The United States is known for many things: American football, Hollywood, and fast-food, to name a few. However, one thing it is increasingly becoming infamous for is the way it taxes its people. U.S. taxation is based on citizenship, while taxation in virtually all other countries in the world, including Canada, is based on residency. This seemingly small difference has far-reaching consequences if you are a U.S. citizen or have dual-citizenship status with the U.S., because it means you are liable to pay tax regardless of where you live.
For individuals with disabilities and their family members living in Canada, this can be an additional unnecessary financial and administrative strain. There are steep fines as well as possible jail-time for those who avoid or don’t pay their taxes annually to the U.S. Additionally, there are very few considerations for investments or income that are intended to alleviate poverty or support low-income individuals living in Canada. This includes people with disabilities and specifically, the Registered Disability Savings Plan (RDSP), which is not given any special treatment with regards to double taxation or reporting.
In this article, we explore some common questions associated with the RDSP and U.S. tax and reporting implications. Please note that this information relates to a complex area of tax law. We recommend individuals who are looking for more information to contact an accounting or finance professional with experience in this area to discuss their specific situation. Please also visit Plan Institute’s RDSP tutorial at rdsp.com/rdsp-tutorial, contact our toll-free helpline on 1-844-311-7526, or email us at email@example.com
Do I have to report income to the Internal Revenue Service (IRS)?
Generally, individuals born in the U.S. are citizens from birth. The U.S. also considers children born of a U.S. citizen to also be U.S. citizens, even if they were born in Canada and have never set foot in the United States. In addition, reporting requirements also affect the accounts of any Canadians with a U.S. spouse or other family member, with whom they may hold assets jointly, as well as Canadians who may have temporarily lived or worked in the States.
If you’re considered a U.S. citizen, you will need to annually file tax returns with the IRS and potentially report on other holdings you have, such as the RDSP. It is recommended that you check your status, especially when not living in the U.S., so you aren’t hit with any surprise tax consequences later on. Additional information on citizenship status is available on the U.S. Citizen and Immigration Services website.
A note for holders or past holders of RDSPs: The person setting up the RDSP for the beneficiary (person with the disability) can also be burdened with the U.S. tax liability if they are a U.S. citizen. If the person setting up the RDSP is not a U.S. citizen but the beneficiary is then the tax burden shifts. The beneficiary will be the person who must report and pay taxes. The reason that a U.S. citizen who sets up an RDSP remains taxable on income generated by the trust property is because of what are known as the “grantor trust rules” in the Internal Revenue Code, and specifically IRC Sec. 679.
What do I need to report?
For RDSPs, there are two main reporting requirements:
1. Income Tax Reporting
For U.S. income tax purposes RESPs, RDSPs, and TFSAs are not tax-deferred, meaning any income and capital gains earned within the plans are subject to U.S. tax on an annual basis. The income earned in an RDSP is taxable in the U.S. each year – not when it comes out. As mentioned above, this tax liability can be on the beneficiary or the person who set up the RDSP. To learn more about filing U.S. taxes you can visit the government website here.
2. Foreign Bank and Financial Accounts (FBAR) Reporting
In addition to filing annual U.S. income tax returns, there are information reporting requirements that U.S. citizens must fulfill. In fact, it is often the penalties on these information returns where Canadian residents have the greatest exposure to IRS liabilities.
One of these information reporting requirements is the Report of Foreign Bank and Financial Accounts (best known as the “FBAR” but formally called Form TD F 90-22.1 or FinCEN Form 114). This must be filed if a U.S. citizen has a financial interest in or signature authority on one or more non-U.S. financial accounts and the total value of those accounts exceeds U.S. $10,000 in a calendar year. Though in many ways redundant with the FBAR, IRS Form 8938 can also be required if the value of a U.S. citizen’s non-U.S. financial holdings exceed specified thresholds.
Note: Trust Reporting
As of March 16, 2020, Revenue Procedure 2020-17 (“Rev. Proc. 2020-17”) provides eligible U.S. taxpayers with an exemption from the trust reporting requirements for eligible foreign trusts including RESPs and RDSPs. RDSPs are classified as foreign trusts for U.S. purposes. For more information on this update and changes to the rules, please see the guidance here. Note: Income Tax reporting and FBAR reporting are still required for RDSPs. Contact a finance professional for more information on what reporting requirements are needed in your situation.
I am a U.S. citizen living in Canada, but I haven’t filed any U.S. income tax returns in the past. Is there a special process available for U.S. citizens who live outside the U.S. to enable me to become compliant?
Yes, the IRS currently offers five distinct voluntary disclosure programs for individuals who need to become compliant with their U.S. tax filings. These programs have the benefit of providing reduced or eliminated penalties and a limited “look back” period so that the taxpayer only submits returns for the past 3 to 6 years to get “caught up” rather than the entire period of non-filing.
For most Canadian residents, the best program is either the “Streamlined Foreign Offshore Procedures” or the “Relief Procedures for Certain Former Citizens” (for individuals who choose to renounce U.S. citizenship and meet the other program requirements). Both programs require a certification that the taxpayer’s previous non-filing was “non-willful”, meaning it was due to lack of ignorance of all the required filings, negligence, etc.
For individuals who can certify non-willful conduct but who for some reason do not meet other Streamlined or Relief criteria, there are the less favourable “Streamlined Domestic Offshore Procedures” and the “Delinquent International Information Return Submission Procedures.” Individuals who cannot certify non-willful conduct need to use the IRS “Criminal Investigation Voluntary Disclosure Practice.”
It is worth noting that one IRS voluntary disclosure program, the “Offshore Voluntary Disclosure Program,” closed in September 2018 and there is currently no legal requirement that the IRS keep these programs open. The IRS has indicated in public comments that programs with the most generous terms, i.e., the Streamlined and Relief programs, will eventually be phased out.
For more guidance, see the IRS FAQ page here.
I don’t need my U.S. citizenship or green card. If I renounce my citizenship or file to terminate the green card does that eliminate the need to file U.S. tax returns?
In the long term yes but in the short-term no. On the one hand, once a person is no longer a U.S. citizen or green card holder, they are not taxable by the United States on their worldwide income during life and, in the case of citizens, assets at death. On the other hand, renouncing by itself does not fix the problem. To avoid the U.S. “exit tax” as well as a special tax on any future gifts or inheritances given to U.S. persons the renouncer must become compliant with their U.S. filing requirements.
There can also be serious immigration consequences to consider, particularly if the person wants to preserve their ability to travel back to the United States as a visitor. Individuals should weigh up the pros and cons of renouncing as it is a difficult process to regain citizenship or green card status after the fact.
As always, each situation will be unique and we recommend additional research and consultation with relevant professionals.
For more information on the reporting and taxation requirements of the RDSP, please visit our tutorial rdsp.com, contact our toll-free helpline on 1-844-311-7526, or email us at firstname.lastname@example.org
This article was written with the assistance of Kevin Kirkpatrick of Moodys Tax. Kevin is called as a lawyer in both Alberta and Minnesota and he practices primarily in the fields of international tax and citizenship law. He is based in the Calgary office of Moodys Tax Law LLP. For more information, please visit their website, www.moodystax.com.
*Please note that Plan Institute does not suggest or recommend working with Moody’s Tax Law LLP and that this information has been shared as educational information only. You will want to complete your own research to see whether Moody’s Tax would be a suitable company for you to work with.
This is not professional advice:
This document and its contents are for informational purposes only and are not legal, tax, investment, financial, medical or other professional advice, and should not be construed as a recommendation for any particular course of action.
Plan Institute is providing the information “as is” and is not responsible or liable for any inaccuracies, errors or omissions in the information, or for the information being incomplete or out of date. You use the information and make decisions and take actions in reliance on the information solely at your own risk, and Plan Institute will not be liable for your use or reliance on any information it provides.
You should consult with qualified professional advisors before making any legal, financial, medical or health care decisions.
Restrictions: You may only copy and use this document and its contents for your own personal use, and you must not distribute, publish, disseminate or otherwise make available this document without Plan Institute’s consent.