How TFSA (Canadian Tax-Free Savings Account) is Taxed in US

How TFSA (Canadian Tax-Free Savings Account) is Taxed in the US

TFSA (Canadian Tax-Free Savings Account) U.S. Taxation

Many Canadians invest in a vehicle referred in Canada referred to as a Tax-Free Savings Account (TFSA). As the name connotes, in Canada this type of investment account grows tax-free — presuming that the assets qualify as “qualified assets” — or else the portion that is not considered qualified could become subject to tax. Most of the major financial institutions in Canada such as Royal Bank of Canada; Bank of Nova Scotia; Toronto-Dominion Bank; Canadian Imperial Bank of Commerce, and Bank of Montreal offer these types of TFSA products. But, if a Canadian person then becomes a US Person, it can get much more complicated from a US tax perspective 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 phase in which income is accruing but not being distributed (which is different than RRSP and RRIF tax Treatment, at least at the Federal Level). Let’s go through some of 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 bonds, mutual funds, and even GICs. Depending on what the type of underlying assets will impact the tax and reporting requirements in the U.S.

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 double to triple what they would’ve paid if it was a US mutual fund.

TFSA Foreign or Domestic Stock, Bond, or US Mutual Fund

In general, whether stocks are US-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 similar to an RRSP or RRIF  for tax deferral purposes –and therefore even though the stock and bonds may be wrapped in a TFSA, they would still presumably be taxable unless the taxpayer was to make a treaty election if they qualify.  

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 or 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. There are some potential exceptions and exclusions from reporting on 8621, but they are limited.  In addition, the Internal Revenue Service does not require duplicative reporting of the same asset on Form 8938 and Form 8621— although if the taxpayer has multiple types of investments and categories of investments (RRSP, RRIF, Investment Accounts, etc.) — both forms may still be required. While the failure to report these accounts may result in significant fines and penalties, the Internal Revenue Service has developed various amnesty programs to assist taxpayers with safely getting into compliance with a reduced penalty, or even a complete penalty waiver.

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