Q: I was born in the U.S. but have lived in Canada since I was two. That makes me an American citizen who just happens to live in Canada in the eyes of the U.S. So, I have a lot of new tax reporting issues, which I have managed to comply with. My question is about my TFSA. I have about $45,000 in it, and have done well with my investment choices. I want to keep it, but I have heard from others in my situation that I am better off just closing it out. The accounting costs of reporting it are costly, and I may end up with a tax bill on the U.S. end for my “Tax-Free” savings account. Any insight?
A: Indeed, the U.S. does not consider a TFSA to be any special type of account for tax sheltering purposes, so from their perspective, it’s a regular investment account and the income earned would be investment income which, as a U.S. citizen, you must report to the IRS on your U.S. tax return. However, the precise nature of further reporting is unclear, as the IRS does not appear to have provided any guidance so far.
We know that TFSAs must not be reported by financial institutions to the IRS under the FATCA rules. However, while some tax practitioners believe the TFSA is not considered to be a foreign trust for personal tax reporting purposes, arguing that filing form 8858 is all that is required.
An excellent book on this subject is Canadians and the IRS by Angela Preteau, CPA, who is a partner with Frostiak and Leslie in Winnipeg. It would be an excellent investment for anyone in your situation, who is a U.S. citizen living in Canada. Angela differs in her opinion on required reporting: “I consider a TFSA to be a foreign trust under the U.S. rules so I recommend all my clients file Form 3520 and 3520-A,” she advises.
However, investors also need to carefully choose their investments as well, she warns. “Stay away from mutual funds unless you want to incur additional reporting and potentially double taxation. Use form 8621 under the PFIC (Passive Foreign Investment Company) rules.”
No doubt, being compliant will cost some money in terms of additional professional fees, but if the balance within the TFSA becomes significant, it will be well worth it. “If you maximize your TFSA contributions every year, it can be beneficial to have a TFSA even though you are a U.S. citizen,” says Angela.
Whether your TFSA is actually tax-free will depend on your other income. As a resident of Canada you’ll be reporting your income to Canada and paying income taxes on it, but without any regard to the income in the TFSA because here, of course, that income is tax exempt.
As a U.S. citizen, you’ll be reporting that same income, plus the TFSA income, on your U.S. tax return. You’ll qualify for some credits and exemptions and you may receive a credit on your U.S. return for some or all of the taxes paid to Canada on income that is reported in both countries (but this of course will not include the TFSA income). Depending on your other income sources, it is possible that your Canadian taxes would be more than the taxes on your U.S. return and, so in a roundabout way, your TFSA would remain tax free. This should become clear on the first U.S. return you filed including your TFSA income.
Evelyn Jacks is president of Knowledge Bureau, which offers e-learning at knowledgebureau.com. Evelyn tweets @evelynjacks and blogs at evelynjacks.com