The IRS estimates as many as 20,000 people will benefit
For U.S. citizens and residents, participation in Canadian pension plans has been a tax headache. Under U.S. law, a citizen or resident of the United States is subject to current income tax on the accrued income from a Canadian pension plan. This includes accrued income from a registered pension plan (RPP), registered retirement income fund (RRIF), registered retirement savings plan (RRSP), or deferred profit sharing plan (DPSP) even though the income has not yet been distributed.
Under Canadian law these plans are not subject to income tax until the income is actually distributed. This situation creates a potential “mismatch” in the timing of U.S. and Canadian income taxes. As a result, some individuals have been subject to double taxation on their accrued income, with no relief available.
To prevent this timing mismatch, the United States’ Internal Revenue Service (IRS) has recently issued Revenue Procedure (Rev. Proc.) 2002-23, under Article XVIII(7) of the U.S. – Canada Income Tax Convention (the Tax Treaty) enabling affected individuals to elect to defer U.S. income tax on the accrued income in an eligible Canadian retirement plan until the plan’s funds are actually distributed.
The new procedures
Rev. Proc. 2002-23 applies to taxation years on or after Dec. 31, 2001. For taxation years before Dec. 31, 2001 and beginning on or after Jan. 1, 1996, affected individuals may elect to apply under either Rev. Proc. 2002-23 or Rev. Proc.89-45.
The IRS estimates that as many as 20,000 people may elect to defer U.S. income tax using Rev. Proc. 2002-23. Previously, Rev. Proc. 89-45 provided affected individuals with only limited relief.
Former Article XXIX(5) of the Tax Treaty permitted a U.S. citizen, who was also a resident of Canada with an RRSP, to elect to defer U.S. taxation on the accrued income until its distribution from the RRSP, “or any plan substituted therefor.” These rules were set out in Rev. Proc. 89-45. In addition, Revenue Ruling 89-95 provided that if the RRSP funds were transferred into a RRIF, the RRIF would be considered a substituted plan. The transferred funds along with any income accrued inside the RRIF would, therefore, also qualify for a tax deferral until the funds were distributed.
On March 17, 1995, a Protocol signed between Canada and the U.S. added Article XVIII(7) to the Tax Treaty, replacing Article XXIX(5) and permitting an individual who is either a citizen or a resident of the U.S. and who is the beneficiary of an eligible Canadian plan (RRSP, RRIF, RPP or a DPSP) to elect to defer U.S. taxation on the income accrued in the plan until the time and to the extent that a distribution is made by the plan or any substituted plan.
Article XVIII(7) expands upon Article XXIX(5) in several ways. First, it eliminates any timing issues, because it applies regardless of whether or not the individual was a Canadian resident at the time the contributions were made to the eligible plan. Second, it now includes U.S. residents with eligible Canadian plans and not just U.S. citizens. Further, Article XVIII(7) now includes not just an RRSP, but also a RPP, DPSP or RRIF as eligible plans.
What employees need to do
To defer the tax on accrued income under the new Rev. Proc. 2002-23, the beneficiary of an eligible plan makes the election by attaching a statement to a “timely filed (including extensions)” United States federal income tax return for the current taxation year. The statement must include the following:
•a statement that the beneficiary taxpayer is claiming the election under Rev. Proc. 2002-23, which applies Article XVIII(7) of the Tax Treaty;
•the name of the plan’s trustee and its account number, if any; and
•the balance in the plan at the beginning of the current year.
Once the election is made, it cannot be revoked except with the consent of the IRS Commissioner.
Each subsequent year, until the year in which the distribution from the plan is made, the beneficiary must attach a copy of the statement to his U.S. federal income tax return.
If the proceeds are rolled over to another eligible plan (which does not result in the imposition of Canadian income tax), the previous election is deemed to carry over to the transferee plan.
Along with a copy of the transferor plan’s original statement, the beneficiary must attach an additional statement to his/her income tax return in the year of transfer. The additional statement includes the following:
•a statement that the beneficiary taxpayer is claiming the election under Rev. Proc. 2002-23, which applies Article XVIII(7) of the Tax Treaty;
•the name of the transferee plan’s trustee and its account number, if any;
•the name of the transferor plan’s trustee and its account number, if any;
•the total amount of accrued income in the transferor plan on which U.S. income tax was deferred under either Article XVIII(7) or former Article XXIX(5); and
•the initial balance in the transferee plan.
The beneficiary must attach copies of the transferor plan’s original statement and the transferee plan’s additional statement to his U.S. federal income tax return each year until the year in which the distribution from the transferee plan is made. A separate election and a separate statement must be filed for each eligible plan for each subsequent taxation year until the year of distribution.
Neil Cohen is a Toronto-based research lawyer with Watson Wyatt’s Canadian Research and Information Centre. He can be reached at (416) 943-6081 or [email protected].
Under Canadian law these plans are not subject to income tax until the income is actually distributed. This situation creates a potential “mismatch” in the timing of U.S. and Canadian income taxes. As a result, some individuals have been subject to double taxation on their accrued income, with no relief available.
To prevent this timing mismatch, the United States’ Internal Revenue Service (IRS) has recently issued Revenue Procedure (Rev. Proc.) 2002-23, under Article XVIII(7) of the U.S. – Canada Income Tax Convention (the Tax Treaty) enabling affected individuals to elect to defer U.S. income tax on the accrued income in an eligible Canadian retirement plan until the plan’s funds are actually distributed.
The new procedures
Rev. Proc. 2002-23 applies to taxation years on or after Dec. 31, 2001. For taxation years before Dec. 31, 2001 and beginning on or after Jan. 1, 1996, affected individuals may elect to apply under either Rev. Proc. 2002-23 or Rev. Proc.89-45.
The IRS estimates that as many as 20,000 people may elect to defer U.S. income tax using Rev. Proc. 2002-23. Previously, Rev. Proc. 89-45 provided affected individuals with only limited relief.
Former Article XXIX(5) of the Tax Treaty permitted a U.S. citizen, who was also a resident of Canada with an RRSP, to elect to defer U.S. taxation on the accrued income until its distribution from the RRSP, “or any plan substituted therefor.” These rules were set out in Rev. Proc. 89-45. In addition, Revenue Ruling 89-95 provided that if the RRSP funds were transferred into a RRIF, the RRIF would be considered a substituted plan. The transferred funds along with any income accrued inside the RRIF would, therefore, also qualify for a tax deferral until the funds were distributed.
On March 17, 1995, a Protocol signed between Canada and the U.S. added Article XVIII(7) to the Tax Treaty, replacing Article XXIX(5) and permitting an individual who is either a citizen or a resident of the U.S. and who is the beneficiary of an eligible Canadian plan (RRSP, RRIF, RPP or a DPSP) to elect to defer U.S. taxation on the income accrued in the plan until the time and to the extent that a distribution is made by the plan or any substituted plan.
Article XVIII(7) expands upon Article XXIX(5) in several ways. First, it eliminates any timing issues, because it applies regardless of whether or not the individual was a Canadian resident at the time the contributions were made to the eligible plan. Second, it now includes U.S. residents with eligible Canadian plans and not just U.S. citizens. Further, Article XVIII(7) now includes not just an RRSP, but also a RPP, DPSP or RRIF as eligible plans.
What employees need to do
To defer the tax on accrued income under the new Rev. Proc. 2002-23, the beneficiary of an eligible plan makes the election by attaching a statement to a “timely filed (including extensions)” United States federal income tax return for the current taxation year. The statement must include the following:
•a statement that the beneficiary taxpayer is claiming the election under Rev. Proc. 2002-23, which applies Article XVIII(7) of the Tax Treaty;
•the name of the plan’s trustee and its account number, if any; and
•the balance in the plan at the beginning of the current year.
Once the election is made, it cannot be revoked except with the consent of the IRS Commissioner.
Each subsequent year, until the year in which the distribution from the plan is made, the beneficiary must attach a copy of the statement to his U.S. federal income tax return.
If the proceeds are rolled over to another eligible plan (which does not result in the imposition of Canadian income tax), the previous election is deemed to carry over to the transferee plan.
Along with a copy of the transferor plan’s original statement, the beneficiary must attach an additional statement to his/her income tax return in the year of transfer. The additional statement includes the following:
•a statement that the beneficiary taxpayer is claiming the election under Rev. Proc. 2002-23, which applies Article XVIII(7) of the Tax Treaty;
•the name of the transferee plan’s trustee and its account number, if any;
•the name of the transferor plan’s trustee and its account number, if any;
•the total amount of accrued income in the transferor plan on which U.S. income tax was deferred under either Article XVIII(7) or former Article XXIX(5); and
•the initial balance in the transferee plan.
The beneficiary must attach copies of the transferor plan’s original statement and the transferee plan’s additional statement to his U.S. federal income tax return each year until the year in which the distribution from the transferee plan is made. A separate election and a separate statement must be filed for each eligible plan for each subsequent taxation year until the year of distribution.
Neil Cohen is a Toronto-based research lawyer with Watson Wyatt’s Canadian Research and Information Centre. He can be reached at (416) 943-6081 or [email protected].
