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The State of California and Canadian RRSPs – The Tax Facts

So, you’re a Canadian who decides to move to the Sunshine State. At this point in the season – that season being “not winter, but also not spring” – it’s something I think about every day. However, if you’re a Canadian who: 1) Flew south for more than just the winter; 2) Is a resident of California; and 3) holds RRSPs, LIRAs, RRIFs or other Canadian tax-deferred accounts, you need to read this.

The Canada-US Income Tax Convention or “tax treaty”, provides a tax deferral for RRSP and similar retirement accounts until the time of withdrawal.  Essentially, giving Canadian retirement plans the same tax treatment as US Individual Retirement Accounts (IRAs). But not every state follows federal tax treaties. California is a state that does not abide by federal tax treaties. According to the California State Franchise Tax Board (FTB), your RRSP is…well…more like a savings account.  Translation – the income and capital gains are taxable in the year earned!

The IRS has issued Revenue Procedure 89-45 which provides guidance with respect to why, under US domestic tax law, RRSPs, LIRAs and RRIFs are not considered to be the same as US IRAs. This particular procedure goes on to explain that, in fact, the earnings from this type of plan should be reported as part of your gross income on your US tax return. Of course, this is before considering Income Tax Treaties.

In summary, a California resident must include any earnings from their RRSP in their taxable income and pay taxes in the year it is earned. There is an upside. (Finally!) But one would need to have good bookkeeping skills to take an advantage of it. After tax is paid on these earnings, the earnings will also be treated as capital invested in the RRSP, for California tax purposes. When a taxpayer receives a distribution from their RRSP, the amount of the contributions and the previously taxed earnings is considered a nontaxable return of capital for the California purposes.  However, the withdrawal will be taxable federally, meaning an adjustment will be required state-side to avoid double-taxation

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US Persons with Foreign Interests may be overlooking important reporting requirements

IRS Form 5471 Penalty

U.S. citizens or residents who are officers or directors of a foreign corporation (e.g. a Canadian corporation) often overlook their U.S. filing obligations, and it is important to understand the stiff penalties for not properly disclosing foreign interests.

If a U.S. citizen or resident is an officer or a director of a foreign corporation in which a U.S. person has: 1) acquired 10% or more of votes or value of the corporation during the year or 2) acquired an additional 10% or more of votes or value of the corporation during the year, the officer/director is required to report as a Category 2 filer on Form 5471 (Information Return of U.S. Persons With Respect to Certain Foreign Corporations).  Reporting is required whether or not the officer/director owns shares in the foreign corporation and regardless of whether the foreign corporation is a controlled foreign corporation (“CFC”).

Failure to file, or filing an incomplete Form 5471, can result in penalties of $10,000 per foreign corporation, unless a reasonable cause defense exists. At any time, the IRS may issue a written request to file Form 5471 within 90 days. If not filed, the continuous penalty applies at $10,000 per month to a maximum of $50,000. The combined penalty is capped at $60,000.

Other information returns that are either filed late or incomplete may attract initial and similar continuous penalties and are summarized as follows:

 

Form Initial Penalty Continuous Penalty Maximum Penalty
Form 8938, Statement of Foreign Financial Assets $10,000 per return Additional $10,000 penalty per month that the failure continues, beginning 90 days after initial notice Maximum continuous penalty of $50,000 for a combined penalty of $60,000
Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts Greater of $10,000 or 35% of the gross reportable amount

 

In the case of greater than $100,000 of foreign gifts received, the penalty is 5% of the value of the gift per month.

 Additional $10,000 penalty per 30-day period, or a fraction thereof, that the failure continues beginning 90 days after initial notice Gross reportable amount plus initial penalty

 

 

 

 

Maximum penalty of 25% of the value of the gift
Form 3520-A, Information Return of a Foreign Trust with a U.S. Owner Greater of $10,000 OR 5% of the gross value of trust assets owned by the U.S. person Additional $10,000 penalty per 30-day period, or a fraction thereof, that the failure continues beginning 90 days after initial notice Gross reportable amount plus initial penalty

 
Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation 10% of the value of the property transferred Not applicable $100,000

 

No maximum if due to intentional disregard
Form 8865, Return of U.S. Persons with Respect to Foreign Partnerships $10,000 for failure to file

 

 

 

Plus, 10% of the value of any unreported transferred property

 Additional $10,000 penalty per month that the failure continues beginning 90 days after initial notice Maximum continuous penalty of $50,000 for a combined penalty of $60,000

 

 

$100,000
Form 5472, Information Return of a 25% Foreign Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business $25,000 per foreign corporation ($10,000 prior to 2018) Additional $25,000 penalty per month that the failure continues beginning 90 days after initial notice NO MAXIMUM PENALTY
Form 114, Foreign Bank Account Report Willful penalty of the higher of $100,000 or 50% of the total balance of the foreign financial account per violation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-willful penalty of up to $10,000 per account per year

 

 

 

 

 Not applicable. Aggregate of all accounts that does not exceed $50,000, penalty is greater of $1,000 per violation on 5% of the maximum account balance in the calendar year

 

Aggregate balance of more than $50,000 but no more than $250,000, penalty is the greater of $5,000 per violation or 10% of the maximum account balance

 

Maximum aggregate balance is greater than $250,000 and less than $1,000,000, penalty is greater of 10% of the maximum account balance or 50% of the closing balance in the account on the last day for filing the FBAR

 

If the account exceeds $1,000,000, the penalty is the greater of $1,000,000 or 50% of the closing balance of the account

 

In most cases, the total penalty amount for all years under examination will be limited to 50% of the highest aggregate balance.  Although penalty may be higher or lower, the total penalty should not exceed 100% of the highest aggregate balance.

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Aggregate of all accounts that does not exceed $50,000, penalty is $500 per violation not to exceed $5,000

 

Aggregate of all accounts that exceed $50,000 but less than $250,000, penalty is lesser of $5,000 or 10% of the highest balance in the account during the year

 

For violations regarding an account exceeding $250,000, the maximum penalty is $10,000 per violation.

 

In no event will the penalties for non-willful violations exceed 50% of the account balances.

 

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