Introduction – U.S. citizenship has opportunities, liabilities and disabilities
Living as a U.S. citizen outside the “Homeland” is at best difficult and at worst impossible.
Those who wish to remain U.S. citizens and live outside the United States must live by the motto:
“The difficult we do today. The impossible takes a bit longer”.
Many will see the difficulties as being too great, too time consuming and too expensive and will renounce their U.S. citizenship. At the very least, you should fully understands the opportunities, liabilities and disabilities of U.S. citizenship.
The difficulty of financial planning and investing – A Major Disability
As a U.S. citizen you are taxed in the same way and according to the same rules as U.S. citizens who live in the U.S. It is important to understand that the U.S. tax system is almost the exact opposite of Canada’s tax system. The reason is that:
Retirement planning in Canada is based on the principle of tax deferral. That is what an RRSP or TFSA is – a tax deferred investment plan. You will NOT (at least in the short term) pay tax on income earned inside one of these investment vehicles.
The U.S. tax system is designed to attack “tax deferral” (examples PFICS and Subpart F income) and will severely (and if you want to see how bad this is see this post about PFICs) punish you if you invest in these things.
By the way, if you are not already aware of this U.S. citizens should not invest in Canadian based mutual funds. (The are considered by the IRS to be PFICs.)
While I am on a roll, I will also remind you of the problems of:
Now, back to the main point of this post.
The Four Principles Of US Taxation Abroad
The U.S. tax system (at least in relation to U.S. citizens abroad) operates on the following four basic principles:
1. If something is “foreign” it should be punished.
2. The “principle of penalty” – There is no way that somebody can clean up innocent mistakes without paying penalties or the threat of penalties.
3. “No good deed goes unpunished” – Those who have filed (and are in the system) will have greater problems than those who have never filed. (Look at the new Streamlined compliance procedures for evidence of this – those who have filed cannot use the procedure to amend returns)
4. U.S. citizens abroad are tax cheats.
Those four principles sum it up.
This morning I came across an article preaching the virtues of the TFSA (“Tax Free Savings Account”) for Canadian residents. The article points out that:
Among the top reasons for the rise in popularity of TFSAs is their flexibility. Money can be pulled out without penalty in case of a financial emergency, TFSAs don’t have to be converted into a RRIF upon retirement, and they can contain a variety of different types of investments. Investors don’t get an immediate tax break the way they do with an RRSP contribution, but investments inside a TFSA grow tax-free
The TFSA is going to become a very significant means of investing and savings for Canadians.
Well, not all Canadians. As you know “Not all Canadians are created equally”. Those Canadians who are also U.S. citizens are, by virtue of “American Exceptionalism”, simply exceptional. They are exceptionally different. They are also targeted for exceptionally harsh tax treatment. For those who just want the bottom line:
Under no circumstances should a U.S. citizen invest in a TFSA. I came across a TFSA video on the Globe web site (it’s only one minute you can view it now) that suggests that TFSAs might be a good investment for U.S. citizens in Canada. The video is full of half truths and IMHO is wrong. As discussed in some of the comments, the reporting costs and potential for penalties for investing in a TFSA (not to mention the LCUs) are so extreme that you should run. This comment is particularly succinct:
As the “Interested Layman” stated below. TFSAs are only recognized as Trusts. As a trust form 3520A is supposed to be filed by March 15. (I know that is before US income filing is due). Then form 3520 when you file your US income tax. Fun, fun, fun! Just adding the income to your income tax is not what they want. My US tax accountant would not do my income tax unless I filed this form and back-filed it for years 2009 and 2010 (TFSA started in 2009). The IRS fine for not filing these forms is $10,000 or 35% of the account.
Next any Dual (like myself) or US citizen living in Canada who has opened a RESP must also file the same forms. Unlike RRSPs an RESP is recognized as a TRUST and also is taxed by the IRS. I know individuals who have paid the accountant more to file the forms then they have in the RESP account. Fun, Fun, Fun!
Now for the rant!
I find it very interesting that the IRS insists on pursuing law abiding citizens as if they are criminals. One of the reasons for the Revolutionary war was to keep King George from taxing the colonies. Very ironic. Canada only taxes by residency. The US taxes by birth. Once a citizen always a citizen. You pay tax no matter where you reside.
If you want to give up your citizenship you have to pay all taxes you are deemed to owe. This means if you own a business or a home, you have to pay the taxes on unrealized capital gains on them to be free.
I left the US 40 years ago. I received no money from the US. I could not write off mortgage interest on my home to pay for it. Now if I sell my home I will be tax liable to the US for taxes on the Capital gains? Damn!
By the way, there are many investments that are prohibited to US citizens in Canada.
That’s the bottom line. For those who did not fully understand the above comment, let me explain:
1. Unless you have been living under a rock you know that U.S. citizens, regardless of where they live must file tax returns and pay tax on their world income. Since at least 2011 U.S. citizens abroad are presumed to be tax cheats. (Principle 4 – All U.S. citizens abroad are tax cheats.)
2. U.S. citizens abroad are taxed in the same way as U.S. residents. They complete the same tax return. They are subject to the same rules. (The only exception is that at least for the moment they have the possible benefit of the Foreign Earned Income Exclusion.)
3. From a U.S. perspective the TFSA is NOT tax free. Hence, you must include the income every year on your U.S. return. But, TFSA is not just any kind of income, it is income from a “Foreign Trust”.
4. The U.S. penalizes and puts special restrictions on anything “Foreign” including “Foreign Trusts”. (Principle 2 – If something is foreign it should be punished.)
5. All Foreign Retirement and Investing Plans are “Foreign Trusts”. TFSAs are “Foreign Trusts”.
6. Form Nation imposes special reporting requirements on Foreign Trusts. There are two forms. The first is Form 3520. The second is Form 3520A.
7. Form 3520 is the form where you as the taxpayer have to report the information on the Foreign Trust. This is complicated, time consuming and expensive to complete. US citizenship has been priced out of the market. It is filed along with your tax return and is due when your tax return is due.
8. Form 3520A is a form that the administrator of the trust/TFSA (for example the CIBC bank is required to complete. This particular form -are you ready for this – is due on March 15. Yes, you got it. Form 3520A is due before your tax return is filed. Do you really think you could get your bank to complete a 3520A for you and file it?
9. What happens if CIBC does not not file the From 3520A by March 15? Answer: as the beneficiary of the Foreign Trust, you will be subjected to draconian, idiotic and unfair penalties. (Principle 2 – The Principle of Penalty)
10. Who could possibly know about Form 3520A? Answer nobody. Well, not quite. Once you file your return with the Form 3520 and they see there was no Form 3520A, they will educate and threaten fines. (Principle 3 – No good deed goes unpunished.)
Conclusion: Stay away from any Canadian investment plan except the RRSP. Although an RRSP is a “Foreign Trust”, they are covered by special arrangements. First, the IRS does not require the 3520 for RRSPs. Second, remember the Form 8891 every year. Form 8891 is required to ensure that the income from your RRSP does not have to be included on your U.S. tax return.
Who could have known all this? Nobody!
Also, US citizens in Canada should NOT purchase Canadian mutual funds (they are PFICs). Furthermore, for US citizens abroad, home ownership can be very taxing. There are many other problems, but I won’t wreck YOUR Thanksgiving weekend. And Homelanders wonder why US citizens expatriate. Now really.
From the IRS – As of October 5, 2012 – Seeing Is Believing – Note the Principle of Penalty
Form 3520 – This is the information the taxpayer must provide
The U.S. owner is subject to an initial penalty equal to the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year, if the foreign trust: (a) fails to file a timely Form 3520-A or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(b). Additional penalties will be imposed if the noncompliance continues after the IRS mails a notice of failure to comply with the required reporting. For more information, see section 6677.
Criminal penalties may be imposed under sections 7203, 7206, and 7207 for failure to file on time and for filing a false or fraudulent return.
Penalties may also be imposed under section 6662(j) for undisclosed foreign financial asset understatements.
The fact that a foreign country would impose penalties for disclosing the required information is not reasonable cause. Similarly, reluctance on the part of a foreign fiduciary or provisions in the trust instrument that prevent the disclosure of required information is not reasonable cause.
Form 3520 A:
Purpose of Form
Form 3520-A is the annual information return of a foreign trust with at least one U.S. owner. The form provides information about the foreign trust, its U.S. beneficiaries, and any U.S. person who is treated as an owner of any portion of the foreign trust.
A foreign trust with a U.S. owner must file Form 3520-A in order for the U.S. owner to satisfy its annual information reporting requirements under section 6048(b). Each U.S. person treated as an owner of any portion of a foreign trust under sections 671 through 679 is responsible for ensuring that the foreign trust files Form 3520-A and furnishes the required annual statements to its U.S. owners and U.S. beneficiaries.
Exception. Canadian registered retirement savings plans (RRSPs) and Canadian registered retirement income funds (RRIFs) are not required to file Form 3520-A with respect to a U.S. citizen or resident alien interest holder who is eligible to file Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, with respect to the RRSP or RRIF. In addition, other eligible Canadian plans within the meaning of section 3 of Rev. Proc. 2002-23, 2002-15 I.R.B. 744, are relieved of any obligation to file Form 3520-A with respect to a U.S. citizen or resident alien beneficiary who has made an election in accordance with section 4 of Rev. Proc. 2002-23 and has complied with the annual reporting requirements of Rev. Proc. 2002-23.