US Taxation of Roth Overcontribution

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Fug1
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US Taxation of Roth Overcontribution

Post by Fug1 »

I'm a Canadian and former US resident. I moved back to Canada and relinquished my US green card in 2019.

Before I moved back to Canada in 2019, I contributed to my Roth IRA. When I went to file my 2019 USA returns, I found out that my final year return needed to be filed separately (as opposed to jointly with my wife), which meant that I was not eligible to contribute to a Roth in 2019. To correct this discrepancy, I filed a "Return of Excess Contribution" form with my broker to get my Roth contribution amount back. The broker then returned my 2019 Roth contribution plus a few hundred dollars in gains. The return of this money occurred in early 2020 before I filed my 2019 tax return.

Now I realize that I must need to claim the gains from this return of excess contribution as pension income on a US tax return. I'm just trying to understand the best way to go about this.

Should my broker have withheld tax on the gains, since I'm not a US resident? I did have a correct W-8BEN filed with them at the time, but they didn't apply withholding. If I contacted them about this, would they be able to apply withholding retroactively?

If I can't get the broker to apply withholding, I supposed I'll need to submit a 1040NR to the IRS. The amount of tax will end up being less than $100. Is there an shortened process that would apply for small amounts like this?

TIA!
nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

You need to file a 1040NR for the gains.
You also need to include this on your 2020 CDn return, since it is taxable pension income in US, it also is taxable pension income in Canada.
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nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

Can I ask why you determined that you had to file separately in 2019?
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nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

Was it due to being dual-status because of expatriation?
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Fug1
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Re: US Taxation of Roth Overcontribution

Post by Fug1 »

Yes, we had to file separately in 2019 because we were dual-status.

For anyone else this may affect, the IRS specifies this restriction here: https://www.irs.gov/individuals/interna ... tus-aliens.

Should our brokerage have applied withholding tax on the gains? We have traditional IRAs in the US, and when we eventually start to take distributions I'm hoping we can avoid filing a US tax return every year.

Thank you!
oakweather
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Re: US Taxation of Roth Overcontribution

Post by oakweather »

Another perfectly legal way to overcome this Roth overcontribution problem is to do something called the "backdoor Roth".

You contribute the money first into a traditional IRA (which may not be limited the same way as Roth is due to your filing status). Then you do a traditional-to-Roth conversion on the same amount (perhaps the following day after the nondeductible contribution). The IRS will allow you the Roth conversion amount despite the limitations imposed on Roth due to your filing status.

This will only work if you're not yet a Canadian resident at this point.

I am also not an official accountant and this is not actual accounting advice.
Fug1
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Re: US Taxation of Roth Overcontribution

Post by Fug1 »

@oakweather, that's a good point. That option did come up with my tax accountant, but I think they determined that the IRS would know it went straight to a Roth IRA and so it might not be able to re-classify the contribution under a Traditional IRA. And if the Roth conversion was determined to happen after expatriation, the CRA would now consider the entire Roth account taxable...the risk here wasn't worth trying the backdoor approach.
nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

The backdoor approach is well known, however it does not work once you are a Cdn resident for the reason mentioned above.
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Fug1
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Re: US Taxation of Roth Overcontribution

Post by Fug1 »

Since my brokerage didn't apply withholding tax on the gain of this distribution, I'm working on the 1040NR form.

The gain was a very small amount (~$500). Judging by the instructions for 1040NR/1040, it looks like my tax owed is $50 (10%).

Is this right? I was expecting I would owe 15%, but perhaps the 15% is just the upper limit on how much tax would be owed to the IRS based on this line in the Canada-USA tax treaty:

Article XVIII.2a) pensions may also be taxed in the Contracting State in which they arise and according to the laws of that State; but if a resident of the other Contracting State is the beneficial owner of a periodic pension payment, the tax so charged shall not exceed 15 per cent of the gross amount of such payment

TIA!
nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

For most US pension income youy can choose that it be effectively connected (page 1 income) or NEC income (flat rate on the NEC table). You coose which is best.
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Fug1
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Re: US Taxation of Roth Overcontribution

Post by Fug1 »

That's great info, thank you very much.

So it sounds like I can consider this effectively connected income and use the standard 1040 tax table. In my case, that yields a tax rate of 10%.

If I needed to claim the maximum treaty rate (15%), I would use Schedule NEC and put this income under the 15% column. Is that right?
nelsona
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Re: US Taxation of Roth Overcontribution

Post by nelsona »

Correct.
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