Another TFSA question

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eortlund
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Joined: Tue Aug 07, 2007 12:18 pm

Another TFSA question

Post by eortlund »

I am thinking of opening TFSAs soon, and I ran across this article. http://www.investmentexecutive.com/clie ... 2&PageMem=

These two paragraphs brought up questions for me:

[i]In addition, U.S. citizens who hold TFSAs and RESPs would have to disclose their holdings in any of these plans annually to the IRS, adding yet another layer of paperwork for the U.S. citizen. In most cases, Ritchie says, it may not be in a client’s interest to hold one of these plans. However, it’s conceivable that a U.S. citizen could, over the years, have built up enough foreign tax credits to offset U.S. taxes due on the income generated in these plans, making them worthwhile to hold.

U.S. citizens should also avoid holding Canadian mutual funds and exchange-traded funds outside of registered plans, as they are regarded as passive foreign investment companies (PFICs) by the IRS. When a Canadian mutual fund or ETF is sold, any capital gains are taxed at a rate of 35%. As well, the U.S. considers the capital gain from a fund to have been deferred over the length of the ownership of the fund. Interest is then assessed on the gain, exacerbating the tax hit.[/i]

I understand that I would need to report the TFSA to the IRS as it says in the first paragraph, but my understanding from previous posts here is that I would report it as I currently do a regular bank savings account. I wouldn't have to go into detail as to what it is invested in, would I?

As for the second paragraph--we currently have our RRSPs invested with the RBC Canadian Dividend Fund. Would such a choice not be OK for a TFSA?
eortlund
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Joined: Tue Aug 07, 2007 12:18 pm

Post by eortlund »

And then from this related article at http://www.investmentexecutive.com/clie ... m=&nbNews=

"RESPs and TFSAs. U.S. authorities do not recognize the tax-deferred status of either the RESP or the tax-free savings account. That means U.S. citizens or green-card holders must declare all income generated in those plans on their U.S. tax returns. They must also file a U.S. IRS Form 3520 declaring the ownership of any RESPs or TFSAs, which the U.S. tax authorities consider non-resident foreign trusts. Failure to do so could generate fines."

A TFSA is also considered a foreign trust?? I haven't heard that before.
nelsona
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Post by nelsona »

Personally, I don't consider TFSAs a trust.

As to the tax treatment of funds held outside RRSPs, it CAN be as described above, but is not usually.
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eortlund
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Post by eortlund »

So, are you saying that in your opinion, I am unlikely to run into trouble if I report the TFSA as I would a savings account, and invest in whatever funds I like?

If it's going to end up being a hassle, perhaps I'll just try to pay extra toward our mortgage instead.
nelsona
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Post by nelsona »

No, I didn;t say "invest in what you like".

Only investments within an RRSP have the special protection of avoiding extra reporting.

If you have funds described in your initial post outside your RRSP, be it in an investment account, or a TFSA, you may have further reporting issues with respect to the actual investments you hold. Also, RESPs themselves, even if it is a simple savings account, must follow trust reporting.
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nelsona
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Post by nelsona »

TFSAs are being over-hyped right now by the banks.
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eortlund
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Post by eortlund »

Thanks--how would I know if I had extra reporting to do? Would I have to ask the IRS specifically?
nelsona
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Post by nelsona »

Is the investemt you hold a PFIC. Usually the individual company that you invest in knows. Trouble with mutual funds and etf's is that they may hold 100's of companies, some of which are PFIcs.

The IRS won't be able to anwer, your fundco will.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
eortlund
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Post by eortlund »

Thanks--good information.
bruce
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Post by bruce »

Sounds to me like these are some gray areas where the authors are taking pretty aggressive interpretations.

As for Canadian mutual funds and ETFs being considered PFICs, that sounds like a very aggressive interpretation doesn't it? All such funds distribute all their income on an annual basis and it seems to me that the number of companies within the fund that would be considered PFICs would be extremely small. For example, just look at the TSX 60 index. The vast majority of companies are inter-listed with the NYSE or NASDAQ. By market cap, it has to be well over 90% are inter-listed (and, therefore, by definition not PFICs). I suppose there could be a little PFIC exposure in there but probably rounding error.
nelsona
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Post by nelsona »

Good point. However, I'm sure you'd agree thta IRS often takes agressive positions, too.

Remember how they insisted for 2 years thta RRSPs were 3520 required, after they were considered exempt for YEARS.
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andied
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Post by andied »

"Good point. However, I'm sure you'd agree thta IRS often takes agressive positions, too."

I opened an TFSA early last year and when I got home from the bank, I read all the documents and there were several references to "Trustee" and "Declaration of Trust", and the prospect of saving a few tax dollars did not seem worth the hassle of filing form 3520 and/or risking the wrath of the IRS, so I immediately canceled the TFSA. I sleep better...
eortlund
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Post by eortlund »

Andied, I decided not to deal with it either at this point. Focusing on the RRSP and paying down the mortgage. I can now do both country's taxes independently so I don't want to have to pay someone to report a TFSA correctly.
bruce
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Post by bruce »

Hi Nelsona,

After re-reading this thread, I am very concerned about the notion that Canadian Funds/ETFs may be considered PFICs. I have done numerous searches on the internet and reviewed the few published opinions that I could find (including those quoted above by eortlund), and it seems that you are unfortunately in the minority among the experts.

Most of what I have read suggests that all foreign mutual funds (i.e. non-US) are considered PFICs by the IRS. It seems like the PFIC rules were written to discourage US taxpayers from investing in foreign funds of any kind. Plus, based on what you said above, any mutual fund could be "tainted" by a single holding of a PFIC. This means there is a very good chance that the IRS could nail a USC for holding a Canadian Fund/ETF if they wanted to.

(Believe me, I really want to believe your interpretation. I love the simplicity of mutual funds and ETFs and have immense respect for your knowledge. But it seems that the ramifications of being on the wrong side of a gray area are potentially catastrophic.)

If a USC holds a Canadian ETF over the long-term while assuming/thinking that it was not a PFIC and then sells in retirement, the potential liability could be absolutely huge! The capital gain could easily be several hundred percent and that gain gets pro-rated across each year the ETF was held. That gain is then taxed at the highest individual rate in effect for each year, and then interest charged all the way up until the sell date. With a ~40% tax on the gain plus years and years of compound interest, the math gets very ugly. Yikes!!! That would be a rude shock if a majority of somebody's retirement funds were taxed away upon sale. This is a very scary.

So with that fearful assessment in mind, here's my main question/dilemma: while an Canadian Index Fund/ETF is a very easy and cost effective way to save for the long-term in a taxable account, could this possibly be worth the risk?
nelsona
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Post by nelsona »

There is no evidence of this being a concern. if it becomes a concern, teh 2 countries will iron something out.
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