Author Topic: American living in Canada with a TFSA - Maybe not so tax-free?  (Read 7286 times)

AmbitiousCanuck

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Hi all,

My wife is an American-Canadian dual citizen living here in Canada.  She just opened a TFSA this January.  I was recently reading about the tax implications of an American with a TFSA and from what I have read so far, it appears that the IRS does not recognize the tax-free status of a TFSA, and will expect her to pay taxes on all income inside the account!

So I guess the problem is that she has to report the income on her American tax return, but then she cannot deduct the fact that she paid the tax on her Canadian return because there is no tax to pay, so she gets stuck with a tax bill in the US.

Lets consider the absurdity of this situation for a minute:

She is a Canadian citizen and resident, who has a Canadian Tax-Free Savings Account, inside which she has invested in a Canadian index-fund holding Canadian Companies on a Canadian stock exchange........... and the IRS things that she should pay THEM taxes on the income?  What???

So do I understand this situation correctly?  Is she going to be stuck paying the IRS tax on income they shouldn't even care about?

Cathy

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #1 on: March 14, 2015, 09:10:42 AM »
[Please note: Despite some of the wording in this post, this post does not contain any specific advice. This post, like all my posts, contains only general information and it should not be relied on as a guide to any individual situation. Please retain counsel if you need legal advice.]

So do I understand this situation correctly?  Is she going to be stuck paying the IRS tax on income they shouldn't even care about?

No, your wife doesn't have to keep paying US tax on income from sources outside the US if she doesn't want to. She can relinquish US nationality at any time and then she will only be subject to tax as a nonresident alien for US tax purposes. As a nonresident alien, she would only be required to pay tax on income from US sources and income effectively connected with a US trade or business.

If you search the internet, you'll read about an alleged high fee to relinquish nationality, but this is bogus. According to 8 USC 1481(a), a US citizen shall lose US nationality if she "voluntarily" performs an act in the enumerated list "with the intention of relinquishing United States nationality". One method of relinquishment is renunciation before a US consular officer in a foreign state pursuant to 8 USC 1481(a)(5) in the form prescribed by the Secretary of State. The Secretary of State does charge a fairly significant fee for that service, but it's only one way to relinquish US nationality. There are other ways that are free. In particular, 8 USC 1481(a)(2) provides that a US citizen gives up US nationality by voluntarily (and with the intention of relinquishing US nationality) taking an oath or other formal declaration of allegiance to a foreign state after turning 18. This is something that your wife can do at any time to relinquish US citizen for free (for nationality purposes).

Somewhat bizarrely, the tax laws actually contains a slightly different relinquishment regime. For nationality purposes, your wife would give up US citizenship simply by voluntarily performing an expatriating act while having the relevant intention. No notification to anyone is required. However, for tax purposes (pursuant to 26 USC 877A(g)(4)), your wife will not be treated as giving US citizenship until she furnishes to the Department of State a "a signed statement of voluntary relinquishment of United States nationality confirming the performance of an act of expatriation". The law apparently does not require this to be in any particular form. Alternatively, instead of sending a statement, your wife could file Form DS-4079 (Request for Determination of Possible Loss of United States Citizenship) to obtain a certificate of loss of US nationality, the issuance of which also establishes relinquishment for tax purposes pursuant to 26 USC 877A(g)(4)(C). The Form looks like more work than simply sending a statement and, moreover, using the Form allows the Department of State to disagree with you and not issue a certificate.

After complying with the notification requirement of 26 USC 877A(g)(4), your wife would no longer be a US citizen for tax purposes. In order to memorialise that she has expatiated for tax purposes, the IRS requires the filing of Form 8854. Unless your wife is pretty wealthy, she will not face any expatriation tax, because it is a tax on unrealised capital gains and it only applies to the portion of unrealised capital gains above $680,000 for 2014 (adjusted for inflation each year, so it will be higher for 2015). At age 26, your wife is unlikely to have that magnitude of unrealised capital gains, but of course it's not impossible.

So, the truth is, your wife is not forced to pay tax on her TFSA while living in Canada. That is a choice she is voluntarily making.

Americans often want to have it both ways. They want the ability to enter and live in the US for any reason, taking advantage of the very strong US economy and job market, and they also don't want to pay the taxes that come with that privilege. There are many people in the world who would gladly pay the taxes for the privileges of US citizenship, including the right to enter and work in the US for any reason. That is an especially valuable privilege in the context of this forum because it is much easier to get rich in the US than in Canada. Of course, there's nothing wrong with not wanting to pay tax; many people don't like to pay tax. Just recognise that many people globally would gladly pay it in your stead.

All that said, if your wife is not going to relinquish US citizenship, then you should get some professional legal advice on her tax obligations, because from your post, it does not sound like she knows what she is doing, and the laws are complicated. It would be unreasonable for me to summarise everything here.

Finally, I should note that the IRS did not create any of these rules. Your complaint there lies with Congress. The IRS is simply implementing the law as crafted by your elected representatives.
« Last Edit: November 24, 2015, 02:42:06 AM by Cathy »

AmbitiousCanuck

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #2 on: March 14, 2015, 09:45:38 AM »
Cathy,

Thank you for all of the information.  Unfortunately you seem to have managed to avoid answering my actual question. :)

Yes I am aware we could pay exorbitant fees for professional legal advice, however we will not be doing so.  We have no problem handling legal and tax formalities on our own.

Cathy

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #3 on: March 14, 2015, 09:56:10 AM »
I answered the question in your last sentence -- whether your wife is "stuck" paying these taxes. She is not.

Let me explain why I responded that way.

I did not offer any advice on the specific tax situation because the matter is both complicated and not free from doubt. US persons with foreign assets are subject to several different reporting regimes with different requirements under different laws. In addition, the IRS often declines to issue any guidance on how US tax law applies to foreign instruments. To date, the IRS has declined to offer any guidance on how US tax law applies to a Canadian TFSA.

The most commonly cited legal theory is that a TFSA is a foreign grantor trust, and the grantor must pay tax on the undistributed income within the trust, as well as filing both Form 3250-A (Annual Information Return of Foreign
Trust With a U.S. Owner) and Form 3250 (Annual Return To Report Transactions With Foreign Trusts) each year with the IRS.

A second legal theory would be that TFSA is not a separate person from its owner, and is a disregarded entity under US tax law. Under this theory, the TFSA is just like a normal bank or brokerage account, and the income earned within is taxable on the same basis as if the things inside the TSFA were owned outside the TFSA.

A final legal theory, and one that I have never seen anyone advocate, is that income earned inside a TFSA is not taxable in the US while the grantor is a resident of Canada because the TFSA is a trust which is "generally exempt from income taxation in a taxable year in [Canada] and operated exclusively to administer or provide pension [or] retirement ... benefits" pursuant to Article XXI(2) of the US-Canada tax convention (treaty). If you take that position, you would need to file Form 8833 (Treaty-Based Return Position Disclosure), Form 3250, and Form 3250-A, each year with the IRS, but no tax would be due (assuming the IRS accepts your position).

I want to emphasise very strongly that I am not offering any advice on which one of the above legal theories is correct. Maybe they are all wrong. There is no case law, no regulations, and no IRS guidance, on this topic. You are left to read the tax law and draw your own conclusions. Or you could retain an attorney to offer you advice. The attorney would not have access to any secret information, but he or she could go over the risks of each approach and help you develop a strategy that you are comfortable with. There are risks regardless of which approach is taken.

And this is just the niche topic of TFSAs. I am willing to bet that US tax law contains many other requirements that your wife may be violating or has the potential to violate, and she does not even know it, because the law is very complicated. It is not something that anyone can address in the context of a casual forum post, as much as I wish I could help more.
« Last Edit: March 14, 2015, 10:17:10 AM by Cathy »

Retire-Canada

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #4 on: March 14, 2015, 10:13:45 AM »
It is not something that anyone can address in the context of a casual forum post, as much as I wish I could help more.

BTW- thank you for the time and effort you put into this forum. :)

-- Vik

AmbitiousCanuck

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #5 on: March 14, 2015, 01:30:03 PM »
Thank you so much for the additional explanations Cathy, that was more so what I was looking to hear.  I agree the situation is complex.  I mostly am looking to hear what others in our situation have done so that we can draw on their experience and possibly their mistakes.

I am not sure what we will do yet about the TFSA, but luckily we have a whole year to figure it out before the next tax season.

Cathy

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #6 on: March 15, 2015, 12:23:14 PM »
I mostly am looking to hear what others in our situation have done so that we can draw on their experience and possibly their mistakes.

There are no publicly known cases of the IRS choosing to challenge anybody's filing position on a TFSA, regardless of what it was. As a practical matter, the IRS does not audit most returns, especially when the amounts involved are small.

What other people have filed in their tax return is irrelevant and does not create any kind of precedent or estoppel. All that matters is the law and whether your position is legally defensible. You should not make your tax decisions based on what other people have done. You should make the decisions based on the law.
« Last Edit: March 15, 2015, 12:39:16 PM by Cathy »

AmbitiousCanuck

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #7 on: March 15, 2015, 01:05:58 PM »
What other people have filed in their tax return is irrelevant and does not create any kind of precedent or estoppel. All that matters is the law and whether your position is legally defensible. You should not make your tax decisions based on what other people have done. You should make the decisions based on the law.

Yes, from an entirely legal standpoint you are correct.  But in reality, what the law says and what the enforcers of the law actually do can be two entirely different things.  Occasionally wisdom trumps knowledge, and my best move would be to seek both.

daverobev

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #8 on: March 15, 2015, 02:57:48 PM »
TL; DR: If you're American, you have to file a US return even while non resident; the law is murky at best; an RRSP is fine, but to save yourself a headache avoid anything else registered.

As to the US and Eritrea, I think, being countries that tax citizens on all income no matter where they live... not very fair. Guess that's what liberty and freedom gets you. Um. Or something.

SoftwareGoddess

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #9 on: March 15, 2015, 03:06:13 PM »
I'll give you a datapoint. I'm a dual American-Canadian citizen living in Canada. I don't have a TFSA. This is because my tax accountant takes the position Cathy mentioned that a TFSA is a foreign grantor trust, and the yearly reporting on it is so burdensome that it would cost me more in accountant's fees than I would make on the investments. And, if I remember correctly, the penalties for not filing or filing incorrectly are quite punitive. Therefore, it's not worthwhile for me to have a TFSA.

plainjane

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #10 on: March 15, 2015, 03:57:52 PM »
I am in the same spot and my accountant recommended/required that I close my TFSA a couple of years ago. 

Because of that, I'm now in the position that I've basically maxxed out my tax sheltered space for investments, and taxable accounts can't be as efficient because either Canada or the US will consider them as "foreign" investments.  I haven't seen any next steps for people in this situation, so I might actually look for a financial planner this year or next to help me make a roadmap.

For all Canadians in this situation, contact your MP and ask that they reopen the tax treaties with the US to get the TFSA back under an umbrella for us.  IMO it's unfair that the US has a post-tax shelter of a similar size that we aren't allowed to access, while denying us reasonable access to the Canadian equivalent.

AmbitiousCanuck

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #11 on: March 15, 2015, 04:02:46 PM »
taxable accounts can't be as efficient because either Canada or the US will consider them as "foreign" investments

Now that is something that never crossed my mind!  We do not yet have any taxable investments, but that is concerning.  Can you elaborate how a taxable investment works for a Canadian resident with American citizenship?

plainjane

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #12 on: March 15, 2015, 05:25:57 PM »
taxable accounts can't be as efficient because either Canada or the US will consider them as "foreign" investments
Now that is something that never crossed my mind!  We do not yet have any taxable investments, but that is concerning.  Can you elaborate how a taxable investment works for a Canadian resident with American citizenship?

This is my problem, I don't have a good answer.  I can see that Canadian capital gains and dividends are given preferential treatment in Canada, and that they are not in the US.  So I'd assume the US would tax the difference between the two.  And I do know that the US doesn't like Canadian mutual funds (they might be considered passive foreign investments companies?)

And as the thread above shows, there are a lot of places where things are complicated and uncertain, which is likely why nobody is giving solid generic info online.  Perhaps the easiest thing for a couple (ETA: if married) is to have the non-American hold all the taxable accounts plus a maxed out TFSA? 

My current thought is to postpone decisions for a bit longer and pay off the mortgage before I go taxable.  My amortization is currently at ~6 months after my current term is up, so might as well just kill that off, and maybe the taxes will start making more sense by that point since there are so many dual citizens filing now.
« Last Edit: March 15, 2015, 05:35:25 PM by plainjane »

daverobev

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #13 on: March 15, 2015, 05:57:09 PM »
If the US is punitive, I'd suggest getting two Vanguard ETFs, eg VXUS and whatever the broad market US one is, unreg.

You'll be taxed once at the end of it all due to treaties.

Sucks, but what can you do.

SoftwareGoddess

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #14 on: March 15, 2015, 06:09:16 PM »
If the US is punitive, I'd suggest getting two Vanguard ETFs ...

If purchased in Canada, these funds are likely to be domiciled in Canada and subject to US Passive Foreign Investment Company rules, which again entails complex yearly reporting. On my tax accountant's advice, I avoid holding mutual funds, index funds, and ETFs in taxable accounts. Yes, it sucks!

daverobev

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #15 on: March 16, 2015, 06:17:09 AM »
If the US is punitive, I'd suggest getting two Vanguard ETFs ...

If purchased in Canada, these funds are likely to be domiciled in Canada and subject to US Passive Foreign Investment Company rules, which again entails complex yearly reporting. On my tax accountant's advice, I avoid holding mutual funds, index funds, and ETFs in taxable accounts. Yes, it sucks!

VXUS is a US ETF, as is... VTI, that's the ticker I was thinking of.

SoftwareGoddess

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #16 on: March 16, 2015, 12:36:25 PM »
VXUS is a US ETF, as is... VTI, that's the ticker I was thinking of.

A fund in US dollars or a fund domiciled in the US? I'm fairly sure that funds purchased from Vanguard Canada are domiciled in Canada. However, I admit that I haven't looked too far into this, only enough to know that buying US-domiciled funds from Canada would be difficult (though perhaps possible), and I haven't examined the tax implications from the CRA side of things.

daverobev

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #17 on: March 16, 2015, 01:24:11 PM »
VXUS is a US ETF, as is... VTI, that's the ticker I was thinking of.

A fund in US dollars or a fund domiciled in the US? I'm fairly sure that funds purchased from Vanguard Canada are domiciled in Canada. However, I admit that I haven't looked too far into this, only enough to know that buying US-domiciled funds from Canada would be difficult (though perhaps possible), and I haven't examined the tax implications from the CRA side of things.

It's not Vanguard Canada. Most or all Canadian brokerages allow the puchase of stuff US side.

I have no idea about withholding and all that, but from the Canadian side any dividends will just be dividends (no tax breaks, not Canadian eligible), treated like interest basically, though any foreign tax is claimable. Cap gains are cap gains.

Vanguard Canada has only a few ETFs, and they are generally listed 'VUN.TO' or similar. VXUS is world-ex-US, on the NYSE I think, a fully US product.

plainjane

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #18 on: March 16, 2015, 02:33:51 PM »
VXUS is a US ETF, as is... VTI, that's the ticker I was thinking of.
I have no idea about withholding and all that, but from the Canadian side any dividends will just be dividends (no tax breaks, not Canadian eligible), treated like interest basically, though any foreign tax is claimable. Cap gains are cap gains.
Vanguard Canada has only a few ETFs, and they are generally listed 'VUN.TO' or similar. VXUS is world-ex-US, on the NYSE I think, a fully US product.

So for the taxable side of things perhaps have the non-USian take on Canadian & International exposure, and the USian hold the US funds.  Again, this is me thinking out loud, looking for people to pipe in and tell me if they see flaws in the reasoning.  That way the entire couple's portfolio can be more balanced, even if not individually.

daverobev

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Re: American living in Canada with a TFSA - Maybe not so tax-free?
« Reply #19 on: March 16, 2015, 04:52:56 PM »
VXUS is a US ETF, as is... VTI, that's the ticker I was thinking of.
I have no idea about withholding and all that, but from the Canadian side any dividends will just be dividends (no tax breaks, not Canadian eligible), treated like interest basically, though any foreign tax is claimable. Cap gains are cap gains.
Vanguard Canada has only a few ETFs, and they are generally listed 'VUN.TO' or similar. VXUS is world-ex-US, on the NYSE I think, a fully US product.

So for the taxable side of things perhaps have the non-USian take on Canadian & International exposure, and the USian hold the US funds.  Again, this is me thinking out loud, looking for people to pipe in and tell me if they see flaws in the reasoning.  That way the entire couple's portfolio can be more balanced, even if not individually.

The American can hold VXUS quite happily; it is US domiciled, but contains everything BUT the US. I (Canadian resident, in no way American) happily hold VXUS in my RRSP because the US has good tax treaties so there is probably less withholding than the Canadian equivalent (well, there isn't one, so the composite that makes roughly the Canadian equivalent), and the MER is lower.

VXUS is awesome. If I could hold one thing, it would be that.