Tax-Free Savings Accounts (TFSAs) for US Citizens: Consequences for American Expats in Canada
TFSAs for US citizens: what are they, and how will they affect your expat taxes? Read the information below before deciding whether or not American expats in Canada should contribute to a plan like this.
A Brief History of Tax Free Savings Accounts
The Tax-Free Savings Account (TFSA) was introduced in Canada in 2009 as a way for individuals who are 18 and older and who have a valid Social Insurance Number to set money aside—tax-free—throughout their lifetime. Contributions to a TFSA are not deductible for income tax purposes in Canada. Any amount contributed as well as any income earned in the account (for example, investment income and capital gains) is tax-free, even when it is withdrawn.
TFSA US Tax Treaty
Giant caveat: this is not the case for US taxpayers. A TFSA has no special status under the Internal Revenue Code, and there are no relieving provisions contained in the Canada-United States Tax Treaty (1980). As such, income earned in a Tax-Free Savings Account is not tax-free for American expats in Canada. The income should be reported on the US return and is subject to US taxes.
IRS Taxation of the TFSAs for American Expats in Canada
A TFSA is generally assumed to be a foreign trust for US tax purposes and thus necessitates the filing of Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520-A, Annual Information Return of Foreign Trust With a US Owner.
Deadlines and Penalties Associated with a TFSA for American Citizens in Canada
The due date for Form 3520-A is March 15. An automatic extension can be obtained by filing Form 7004, also known as the Application for Automatic Extension of Time To File Certain Business Income Tax, Information and Other Returns, by the original due date. The filing of this form extends the filing date from March 15 to September 15. If the Form 3520-A is not timely filed, the IRS can assess a penalty equal to the greater of $10,000 or 5% of the gross value of the TFSA at the close of that tax year (the December 31 fair market value). This yields a minimum penalty of $10,000 per year.
Form 3520 is due at the same time as a taxpayer’s personal tax return, including extensions. If the Form 3520 is not timely filed, the IRS can assess a penalty equal to the greater of $10,000 or 5% of the gross value of the TFSA at the close of that tax year (the December 31 fair market value) or 35% of the amount of the contribution or of the withdrawal. This yields a minimum penalty of $10,000 per year.
If the funds in the TFSA are invested in mutual funds or a similar regime, the TFSA owner has to report income from the PFIC (Passive Foreign Investment Company) and file Form 8621, also known as the Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, as if the taxpayer owned the PFIC directly.
A TFSA is a foreign financial account for purposes of reporting the account on a US taxpayer’s FinCEN Form 114, or FBAR, since the contributor has a direct financial interest in the plan. Failure to disclose the account can result in significant penalties. The TFSA is also a reporting requirement on FATCA Form 8938, also known as the Statement of Specified Foreign Financial Assets. Failure to disclose the account can also result in penalties.
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