Q I lived and worked in the U.S. from 2000-2008 and accumulated some money in a 401K retirement savings plan during this time. I returned to Toronto in 2008, but the 401K was left in the U.S. I’ve decided to move all of the funds from the U.S. account into my RRSP for 2017 and made a full withdrawal of the 401K earlier this year. Will I need to file U.S. taxes with the withdrawal? I have read that a foreigner is not required to file for U.S. tax for this type of withdrawal if this is the only transaction for the year since the 15% withholding tax has already been applied.
My second question is regarding the 10% early withdrawal penalty. I was under the age of 59 when I withdrew the 401K money. However, I don’t see the 10% early withdrawal penalty on the statement. Do I need to include that amount in the U.S. tax filing if I do need to file?
A Adam, there is good news and bad news on your situation. The bad news is that yes, you need to file a U.S. tax return and pay both income tax and the 10% penalty for early withdrawal of your U.S. retirement account unless you meet one of the exceptions to the penalty.
The 10% penalty is accounted for on your tax return, not by the payor of your 401K. You should have a social security number (SSN) from the time you worked in the U.S. and this is the number the plan administrator needs in order to provide you with a U.S. tax slip showing the amount distributed and the taxes withheld.
If you did not have an SSN but had an Individual Taxpayer Identification Number (ITIN) instead, you will still provide this number to the plan administrator for the tax slip, but when you file your U.S. taxes, you will most likely need to renew your number by including a Form W-7 and appropriate identification documents along with your tax return.
The other issue is that the 15% tax treaty rate only applies to periodic pension distributions. Since this was a lump sum withdrawal, depending on the amount of your U.S. income, you will pay more or less than the 15% rate, plus the 10% penalty.
Canada will also tax the money, but they will provide you with a credit for taxes paid to the IRS, which will include the penalty. This credit will be calculated based on the percentage of U.S. income versus the amount of your world income on your T1 General. It is not just a straight dollar for dollar credit.
If you have any other concerns, it’s worth consulting with a cross-border tax lawyer near you to get more clarity on your individual situation.
Cleo Hamel is a senior tax expert with American Expat Taxes in Calgary
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