Taxation of US pension for Canadian resident

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rlb
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Taxation of US pension for Canadian resident

Post by rlb »

I am a dual US/Canadian citizen, now residing once again in Canada after many years in the US. I am (and will be) filing both US and Canada income tax returns (also up to date on FBAR). Most of my income is from a US company pension from work in the US, supplemented by withdrawal(s) from IRA's. My questions concern taxation of pension income by the US:

(1) My understanding is that the income tax rate on a corporate pension is limited by treaty to a maximum of 15% by the US for a Canadian resident. The full amount is also included in Canadian income, with a Canadian tax credit equal to the US taxes paid, as long as they do not exceed the treaty rate (15%). Is this correct?

(2) Does this apply only to the corporate pension, or also to IRA withdrawals? If not to the IRA withdrawals, then are they considered US source, so that the US gets first call on the tax so to speak (may end up being taxed at more than 15%)?

(3) How does one calculate the proper US tax so that the 15% rate is not exceeded on the pension income? Does one add the pension income as marginal income or are there special forms? For example, if I had $60,000 in pension income, but in 2011 made a large IRA withdrawal (let's say $100,000 though I'm sure I won't do that), my average tax rate will exceed 15% so how do I ensure that the $60,000 part is taxed only at 15% max?

My wife is in the same situation, except with no pension income, just IRA withdrawals plus a little investment income.

Thanks for any help.
nelsona
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Post by nelsona »

1/2) since you are a US citizen, no such limit on taxation exists. You will include the income on your 1040 and calculate tax, with no foreign tax credit. It should still come out less than 15%. in BIG years it will bemore.

You will use the tax on your Cdn return.

The treaty by and large does not apply to you.
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rlb
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Post by rlb »

Would I then proceed as follows?

(1) Figure out US tax return on pension and IRA withdrawals, keeping back Canadian source investment income.

(2) Figure out Canadian tax on all income, with a tax credit for the US tax on pension and IRA withdrawals.

(3) Perform a final pass on US tax return now including all income (adding in investment income), but giving a foreign tax credit on the Canadian source (investment) income calculated as:
(investment income) / (total income) * Canadian taxes paid
(i.e., use average Canadian tax rate applied only to investment income)

That still doesn't seem right somehow, since the Canadian marginal tax rate on the investment income would be much higher than the average rate after US credit.

Knowing this will help me get withholding amounts and estimated tax payments in the right ballpark even though I may use professionals for the returns.
nelsona
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Post by nelsona »

You would first prepare FULL Cdn and US returns without foreign tax credits (but using foreign earned income exclusion if that is your option), not holding back any income. The portion of US tax attributable to your US-sourced income is then determined at that stage. So is the portion of Cdn tax attributable to your Cdn-source income.
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Herleston
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Post by Herleston »

Us taxation will apply if you are a pensioner but resident in Canada. You have to maintain your tax record.You will be entitled to tax credit and tax deductions as well.But once you have not submitted your tax liability report then there will be tax deductions.
rlb
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Post by rlb »

nelsona, I have a new wrinkle this year (see your first response in this thread, back in 2011). As background, I am still a US citizen (dual actually), and resident in Canada.

This year my effective US tax rate is 15.6%. As best I can understand, because I am a US citizen, treaty section XVIII 2(a) holding US pension income to a 15% tax by the US, is overruled by section XXIX 2(a) which basically says the US can tax its citizens to whatever extent it wishes regardless of residence. (XXIX 2(a) is limited by the exceptions in 3(a), but pension income is not one of the exceptions.) So I have to pay the full 15.6% to the US on the pension income, as you said in your prior answer to me.

I would think that in this case, I should be able to get a foreign tax credit (FTC) in Canada for the full 15.6% levied by the US. However, section XXIV 4 might allow the CRA to argue that I should get only get the 15% FTC, because that is all the US could tax me if I were not a US citizen.

So can I get the 15.6% FTC in Canada, perhaps because of the Non-Discrimination clause? As a side note, uFile limits me to a 15% FTC on US pension taxes, regardless of citizenship; is there a way to override this if I should be getting 15.6%? (Or I could use TurboTax, which does allow it to be set manually.)
nelsona
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Post by nelsona »

No, canada will only give you 15%. I guess you had a really good year to have such a high effective tax.
So, cliam the 0.6% as a decution on your return (it used to be 256 its another one in that reon now), and claim as muchg pension as you need on a re-sourced 1116 in order to rediuce the US tax on that income to 15%. There is a form in the 1116 guide that explainms re-sourcing procedure.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
rlb
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Post by rlb »

nelsona - Yes, it wasn't that I had such a good year, but that I made a large IRA withdrawal just to get some of that money up here to Canada, and that plus my more moderate pension put me over the 15% effective tax rate.

I have followed your advice and studied how to fix the Canada return and add the re-sourced FTC to the US return.

But advice please: I had actually already filed (electronically) for both US and Canada, the returns have been accepted (Notice of Asessment received for Canada), and my wife and I have received refunds and/or paid tax due in both countries. It was a few days after that when I discovered I might have done things incorrectly, and you have verified that it was incorrect, and what should have been done. Would you then recommend that I contact the CRA about filing a corrected return, and also file an amended return for the US? Basically, I need to pay Canada about $800 more and get it back from the US.

And would my amended US return need a form 8833?
nelsona
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Post by nelsona »

Since CRA is the one that will be asking for more money (and since they accepted your return, there would be no back-interst or penalty, if they change theior mind), I would simply leave it until CRA asks for it. They are the ones that have to interpret treaty matters.

To bad your IRA had not been a Roth. You probably ended up apying more tax on the withdrawal than you saved in taxes when you contributed. Did you have early withdrawal penalty too?
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
rlb
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Post by rlb »

The source of the IRA was employer contributions to a 401(k), which I rolled over to an IRA before we left the US to return to Canada. So I didn't actually save anything on taxes, since I did not contribute to it. It was not really touchable until I retired. No, there is no penalty (I was 62 in 2013).

The IRA derived from the 401(k) was too large to convert to a Roth, as it would have put us in a high tax bracket at conversion, higher than now when I take some out. I probably could have converted part of it though, but that is now a lost opportunity.
nelsona
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Post by nelsona »

I'm thinking more of Roth401(k) at the time of contribution. So, your 401(K) was completely funded by the employer? as you say, Employer-funded can't be a Roth.

by the way, I wonder if Ufile would have limited your FTC if you were reporting US-source wages, since these are not limited by regulation nor treaty.Cdn

The hard 15% limit technically only applies to inteerst dividends and royalties and is a Cdn regulation, not a treaty limit. Of course the treaty establishes even lower limits for these, as well as treaty-defined 15% limit for US-sourced pensions.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
rlb
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Post by rlb »

Actually, the 401(k) was funded by 50/50 contributions from me and from my employer (they were generous in those days, I think the match is 50% now.) Due to some wrinkles in the formula, I had a small after-tax basis in the plans, which I had withdrawn a few years before rolling it over to an IRA.

To satisfy your curiousity and mine, I added USD 50,000 of phantom employment income to the return to see what uFile would do. It clearly separated the employment income form the pension and IRA income, and allowed the full 15.6% credit on the employment income, but held the credit on the pension income to 15%.

Re the 15% hard limit -- this is the way I read it (though I know you are far more experienced with the treaty than I):

(A) Firstly, XVII 2(a) says that pensions sourced in the US will be taxed at 15% by the US if the recipient is a Canadian resident.
(B) Secondly, XXIV 4(a) says that in the case where the Canadian resident is a US citizen, the tax credit it allows for the US tax need not (I note it says "need not" rather than "will not") exceed the tax the US is allowed to levy on a non-US citizen, which by (A) is 15%.
(C) Thirdly, XXIX 2(a) says that, aside from the exceptions in XXIX 3, the US can tax its citizens in Canada as it pleases, regardless of the treaty, including point (A) above. The exceptions in XXIX 3 list quite a few areas where the treaty does override this, but XVII 2 is deliberately left out. So it appears pensions are one area (other than Roth) where the US takes its full cut even if it is more than 15%.
(D) It looks as though it is XXIV 4(b) (right after the stuff in (B) above), that says the US will allow me to get a credit in the US for the Canadian tax on the pension which is beyond the allowable amount of 15% specified by 4(a). (Well, no more than the US tax that would otherwise be payable, 15.6%; in other words, a credit for the 0.6% since the Canadians already gave me credit for the 15%.) I use the re-sourcing procedure to achieve this.

When you mentioned "... only applies to interest, dividends and royalities ...", I think you were referring to the immediate next section of XXIV, i.e. section 5, which explicitly mentions exactly these. However, it seems to me that the chain of arguments above pretty much does the same thing for pensions too.

Whew!
DonMurphyCanada
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Post by DonMurphyCanada »

Hi rlb,

can you cite a reference (link) to the document your reading please?
rlb
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Joined: Thu Feb 17, 2011 8:51 pm
Location: NB, Canada

Post by rlb »

It's the Canada-US Consolidated Tax Treaty (including the Fifth Protocol). You can see an html version on the CRA web site: http://www.fin.gc.ca/treaties-conventions/usa_-eng.asp

A nice pdf version to save is here: http://www.garygauvin.com/resources.htm
nelsona
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Post by nelsona »

going thru each of your points.

(A) the treaty only protect PERIODIC pensions. However US has chosen to tax all pension withdrawals bty Cdns at 15%. That is why Canada can tax RRSPs for US residents at 25% or any other amount they choose.
(B) Correct. US pensions fal under XXIV.4
(C) correct
(D) correct. US credits you 0.6% and Canafa credits you 15. note that the limit is by treaty, not the "hard limit" on the other 3 types of income

XXIV.5, which applies to interest, dividends and royalities, has the extra twist of giving a deduction on your Cdn return AS WELL AS the re-sourcing on the US return. XXIV.4 does not. But that provision will only stay in effect while Canada maintains that hard limit. However because US interest is zero taxed in US for non-residents, you get NONE of it in Canada. It should however, if you have such income, give you (say in your case) .6% as a deduction, while US gives you the 15.6% credit.

It would be nice if all denied credit would give you the deduction in Canada plus the credit in US, but it is only the amount over 15% on those three types of US-source income.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
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