The Tax-Free Savings Account was introduced in Canada to allow qualified individuals (essentially Canadian residents over the age of 18 who have a valid Social Insurance Number ) to be able to earn income, tax-free, on cumulative contributions of up to $5,000 per year.  Unused Tax-Free Savings Account contribution room can be carried forward to future years and withdrawn contributions can be added to future contribution room.

The goal of Tax-Free Savings Account is to encourage Canadians to save on a tax-free basis.  The initial amount contributed as well as income earned in the plan is tax-free, even when it is withdrawn.  However, this is not the case for U.S. taxpayers (U.S. citizens and green card holders) resident in Canada.

The Tax-Free Savings Account has no special status under the U.S. Internal Revenue Code and there are no relieving provisions contained in the Canada-United States Income Tax Convention.  As such, U.S. taxpayers are taxable on any income earned in a Tax-Free Savings Account on a current year basis.  This taxable status eliminates the Tax-Free Savings Account benefits for most Canadian resident U.S. taxpayers.  In some cases, U.S. taxpayers with other investment income may have sufficient Canadian taxes that they will be able to shelter the potential U.S. tax on Tax-Free Savings Account Income with foreign tax credits.

Tax-Free Savings Accounts are generally offered as deposits, annuity contracts or trust type arrangements.  All of these products createU.S. reporting requirements, in addition to U.S. taxable income.

A Tax-Free Savings Account is a foreign financial account for purposes of reporting the account on a U.S. taxpayer’s form TD F 90-22.1.  “Report of Foreign Bank and Financial accounts” since the contributor has a direct financial interest in the plan.  The Report Foreign Bank and Financial accounts is due June 30th, following the end of the taxation year.  There is no ability to extend the due date of this form.  Failure to disclose the account can result in significant penalties.

The Internal Revenue Service may consider Tax-Free Savings Accounts to be foreign trusts.  If a U.S. taxpayer is an owner of a non-resident trust.  Form 3520-A.  “Annual Information Return of Foreign Trust with a U.S. Owner”, is required to be filed 2 ½ months after the trust’s year end.  Tax-Free Savings Accounts originated in 2009, so by now, the 2009 and 2010 form 3420-A are past their respective March 15, 2010 and 2011 deadlines.

An automatic extension can be obtained by filing Form 7004, “Application for Automatic Extension of Time to File Certain Business Income Tax, Information and Other Returns”, by the original due date.  The filing of this form extends the filing date from March 15th to October 15th.  These deadlines have also passed for the 2009 and 2010 years.

If a Tax-Free Savings Account is considered to be a foreign trust and Form 3520-A is not timely filed, the Internal Revenue Service can assess a penalty equal to the greater of $10,000 (U.S.) or 5% of the gross value of the Tax-Free Savings Account at the close of that tax year (the December 31st fair market value).  This yields a minimum penalty of $10,000 U.S. per year, double the maximum annual contribution amount.

In addition, Form 3520, “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts” may be required to report contributions and withdrawals from the Tax-Free Savings Account.  Form 3520 is due at the same time as a taxpayer’s personal tax return, including extensions.  Failure to file this form may result in a penalty equal to 35% of the amount of the contribution or of the withdrawal.

To date, there has been no official Internal Revenue Service position to abate the above-noted penalties where there was reasonable cause for the late filing.  While it would seem that there is reasonable cause with respect to Tax-Free Savings Accounts, one can never be sure.

U.S. taxpayers resident in Canada should consider withdrawing their Tax-Free Savings Account funds.  The withdrawal will not be taxable in Canada or the U.S. and will reinstate Tax-Free Savings Account contribution room for future years.  If the Internal Revenue Service relieves the taxation of Tax-Free Savings Accounts in the future, the renewed contribution room can be used efficiently.

Conclusion

If you want to explore how you can benefit from a Tax-Free Savings Account or if you have any questions with respect to your situation, please contact Joseph A. Truscott at 905 528-0234 x. 224 or e-mail Joe at:  [email protected]