IRA withdrawal

[randyb]

Facts:
I am a US & CDN citizen living in Canada.

I have 100k in an IRA I contributed & deducted before moving to Canada and becoming a citizen.

I am 48 years old.

Question:
What are the US & Cdn tax implications of withdrawing all of the IRA?

If there are penalties in the US for the withdrawal, would these penalties qualify for a foreign tax credit in Canada?

[nelsona]

US: Any withdrawal is included as income on your 1040. Any of the withdrawal that cannot be exempted from the 10% early withdrawl (which would be for certain expenses incurred in the year of the withdrawal, or some other expenses very close to the time of the withdrawal) would be penalized at 10%. You should be looking at the qualified distributions that are exempt from the penalty, to do some tax planning. Any exemption from penalty does not mean exemption from income tax on the entire withdrawal

Canada: The entire withdrawl is taxable. The final US tax, along with the penalty, is eligible towards the tax credit calculations, first federally , then the remainer provincially.

The early withdrawal 'penalty' is really just a tax; CRA doesn't include true penalties in foreign tax credit, but this would be penalties for failure to pay tax, or interest on unpaid tax and the like, not early withdrawal.

<i>nelsona non grata... and non pro</i>

[randyb]

Thank you Nelson,

Due to the fact that the Cdn taxes are at least 10% higher than the US taxes for my income tax bracket, the penalty is really a non-issue as the penalty will qualify for full foreign tax credit to offset my Cdn taxes.

Do I understand you correctly?

Regards,
Randy

[nelsona]

Your penalty will be fully eligible.

However, the way that foreign tax credits are calculated, whereby the foreign income is taxed at your marginal rate, but the credit is given at your effective rate, may yield some unused US tax even when the US tax 'rate' is lower than the Cdn one.

Its a numbers game.

Still, it is good to reduce the US tax as much as possible.

<i>nelsona non grata... and non pro</i>

[cullen]

Nelson:

In repsonse to an old post

It was my understanding that the CRA takes the stance that the 10% penalty for an early withdraw from your IRA is not an "income and profits tax and not eligible for the foreign tax credit.

[nelsona]

No. This is not correct. The early withdrawl tax is not a 'penalty' (like for non-filing for example) which CRA does not accept.

The 10% early withdrawl tax counts towards foreign tax credit (even the treaty would force this if there were some CDn reg against it -- which there is not).

[Carson]

No. This is not correct. The early withdrawl tax is not a 'penalty' (like for non-filing for example) which CRA does not accept.

The 10% early withdrawl tax counts towards foreign tax credit (even the treaty would force this if there were some CDn reg against it -- which there is not).

I have to agree with Nelson. I have certainly read in the past that some tax commentators have said that the "penalty" is not creditable. But in fact, the penalty is called a tax on the 1040. It is shown in the "Other Taxes" section on page 2 of the 1040. All of the terminology that I have seen in the IRS materials refers to it as a "tax". From my research for this very issue for a client recently, I don't think CRA can deny it as tax paid.

CRH

[Mark T Serbinski CA CPA]

The IRA early withdrawal penalty is NOT eligible for a foreign tax credit, nor as a deduction from income.

"A U.S. taxpayer may contribute to an individual retirement account, (“IRAâ€￾) which in some respects is similar to a registered retirement savings plan. Where funds are withdrawn before the individual reaches the age of 59 1/2, a tax for early withdrawal is levied under the Internal Revenue Code. An additional U.S. Excess Retirement Distributions Excise Tax can also be levied where an individual makes an excess withdrawal from an IRA.

Revenue Canada is of the view that the tax for early withdrawal or on an excessive withdrawal would not be an income or profits tax under 126(7)(c). Consequently, a Canadian taxpayer who received a taxable amount from an IRA, would not be able to claim a foreign tax credit under subsection 126(1) or a deduction under subsection 20(12) in respect of the tax paid. "

Technical Interpretation, Reorganizations and Foreign Division
May 19, 1993
Income Tax Act: 20(12); 126(1); 126(7)
CCRA File Number: 9304595

[nelsona]

In an October 2002 Information session conducted bty CRA adressing specifically the issue of a lump-sum withdrawals from IRA subsequently deposited in an RRSP, it was concluded that the Double taxation relief provisions of the treaty protected Cdns from being double taxed on the first withdrawal, and then subsequent withdrawal from the RRSP, by allowing that ALL taxes incurred by the lump-sum withdrawal would be eligible for foreign tax credit calculation.

I will admit that this does not address the specific issue of a simple IRA lump-sum withdrawal, but this would easily be solved by putting the proceeeds of the IRA in an RRSP momentarily.

It would thus appear that CRA has adjusted their view of the early withdrawl tax.

[Mark T Serbinski CA CPA]

Hmmm.

What is an eligible "Tax"?

From above:

"Revenue Canada is of the view that the tax for early withdrawal or on an excessive withdrawal would not be an income or profits tax "

[nelsona]

I can only reprt what is current indusrty and CRA practice.

The scheme of transferring IRA to RRSP has been carefully analyzed by CRA and has its blessing, including the use of ALL US tax to replace Cdn tax on Cdn-source income -- THAT is the only way this strategy makes any sense, and that's why it has been carefully gone over by CRA and cross-border types.

[Figs]

Just to let everybody know -- I have recently seen the CRA deny a foreign tax credit for the 10% penalty on early withdrawal from an IRA. The CRA stated that this is a penalty and does not qualify as a foreign non-business income tax.

[nelsona]

That's too bad.

I thought based on the discussions with CRA in 2003 that they were going to stop that. I know some have gotten credit for it. But this may have been strictly in the context of the IRA to RRSP transfer mechanism.

Perhaps that for straight IRA withdrawals, CRA does not accept the penalty.

[napstolean]

A year later, is there consensus on CRA's treatment of the 10% IRS early withdrawal penalty on 401Ks and IRAs? And if there is still an "out" by putting the proceeds from an early withdrawal of an IRA into an RSP?

(I've searched the boards for "IRA" hoping to find an answer with no luck; apologies if this has been dealt with elsewhere.)

I'd be happy to keep my IRA in the US (CDN citizen; worked in US for several years, built up IRAs and 401Ks; moved back to Canada; many years to go before retiring) but now that US brokerages (I use(d) ML and Schwab) now seem to treat all foreigners as terrorists and won't let me make changes to holdings or asset allocations, and it's probably not wise to keep current holdings for 30+ years - at some point the tax is nothing compared to the risk of a "locked-in" portfolio.

Thanks!

[nelsona]

Consensus is that the 10% is NOT creditable, which would make the whole transfer procedure (unless you are over 60) a waste in my opinion, unless you are facing frozen accounts.