Live in US, work in CAN, RRSP distribution tax

[cullen]

Thanks in advance to Nelson or anyone else who can help untangle this.

I have new client that lives in a US border town. She has worked the last 10 years for a Canadian employer and contributied to RRSP's. On their US tax returns they have included the RRSP contribution amount in computation of total income. Now that she is retiring and beginning to take distributions, they have a double taxation issue as the distributions will now be taxable on the CAN side, and taxable (or excluded) on the US side. In any event, the tax has already been paid to the US and now will be paid again on distribution to CAN.

What is the best solution for this? Correct me if I am wrong - In my reasearch, it seems that we can amend the US return 10 years back (for foreign tax issues), claiming treaty protection under article XXV (non-discrimination), excluding the amounts in each of those years. That would make the current distribution tax sequence equitable - taxable in CAN, and eligile for the FTC on the US side.

In coming to this solution, something seems amiss beacuse the reverse situation - A CAN resident working in the US - would require one to claim any 401K contributions as income for CAN tax purposes, On subsequent distribution, how would 2x taxation be avoided once the US tax is paid on the distribution in retirement?

[cullen]

I addition, I realize that the proposed changes to the US -CAN tax treaty address this issue, but how do we solve it now?

[nelsona]

She was not discriminated against, so XXV does not apply. She was not unfairly taxed by canada as an American. And she was not unfairly taxed as an American by IRS.

Nice try though.

The cross-border issue was known (Cdns face EXACTLY the same problem with 401(K)) and only the treaty could fix it. That is why until the treaty is fixed, all cross-border types have consistently advised AGAINST doing exactly what she did.

Her only remedy: Her contributions made while a US citizen, since they were not deducted from her US income, become her 'investment' in the plan, much like undeducted IRA contributions.

Thus if she contributed $100,000 (her OWN contribution), that portion will not be taxed in US. If say today, she has $400,000, and she takes $10,000 out, $10K will be taxed in canada (at 15%) and she will be taxed on $7500 (reprted on 16b) in US (and can use the 15% tax as FTC). That is the simplest way.

Of course, she would have been compliant with all the RRSP reporting rules over the last 10 years, so her RRSP data is readily available to you.

She can also avail herself of the "General Rule" which would bump up her investment in the plan somewhat. a US acct you should be more familiar with that.

But, bottom line, only the portion that was included as income will not be taxed by IRS. Not quiter remoavl of double taxation, but, that should have been known going in.

The exact same solution exists for Cdns who worked in US while living in canada and contributed to 401(K). A Cdn DOES currently have to report 4019k) contributions as income in canada, and will get to deduct this from the taxable portion of any future withdrawal.

[nelsona]

... btw, the new treaty does NOT really solve this particulr problem, since it applies only to employer-sponsored plans.

If, after the treaty is amended, a person funds their own RRSP, nothing in the new treaty fixes this.

Same for self-funded IRAs.