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
Pursuant to Barry v Commissioner, the courts concluded that dividends paid out of a CFC (following a 962 election) in a country in which has no treaty with a US, is a dividend but taxed at ordinary rates. It has always been my understanding that if a CFC that is otherwise not a PFIC and is situated in country who is party to US treaty, such as Canada, distributes a dividend following a 962 election, would be eligible for qualified dividend rates. In Barry V Commissioner, the courts concluded that the dividend was not considered as paid out of a notional domestic corporation (as the petitioner contends) and neither is considered as paid out of qualified foreign corporation (i.e. non-PFIC in a country that has a treaty with the US) and is therefore subject to ordinary rates.
GILTI will have its own basket with or without a 962 election. However, the proposed regulations do not contain rules on the foreign tax credit as it relates to GILTI, much less the appropriate basket when a distribution is paid out of the notional corporation (under 962). Such guidance is still pending. Neither is it clear that assuming the 962 election is not made and a dividend is distributed concurrently (assuming all income is active business income) in the same year as the GILTI inclusion, that the Canadian tax would also fall into the GILTI basket (or in the general basket if there is no income inclusion (under pre-TCJA Sec. 904) in the US due to PTI or under the CFC look-through rules), or whether or not the Canadian tax would be subject to a grind. Therefore, I would reserve any conclusions with respect to foreign tax credits.
Under the 962 election, we are still waiting for guidance if the 50% deduction under Sec. 250(a)(1)(B) is available to an individual shareholder who makes the 962 election. There is speculation that it would be however, without the 50% deduction, my tentative calculation (again absent any further guidance) demonstrates that a 26.3% tax rate is required in Canada in order to eliminate the GILTI tax on a 962 election. If the 50% deduction is available to individuals on a 962 election, then a 13.125% tax in Canada would eliminate GILTI (again based my tentative calculations). There is also a possibility that Congress may consider extending the 50% deduction to individual shareholders but would require a legislative fix.