Filing 3520/3520-a regarding REPS for the first time

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puzon23
Posts: 61
Joined: Fri Apr 02, 2010 9:04 pm

Filing 3520/3520-a regarding REPS for the first time

Post by puzon23 »

Hi All,

So I have been reading on this forum regarding the requirement to file form 3520/3520-a for RESP accounts.

I have read in some places that technically RESP is not a trust account and there is no official IRS position on this. Some people advise not to file 3520 forms at all but simply attach a letter to 1040 explaining the existence of the account and, of course, report all the income from it on 1040. Not sure that I want to take the risk here and have the IRS come down on me saying that I was supposed to file these forms...

So anyway, I think I'm going to bite the bullet and file the form(s) but I'm not 100% sure that I need to file them both. Last year I did not make a single contribution to the account nor did I receive a distribution from it. So all of the transactions happened inside the account where it grew by some percentage from dividends and capital gains.

Please correct me if I'm wrong but it seems to me that I do not have to file form 3520 at all since there was no contribution nor distribution. The only form I have to file for 2016 is 3520-a to report the account itself.

I will, of course, include my capital gain and dividend income on my 1040 and report the account for FBAR, that's a given.

So, please let me know if I'm correct in my thinking that 3520 DOES NOT have to be filed and only 3520-a has to be.

Thank you all for your time!
MGeorge
Posts: 313
Joined: Fri Jun 22, 2012 9:23 am
Location: Canada

Post by MGeorge »

Hi,

I think you do have to file form 3520. Simply owning a foreign trust triggers this obligation. It is also the filing of form 3520 which triggers the requirement to file 3520A since no RESP promoter will do this for you.
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MGeorge is neither an accounting nor taxation professional.
puzon23
Posts: 61
Joined: Fri Apr 02, 2010 9:04 pm

Post by puzon23 »

Hi MGeorge,

Thank you for your reply! I guess I will file both, oh well. It is what it is...

Now, the dreaded 8621 for PFIC... Does that have to be filed as well? From what I read I this forum and elsewhere it appears like I have to but maybe someone smarter than me thinks otherwise, I hope :)

To clear things up a bit... I moved to US in 2015 and I filed 1040NR for 2015. I thus became US resident for tax purposes in 2016 so this is going to be my first time doing all the typical 1040 stuff, FBAR, FATCA, etc, etc. I have RRSP (includes DPSP for me) for me and my wife but that should not require anything. My understanding is that I don't even have to do form 8891 anymore, just report it on FBAR.

The RESP currently has less than $35,000 CAD in it. There are three funds in it. The only transactions were interest and income distributions, all internal. There were no external contributions, nor external distributions. Overall the account gained about $4,000 CAD last year.

So again, 8621... yes, no? Or, file and do election but which one?

I will continue doing further reading on this but maybe someone can give me a hand here with above questions...

Thank you!
MGeorge
Posts: 313
Joined: Fri Jun 22, 2012 9:23 am
Location: Canada

Post by MGeorge »

Hi puzon23,

OK, so 3 mutual funds in your RESP. Have a look at the balance on Dec 31. Does this put you over $25,000 USD? The exchange rate to use is 0.7448 I believe. If all of the mutual funds that you own are less than $25k, then you might qualify for the "de-minimus" exemption.

Before I suggest making any election, are you planning on returning to Canada in the near future? (making a QEF or mark-to-market election can trigger the dreaded 39.6% tax and interest charge)

Don't sell your mutual funds (with $4k of gain built up) until you've worked out the best coarse of action. If you're returning to Canada in the future, you can sell them when you're not a US taxpayer. Selling causes tax pain!

Also, work out the gain in USD, using the exchange rate on the day you bought the fund units - maybe you don't have much of a gain in USD?

Cheers,
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MGeorge is neither an accounting nor taxation professional.
puzon23
Posts: 61
Joined: Fri Apr 02, 2010 9:04 pm

Post by puzon23 »

Hi MGeorge,

First of all, thank you very much for taking the time to answer my questions! :)

So to explain my situation further...

My 1040 would be a joint return with my wife and me. So I believe that the number I'm looking for is $50,000 threshold and not $25,000, correct? If so, I will not be even close to it this year and given the rate of growth inside the portfolio I should not hit $50,000 in the next few years.

Second thing is that currently my plan is to stay in US for several years possibly even as long as until my children could go to college which is about 10-15 years away. In that time the portfolio might hit $50,000.

Thirdly, there is a possibility that I could ask someone from my extended family to become the subscriber of the RESP who is not a US resident. This would make this whole thing go away completely I believe, including 3520 forms, FBAR, etc.

Assuming that the third option does not happen this year, what would be your suggestion and do I need to file 8621 still?

Thank you again!
MGeorge
Posts: 313
Joined: Fri Jun 22, 2012 9:23 am
Location: Canada

Post by MGeorge »

Hi puzon23,

OK, given the higher exemption of $50k, you could probably put off filing form 8621 for a few years, but you will have to file 8621 when you exceed the threshold, or you sell a fund for a gain. Also, if one of the fund makes a "higher than normal distribution" known as an excess distribution, this will trigger the requirement to file the form.

The problem with not filing 8621, is that your funds will be taxed under the default tax regime. I would encourage you to learn about the default "excess distribution regime". It is a combination with taxation at the highest marginal tax rate with an interest charge.

In the long term, you are most likely better off making one of the 2 other tax elections and this can only be done by filing form 8621 for each of the funds.

While living in the US, you should probably switch your RESP funds to US domiciled ETFs - these are not PFICs, and you can likely achieve the same asset mix. However, you can't contribute to an RESP while not living in Canada, and I'm pretty sure you can't place trades in it.

As you suggest, likely the best thing to do would be to ask a non US resident relative to take over the RESP. A grandparent of the beneficiaries can do this. Some caution though - I believe that transferring ownership of the RESP to a non US person will trigger a deemed disposition of the mutual funds (8621 would have to be filed). Any, if the transfer is bigger than the gift tax exemption it would be subject to gift taxes ($14k is the limit I think). Maybe you could spread this out over 2 years to avoid the gift tax hit. I'm not knowledgeable about gift taxes.

I hope this helps! Again - think before you sell your mutual funds. Triggering a gain is where the hurt begins...
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MGeorge is neither an accounting nor taxation professional.
MGeorge
Posts: 313
Joined: Fri Jun 22, 2012 9:23 am
Location: Canada

Post by MGeorge »

Me again.

Just a thought, since you're in the US, why don't you open a 529 plan (US plan similar to RESPs). You can fund it and invest in non PFICs while living in the US.
You could close your RESP and move the assets to the 529. you'd have to pay back the Canadian grants.

Becoming a non-resident of Canada is one of the few reasons you'd be allowed to collapse and RESP.
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MGeorge is neither an accounting nor taxation professional.
puzon23
Posts: 61
Joined: Fri Apr 02, 2010 9:04 pm

Post by puzon23 »

Hi MGeorge,

Thank you very much for taking the time to answer my post. From your answer it appears that I have a few options. To be frank the option of moving the RESP to another family member is very unlikely. Also, given the timeline to stay in the US and the burden to file all the forms, it seems that the best course of action is to collapse it.

With that, I have a couple of questions...

So when I collapse the RESP in Canada I will be charged 25% withholding tax just on interest and capital gains, not the contributions, correct? Then I would get some of it back by doing a foreign tax credit in US. Since it is a 25% withholding as far as I remember I would not even have to file a Canadian tax return for that but I might be wrong here.

However, what is the implication on the US side of things? When I collapse RESP what does that trigger with the IRS? I would assume capital gains tax but what would be the basis? Would my contributions be taxed as well? I'm assuming that I would have to do the forms 3520/3520-a and 8621 for that year.

And on top of it all... let's say that I go with that plan. What about this year? Do I simply not file 8621 since I don't have to because I'm under the threshold of $50,000? I would just simply file 3520/3520-a. Or, do I have to file 8621 and make one of the elections this year so when I collapse the RESP and do my tax return for it next year, I get some favorable treatment on my US tax return?

BTW, if you know of a good publication that I could read (in English and not lawyer/accountant English) then I would really appreciate it. And it would save you time answering any of my question since I'm pretty sure you have better things to do with your time. :)

Thank you again for all your help!
MGeorge
Posts: 313
Joined: Fri Jun 22, 2012 9:23 am
Location: Canada

Post by MGeorge »

Hi puzon23,

I agree, collapsing it is probably the best idea. The only reason I have an RESP is because I live in Canada and get the grants.

Regarding the Canadian tax on collapsing - I really don't know how this is done for non-residents. I believe you will get back all of your contributions tax free. The CESG grants will have to be repaid. The AIP (accumulated income payment), or the RESP's net increase in value will be taxed by Canada in some form. For a Canada resident - it is ordinary income tax + 20% of the gross AIP. For non-residents, I don't know.

On the US side - you will file a final year 3520/3520A pair with the "final return" box checked. You will have to file form 8621 since you will be selling mutual funds with a gain. You wouldn't need 8621 for any funds that were sold at a loss. Keep in mind gain/loss is defined in US dollars. You will only pay US tax on the income earning in the RESP - so mutual fund gains. You will not pay US tax on your contributions. Any grants received while you were a US resident will be taxable - but I hope this is $0 or very little since you shouldn't have been able to contribute while living in the US.

Your 8621 income (I assume all of your RESP holdings are PFICs) will get the 8621 default treatment. Your basis in the funds is your cost determined in USD while you were a resident of Canada. Unfortunately, I don't think your cost basis is stepped up to the fair market value when you became a US resident, but you should check this. I believe that PFICs don't get the basis step up.

Note - selling a PFIC for a gain means you have to file 8621, no matter what the value of your holdings. If you are selling right away, the 8621 elections won't make any difference, so don't worry too much about it. Step 1 should be figure out what USD gains your sitting on. 3 mutual funds right?

Cheers!
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MGeorge is neither an accounting nor taxation professional.
puzon23
Posts: 61
Joined: Fri Apr 02, 2010 9:04 pm

Post by puzon23 »

Hi,

Thank you for all the answers on this. I have one more question specifically regarding form 3520-a.

If there were no distributions to beneficiaries, do I have to include page 4, beneficiary statement?

I was thinking to include a blank page 4 and write at the top that no distributions were made in 2016 and this is included for completeness only and just sign the bottom.

What do you think?
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