*Please note – this information relates to a complex area of tax law and covers U.S. tax law only. 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.*
If you’re considered a U.S. citizen, you will need to file annual tax returns with the IRS and potentially report on other holdings you have, such as the RDSP. It is recommended that you check your citizenship status, especially when not living in the United States. Additional information on citizenship status is available on the U.S. Citizen and Immigration Services website.
Reporting Requirements for the RDSP
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 investment growth (or capital gains) earned within these plans are subject to U.S. tax on an annual basis. For RDSPs, this means that all grants, bonds, investment growth, and proceeds from rolled-over amounts are taxable each year, rather than when the funds are withdrawn from the RDSP. This tax liability can be on the beneficiary, but can also be on the holder or a contributor to the RDSP, depending on their citizenship. The reason for this is because of what are known as the “grantor trust rules” in the Internal Revenue Code, specifically section 679.
In short, if the person setting up the RDSP or the holder is not a U.S. citizen but the beneficiary is then the tax burden remains with the beneficiary. If the beneficiary is not a U.S. citizen, but the holder and/or contributors are, then the tax liability will shift to those individuals. This tax liability can be avoided if the U.S. contributor makes a gift of cash to a non-U.S. person who could then contribute to the RDSP.
To learn more about U.S. tax filing, 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. 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 $10,000 USD 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.
Example Scenarios and FAQs
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 allow the taxpayer to only have to submit returns for the past 3 to 6 years rather than the entire period of non-filing. They also provide the benefit of reduced or eliminated penalties.
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 wasn’t caused by 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.
What happens to people who are on work visas or other temporary residencies in the U.S. in terms of their RDSP and taxation?
The United States considers green card holders to be U.S. residents for tax purposes. Green card holders file tax returns and pay U.S. tax on their worldwide income, as do U.S. citizens, even if they live in Canada. Green card status may remain active even if the card itself is expired.
The U.S. tax consequences for individuals with other types of U.S. work authorization or vacationing for extended periods (i.e., snowbirds) depend on the amount of time spent in the United States each year. An RDSP held by a non-U.S. citizen only becomes potentially taxable by the United States when that person becomes a U.S. income tax resident.
To determine if someone is a tax resident under its laws, the United States uses a three-year weighted day count test. Consistently spending about 120 or more days in the United States each year will trigger U.S. income tax residency under this test. In many cases, however, it is possible to spend significant amounts of time in the United States but use either a provision of U.S. domestic law or a provision of the Canada-U.S. Tax Treaty to remain classified as a Canadian resident. This is done by filing appropriate paperwork with the IRS.
You can abandon your green card holder status by filing Form I-407, with the U.S. Citizen & Immigration Service, or you renounce your U.S. citizenship under certain circumstances described in the expatriation tax provisions. See Publication 519, U.S. Tax Guide for Aliens, for more details. Note that this is a simplified version relating to income tax. Additional information can be found in the source below.
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