401K Taxation Summary

[SM]

I did a lot of research on this by reading previous posts and want to make sure I understand this correctly. I hope this summary helps others. I understand that the rules changed in 2009 and 401K EMPLOYEE contributions are now deductible on the Canadian side and taxable on the Canadian side when they are withdrawn (just like a normal RRSP contribution would be).

Not a US citizen and let’s assume no growth for simplicity (I realize the growth is all taxable in both Canada and the US). From 2003-2005 was a US resident then moved to Canada and commuted to work from Canada to the US from 2006-2011. Assume employer/employee split is 50/50 for all contributions.

1) $10K employee, $10K employer from 2003-2005 ($60K total while US resident)
2) $10K employee, $10K employer from 2006-2008 ($60K total while Canadian resident pre-2009 changes)
3) $10K employee, $10K employer from 2009-2011 ($60K total while Canadian resident post-2009 changes)

From my calculations $180K (All of it) is taxable in the US and $150K is taxable in Canada. Is this correct? In summary, the only contributions that are not taxed on the Canadian side are the ones you didn’t get deductions for (or in other words already paid tax on) while you were a RESIDENT OF CANADA, correct? In this example, this would be the EMPLOYEE contributions from 2006-2008 (assuming you grossed them up on the T1 General in the applicable tax years).

I understand that CRA does not give the same special treatment that the IRS gives RRSP’s and all contributions made while a resident of the US must be taxed in Canada. I’m also aware that EMPLOYER 401K contributions do not show up on your W2 and therefore you don’t need to gross these up on the Canadian side (this is why they are taxable coming out – you haven’t paid tax on these yet). Does this sound about right or did I miss anything?

[nelsona]

Correct.

To simplify, you get to deduct from 401(k)/IRA income (exclude from taxable income) the contributions you made and reported on your T1. No need for convoluted example.

There is an order to follow as to when to exclude that portion, but I have not looked at this for some time. It matters.

In your example, if you have $30K of non-taxable 401(k)/IRA income, do you exclude it
(a) first,
(b) last, or
(c) pro-rated

I seem to think it is first, but I would have to check.

[nelsona]

Barring any discovery that I make, I would simply pro-rate, since this will give you the best "mesh" between the US and Cdn tax.
I would attacha note to your return, the first yeasr you take some income, explaining your method, and then wait for CRA to tell you otherwise.

The end result: getting $30K out without being taxed by CRA is the same; it's just the distribution of that $30K that is the question.

[SM]

Thanks so much for confirming!! Yes, now that you put it that way, that's all you really need to keep in mind. Thanks for the tip.

I'm glad you mentioned the part about the LIFO, FIFO or proportionate. After I posted this, I was wondering about this. I've read your other posts about how an RRSP is taxed on the US side when using form 8891. If I recall, I think it said you can use any option on the US side as long as you are consistent; but I can’t remember for sure (not that CRA follows the same rule anyway).

In practice have you ever heard of CRA asking the client for records to back up their claim that a portion is not taxable? If so, what did they ask for?

[nelsona]

they would ask for (or already have) your tax returns for the years you made a taxed contribution, since you must always submit a W-2 and 1040 when you have US income.

[SM]

Thanks again, you have been extremely helpful! One last question related to 401K's to get the complete picture.

As EMPLOYER contributions to a 401K do not show up on a W2, how do you figure out the employer contributions to calculate the pension adjustment on the Canadian side for form RC268. I realize that if the 401K is a defined benefit plan it’s 10% of your wages and if it’s a defined contribution plan it’s 100% of the employer contributions.

If it’s a defined benefit plan, this seems easy enough to calculate. It’s simply your wages on the W2 multiplied by 10%. Do your wages include the gross up for your contributions made to a 401K? I assume it must…

If it’s a defined contribution plan, how do you ever know how much the employer contributed? Do you have to check your 401k statements? Or I suppose once you know the employee/employer matching percentage (2:1, 1:1, etc) you can figure it out that way?

Any insight on this would be greatly appreciated.

[nelsona]

YOU know how much the employer contributed, if you need to use this value when computing PA. Everyone at your firm knows hoiw much the cpmapny matches.