Year-End Tax Planning: US Citizens in Canada

Most accountants and financial analysts give the same speech at year-end. Make your donations now, get your medical expenses in, etc. While these are true, for Americans in Canada there are more serious matters that complicate their returns and can cost them money in taxes and professional fees. The following are items that should be dealt with before year-end.

1)     Tax Free Savings Accounts (TFSA):

For ordinary Canadians these are great vehicles for saving money and avoiding taxes. Unfortunately, the USA doesn’t view them in the same manner. For American purposes these investment vehicles come with 2 problems.

  1. All income earned in the TFSA is taxable in the USA. This may result in taxes payable in the USA on the income as there may not be sufficient tax credits available to avoid American taxes.
  2. TFSA accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make these investment vehicles unfavorable for an American residing in Canada. However, if the account is closed before December 31, we can file a final return for the trust in 2012 and there will be no hassles subsequently.

2)     Registered Education Savings Plan (RESP):

Similar to a TFSA described above, these vehicles are a great tool for saving for a child’s college education. Unfortunately, this vehicle has similar constraints to the TFSA.

  1. In Canada, income earned in the RESP is taxable in the hands of the beneficiary when the money is withdrawn to pay for college. In the USA, the income, including government grants, is taxable annually when it is earned. This can result in double tax with the child paying tax on the income in Canada, and the parent paying tax in the USA.
  2. RESP accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make an RESP unfavourable for Americans in Canada. One solution would be to have a non-American spouse or grandparent open the account for the benefit of the child.

3)     Mutual Funds/ETF/REIT

Mutual funds are a standard form of investment. However, if you are an American in Canada, they are taxed in a highly punitive manner. In order to avoid the punitive taxes, a timely election must be made to reduce the penalties. The elections available are:

  1. to record the income attributable to oneself in the current year; or,
  2. to mark the investment to market which results in the reporting of the unrealized gain on the fund in the current year.

This can easily result in paying taxes on this income in both Canada & the USA as the credits may not be available on a timely basis. However, failure to make any election places you in a situation where the taxes will be punitive. The best solution to the mutual fund problem would be to sell off all Canadian mutual funds by the end of the year and replace them with ordinary stocks and bonds.

These are some key investment vehicles and how they impact Americans in Canada. For further information or specific questions regarding your situation, please send us an email ( ) or make an appointment with our US tax specialists (1-888-877-2505).

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