income accrued in their Canadian retirement plan on their U.S. federal income tax return and pay U.S. tax on the undistributed income. If these individuals want to make the election, they must seek approval from the IRS.

YOU NEED TO BE AWARE OF STATE TAXES. 

 

Contributions to RRSP

It is deductible in Canada but not generally deductible in the U.S. There are few exceptions that were introduced in Fifth Protocol  of Canada-US tax treaty. It is discussed below. 

 

Withdrawals from these plans and impact in Canada and the U.S.

Canadian tax implications

If you are considered to be a non-resident of Canada, there is a withholding tax of 15% (generally 25%) due to Canada-U.S. treaty on the withdrawals.

If you are a resident of Canada, then it is an income inclusion as an ordinary income and subject to marginal tax rate. 

U.S. tax implications

If you are a non-resident alien – No tax implications

If you are a resident = You need to pay tax on the withdrawal that represents the income earned since you became a U.S. resident, if you have previously elected to defer U.S. income recognition. Since previous contributions to the RRSP were not deducted in the U.S., the portion representing the original contribution is not taxable. The U.S. will tax it like ordinary income. 

If resident of both Canada and the U.S., then Canada has the right to tax and U.S. will provide Foreign tax credit. 

 

Other filing requirements in the U.S. 

  1. Fincen form 114
  2. Form 8938
  3. Form 3520 and Form 3520-A

 

Fifth Protocol relevant to pensions

Article XVIII (Pensions and Annuities) of the Convention shall be amended by adding the following paragraphs:

8. Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State (Canada) by or on behalf of an individual shall be deductible or excludible in computing the individual’s taxable income in the other Contracting State (U.S.), and contributions made to the plan by the individual’s employer shall be allowed as a deduction in computing the employer’s profits in that other State (U.S.), where:

(a) The individual performs services as an employee in that other State (U.S.) the remuneration from which is taxable in that other State (U.S.);

(b) The individual was participating in the plan (or another similar plan for which this plan was substituted) immediately before the individual began performing the services in that other State (U.S.);

(c) The individual was not a resident of that other State (U.S.) immediately before the individual began performing the services in that other State (U.S.);

(d) The individual has performed services in that other State (U.S.) for the same employer (or a related employer) for no more than 60 of the 120 months preceding the individual’s current taxation year;

(e) The contributions and benefits are attributable to the services performed by the individual in that other State (U.S.) , and are made or accrued during the period in which the individual performs those services; and

(f) With respect to contributions and benefits that are attributable to services performed during a period in the individual’s current taxation year, no contributions in respect of the period are made by or on behalf of the individual to, and no services performed in that other State (U.S.) during the period are otherwise taken into account for purposes of determining the individual’s entitlement to benefits under, any plan that would be a qualifying retirement plan in that other State (U.S.) if paragraph 15 of this Article were read without reference to subparagraphs (b) and (c) of that paragraph.

This paragraph shall apply only to the extent that the contributions or benefits would qualify for tax relief in the first-mentioned State (Canada) if the individual was a resident of and performed the services in that State (Canada).

9. For the purposes of United States taxation, the benefits granted under paragraph 8 to a citizen of the United States shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

10. Contributions made to, or benefits accrued under, a qualifying retirement plan in a Contracting State (Canada) by or on behalf of an individual who is a resident of the other Contracting State (U.S.) shall be deductible or excludible in computing the individual’s taxable income in that other State (U.S.), where:

(a) The individual performs services as an employee in the first-mentioned state (Canada) the remuneration from which is taxable in that State (Canada) and is borne by an employer who is a resident of that State (Canada) or by a permanent establishment which the employer has in that State (Canada); and

(b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the individual performs those services.

This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in the first-mentioned State (Canada).

11. For the purposes of Canadian taxation, the amount of contributions otherwise allowed as a deduction under paragraph 10 to an individual for a taxation year shall not exceed the individual’s deduction limit under the law of Canada for the year for contributions to registered retirement savings plans remaining after taking into account the amount of contributions to registered retirement savings plans deducted by the individual under the law of Canada for the year. The amount deducted by an individual under paragraph 10 for a taxation year shall be taken into account in computing the individual’s deduction limit under the law of Canada for subsequent taxation years for contributions to registered retirement savings plans.

12. For the purposes of United States taxation, the benefits granted under paragraph 10 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

13. Contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of a citizen of the United States who is a resident of Canada shall be deductible or excludible in computing the citizen’s taxable income in the United States, where:

(a) The citizen performs services as an employee in Canada the remuneration from which is taxable in Canada and is borne by an employer who is a resident of Canada or by a permanent establishment which the employer has in Canada; and

(b) The contributions and benefits are attributable to those services and are made or accrued during the period in which the citizen performs those services.

This paragraph shall apply only to the extent that the contributions or benefits qualify for tax relief in Canada.

14. The benefits granted under paragraph 13 shall not exceed the benefits that would be allowed by the United States to its residents for contributions to, or benefits otherwise accrued under, a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States. For purposes of determining an individual’s eligibility to participate in and receive tax benefits with respect to a pension or retirement plan or other retirement arrangement established in and recognized for tax purposes by the United States, contributions made to, or benefits accrued under, a qualifying retirement plan in Canada by or on behalf of the individual shall be treated as contributions or benefits under a generally corresponding pension or retirement plan established in and recognized for tax purposes by the United States.

15. For purposes of paragraphs 8 to 14, a qualifying retirement plan in a Contracting State means a trust, company, organization or other arrangement:

(a) That is a resident of that State, generally exempt from income taxation in that State and operated primarily to provide pension or retirement benefits;

(b) That is not an individual arrangement in respect of which the individual’s employer has no involvement; and

(c) Which the competent authority of the other Contracting State agrees generally corresponds to a pension or retirement plan established in and recognized for tax purposes by that other State.

16. For purposes of this Article, a distribution from a pension or retirement plan that is reasonably attributable to a contribution or benefit for which a benefit was allowed pursuant to paragraph 8, 10 or 13 shall be deemed to arise in the Contracting State in which the plan is established.

17. Paragraphs 8 to 16 apply, with such modifications as the circumstances require, as though the relationship between a partnership that carries on a business, and an individual who is a member of the partnership, were that of employer and employee.

 

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