TFSA (Canadian Tax-Free Savings Account) U.S. Taxation
Many Canadians invest in a Tax-Free Savings Account (TFSA), in which their investment primarily grows tax-free in Canada. Several Canadian financial institutions offer TFSAs, such as Royal Bank of Canada; Bank of Nova Scotia; Toronto-Dominion Bank; Canadian Imperial Bank of Commerce; and Bank of Montreal. Where Canadians often run into issues with their TFSA is if the Canadian person then becomes a U.S. Person for tax purposes, such as a U.S. citizen, lawful permanent resident, or foreign national who meets the substantial presence test. That is because even though there is a robust tax treaty between the United States and Canada, in general, a TFSA would not qualify for tax-exempt treatment in the United States –– even during the accrual phase where no income is being distributed (this is different than the federal tax treatment of RRSP and RRIF. Let’s review the basics of how a US person may be taxed on a TFSA investment — as well as the reporting requirements for the different IRS international information reporting forms such as FBAR and FATCA Form 8938 (and possibly PFIC Form 8621).
What is a TFSA (Tax-Free Savings Account)?
The TFSA is an investment vehicle in Canada, in which the investor typically has an opportunity to select the investments they want within their Tax-Free Savings Account — which may include items such as domestic or foreign stocks, bonds, mutual funds, ETFs, and even GICs. These underlying assets will determine the U.S. tax and reporting requirements.
Foreign Mutual Funds in a TFSA
Foreign Mutual Funds within a TFSA can lead to an unnecessarily complex tax scenario. For example, ownership of Foreign Mutual Funds within the TFSA could lead to the dreaded PFIC tax situation (Passive Foreign Investment Company) – which results in tax-deferred treatment during the growth phase, but then during the distribution time, taxpayers can end up paying significantly more than they would have paid if it was a U.S. mutual fund or ETF.
TFSA Foreign or Domestic Stock, Bond, or US Mutual Fund
In general, whether stocks are U.S.-based or foreign-based, accrued income will be taxed even during the growth phase. That is because the United States does not recognize a TFSA for tax deferral purposes –and therefore, even though the stock and bonds may be wrapped in a TFSA.
FBAR, FATCA & PFIC Reporting for Tax-Free Savings Accounts (TFSA)
Since technically the TFSA is a foreign financial account, it is reportable on one or more international information reporting forms, such as the FBAR (FinCEN Form 114) and FATCA (Form 8938). The FBAR and Form 8938 are not mutually exclusive from each other — and therefore taxpayers may be required to file the FBAR on both forms. If the foreign investment also contains items such as mutual funds, ETFs, or SICAVs, then the investment may become subject to Passive Foreign Investment Company reporting on Form 8621. While there are some potential exceptions and exclusions from reporting on Form 8621, they are limited.
Late Filing Penalties May Be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Current Year vs. Prior Year Non-Compliance
Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
Hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting can be overwhelming for Taxpayers trying to sift through the false information and nonsense they find in online research. Only a handful of attorneys worldwide are Board-Certified Tax Specialists who specialize exclusively in offshore disclosure and international tax amnesty reporting.
*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.
Contact our firm today for assistance.