Roth IRA Withholding Tax - 1040NR

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patti
Posts: 66
Joined: Sun Apr 24, 2011 7:28 pm

Roth IRA Withholding Tax - 1040NR

Post by patti »

Here's the situation:
-Canadian citizen/resident
-Former US citizen that renounced... now a non-resident alien
-Roth IRA from time spent working in USA... deferral election filed with CRA after returning to Canada... no additional contributions made

Questions:
1) When it comes time for withdrawal (after age 59.5), I understand that the IRA custodian will withhold 15% per treaty (assuming W8-BEN on file). Is this amount recoverable by filing a 1040NR?

2) What happens if the funds are withdrawn before 59.5? Presumably there is a 10% penalty on the earnings. Is that withheld by the IRA custodian or is paid through the 1040NR filing?

Thanks.
nelsona
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Location: Nowhere, man

Post by nelsona »

1. It is not clear to me that -- if it is evident to the custodian that your withdrawl is a qualified one (ie. you have held the Roth for more than 5 years with that custodian) -- that any tax would be withheld after 59.5. But, if there were, it would be recoverable on 1040NR. If there was a taxable portion, it would be determined on 1040NR, and your refund would be reduced. You would also have to include that taxable portion on your Cdn return. There would be no early distribution penalty, since you would be 59.5 or older.

2. As above, except that the 10% would be withheld. of course, likley very little of the income would be subject to tax and early withdrawl penalty. Again, the taxable portion would be taxable in canada, and both the tax and penalty could be used as a credit on your CDn return.

I would strongly suggest taking that, if you feel you must take out funds before 59.5, that I would take the non-taxable portion (ie. the contributions) before 59.5, and the potentially non-taxable portion (ie. the 'gains') later.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
patti
Posts: 66
Joined: Sun Apr 24, 2011 7:28 pm

Post by patti »

Hi Nelsona,

Thanks for the response. Great advice!

For what it's worth, my understanding is that custodians are required to withhold 15% by virtue of the funds going to Canada (or 30% if it's going to a non-treaty country), regardless of whether the distribution is "qualified" or not. But I guess that's not a big worry, since it's at least recoverable by the 1040NR process.
nelsona
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Joined: Wed Oct 27, 2004 2:33 pm
Location: Nowhere, man

Post by nelsona »

On closer review, you are correct that the 15% Cdn rate would be withheld. And extra 10% would be withheld if earlier than 59.5.

You would then use forms 8606, 5329 and 1040NR to determine actual tax and recover any refund.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
rsargant
Posts: 155
Joined: Wed Jan 18, 2006 1:37 am

Post by rsargant »

Interesting discussion.

For Q1, shouldn't the fact that its a qualified withdrawal from a Roth IRA instead of a traditional IRA exempt it from withholding regardless of it going to a non-resident? I don't think its even possible to OWE tax on a Roth withdrawal after 59.5 so its silly to put everyone through the rigmarole of filing to get it back. I wouldn't put it past the "system" though :)

For Q2, If you withdraw before 59.5, my understanding is that the "ordering" is fixed by the IRS and goes

1) Direct Contributions
-Penalty & income tax free removal (any age)
2) Taxable portion of oldest roth conversion
-No income taxes (any age)
-Penalty free removal 5 years after conversion date (any age)
3) Non-taxable portion of oldest roth conversion
-Penalty & income tax free removal at any age
4) Repeat 2 & 3 for later roth conversions
5) Investment earnings
-Penalty and income tax free after 59.5.

The rules are hideously complex and require the Roth IRA owner to keep pretty good records to have a hope. Its not surprising the custodian would simply punt on withdrawals before 59.5 , apply the 15% rate, 10% penalty and let the tax payer figure it out.

One question I do have is wether non-residents are subject to the same ordering rules as residents.
nelsona
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Joined: Wed Oct 27, 2004 2:33 pm
Location: Nowhere, man

Post by nelsona »

The taxability of Roths is identical for residents and non-residents, including ordering rules.

However, I can confirm that there will be withholding if you are a non-resident. You will get it all or most of it back on 1040NR.
This is somewhat akin to the withholding that is forced on those selling their homes or former homes when non-resident in US or Canada.

It is possible to owe tax on Roth after 59.5, if for example, you only statrted a roth when you were 55 or older, you still have to wait 5 years.
There will never be any early withdrawal penalty after 59.5, but there can be some tax.
nelsona non grata. Non pro. Please Search previous posts, no situation is unique as you might think. Happy Browsing :D
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