Canadian inheriting traditional IRA

[formerpatriot]

What happens when a Canadian citizen (living in Canada) inherits a traditional IRA from a US relative?
Are there tax-advantageous ways to proceed?

[nelsona]

If you leave the IRA intact, you will be taxed on the withdrawals in US (15%) and you will also report the income in Canada (with credit given for the US tax). The IRA MUST be collapsed in 10 years.
If you take the IRA as a lump-sum, the US tax becomes 25%.

[formerpatriot]

Thank you nelsona.
The US relative is my mother-in-law who recently passed away.
She actually has 2 IRAs, one at Vanguard and one at T. Rowe Price.
My wife and her 3 siblings are equal-parts beneficiaries.
The 3 siblings are US citizens living in the US.
My wife is a Canadian citizen. She renounced her US citizenship a few years ago.
She (my wife) has a 401k at TIAA. We are hoping that TIAA will allow her to open an Inherited IRA.
We would then transfer the IRA from TRP and Vanguard to TIAA.

[formerpatriot]

Thank you nelsona.
The US relative is my mother-in-law who recently passed away.
She actually has 2 IRAs, one at Vanguard and one at T. Rowe Price.
My wife and her 3 siblings are equal-parts beneficiaries.
The 3 siblings are US citizens living in the US.
My wife is a Canadian citizen. She renounced her US citizenship a few years ago.
She (my wife) has a 401k at TIAA. We are hoping that TIAA will allow her to open an Inherited IRA.
We would then transfer the IRA from TRP and Vanguard to TIAA.

[formerpatriot]

Is it true that as a non-US person receiving only Social Security and distributions/withdrawals from an Inherited IRA (with 15% withholding), my wife would not be required to file a tax return with the IRS?

[nelsona]

Maybe. Non-residents with Non-effectively connected (NEC) that are being withheld correctly need not file a 1040NR. IRA income can be treated as non-connected. That applies to ALL non-residents.
However, when it comes to Social security, one *might* have to file a 1040NR (at least schedule OI) to actually claim the treaty benefit which makes SS only taxable in Canada for Cdn residents ONLY.
Since she would be filing MFS statsu, there is no income threshold below which she would not have to report.

[formerpatriot]

One more question.
If the IRA is collapsed and paid as a lump sum, you said that the withholding tax (for the IRS) would be 25%.
Can the beneficiary get a foreign tax credit for the full 25% when they file their Canadian tax return or is the foreign tax credit limited to 15%?
If it is limited to 15%, can the beneficiary file a 1040-NR and reduce the tax paid to the IRS from 25% to 15%?
Thank you.

[nelsona]

The credit would not be limited

[trobinson]

Getting this credit can be administratively challenging. I had a client where 30% was withheld at source and claimed the 30% as a FTC. CRA denied the FTC by indicating that the 15% rate applied. CRA indicated they would only accept the 30% rate if the IRS denied a refund request in writing.

I filed a 1040NR for the client claiming the 15% rate. In the 8833 I explicitly indicated that the distribution was a lump-sum and was not periodic and was being claimed for the purpose of demonstrating entitlement to the foreign tax credit in Canada. To my surprise IRS allowed the claim and paid the refund.

This process is really frustrating, however I don't really blame CRA for imposing this process as it netted the Canadian fisc a pile of extra tax dollars that the IRS just left on the table.

[formerpatriot]

Update:
T Rowe Price is withholding 30% for the IRS and is sending us a check for the remaining 70%.
I argued for 15%. They said that the 15% rate is for periodic withdrawals only.
They said that for a full distribution the tax treaty calls for 30%.

Steps to come:
Next Spring I will claim a FTC for the whole 30% that was withheld.
If CRA refuses, I will try to do as trobinson described in the previous post.

[nelsona]

Just for clarity, the treaty is silent on non-periodic withdrawals, meaning the IRS (30%) and CRA (25%) decide their own non-resident withholding rate.

[formerpatriot]

Thank you nelsona for the correction.

[sk8man]

You'll face US taxes and Canadian taxes on the funds. The US will likely impose a withholding tax, and Canada will tax you on the income. To minimize tax impact, you might want to transfer the IRA to an account that suits Canadian tax rules or consider rolling it into a similar account with tax deferral options.

[ND]

trobonson re "To my surprise IRS allowed the claim and paid the refund."
That's not what happened. IRS processed the return and issued the refund. Until years pass, you will not know if IRS 'allowed' the claim. A famous example of this is a woman who filed a slavery repatriation tax credit of $1,000,000, rec'd and spent it, then IRS came knocking asking for it back along with interest and penalty. The Code doesn't contain any such credit.