Canadian RRSPs: U.S. tax considerations.

• Author: Doiron, Daniel P.
• Position: Registered retirement savings plan

Taxpayers in the U.S. can use an individual retirement account (IRA) as a tax-advantaged investment vehicle to accumulate funds for retirement. Canadian taxpayers have a similar option available called a registered retirement savings plan (RRSP). Tax preparers need to be aware of the consequences for an individual with RRSPs who becomes subject to U.S. income taxation and the relief available under the United States/Canada Income Tax Treaty (Treaty).

RRSPs vs. IRAs

RRSPs and IRAs share many characteristics. Contributions to an RRSP are deductible in determining Canadian taxable income. The earnings of an RRSP are deferred from Canadian income tax until actual distributions are made from the plan. RRSP withdrawals must begin before the end of the year in which the participant turns 69 years old.

Unlike IRAs, however, RRSPs generally do not allow nondeductible contributions. Distributions before retirement are allowed without penalty. Eighteen percent of earned income, up to a maximum of $13,500, can be contributed to an RRSP each year. Because of the significant tax benefits offered by RRSPs, they are quite popular with Canadian taxpayers.

U.S. Tax Consequences

For U.S. income tax purposes, current-year earnings of an RRSP are not eligible for tax-deferred treatment, since an RRSP is not a qualified retirement plan under the Internal Revenue Code. For this reason, a U.S. taxpayer who is a participant in an RRSP is subject to U.S. income tax on the RRSP's undistributed annual earnings. The RRSP is treated no differently for U.S. income tax purposes than a regular savings account.

Besides the obvious problem of Canadian tax-deferred earnings being taxed in the U.S., this situation also creates a mismatch between the year in which the income is reported and the year in which the tax is paid for purposes of claiming a foreign tax credit.

Election Available

A recent amendment to the Treaty added Article XVIII(7), providing for an election to defer taxation on income accrued in, but not distributed from, a pension or retirement plan. The new election is to be made "under rules established by the competent authority" of the U.S. or Canada. As this item goes to press, the IRS has not issued guidance on this election.

Prior to the Treaty's amendment, Article XXIX(5) explicitly provided for an election to defer U.S. income taxes on an RRSP's annual earnings. Article XXIX(5) has been deleted from the Treaty in connection with this recent amendment. The...