Are you an American living in Canada? If you are a US citizen, you have to file a US tax return every year, regardless of where you live.
Unfortunately, this has an impact on how you invest your money. The IRS requires you to report all the accounts you hold with over $10,000 USD, as well as special extra filings for Tax Free Savings Accounts (TFSAs), Registered Education Savings Plans (RESPs) and what are called Passive Foreign Investment Companies (or PFICs). I’ll explain each of these in turn.
Important documents
All US tax filers must file a Report of Foreign Bank and Financial Accounts each year. This report is commonly known as the FBAR. This report must show every financial account (bank or brokerage) that you have a financial interest in, or have authority to sign for, and that exceeded $10,000 USD at any point in the year. There is no tax associated with this filing, it is for information purposes only, primarily for the Financial Crimes Enforcement Network, which is part of the US Treasury Department.
If you haven’t filed these and should have, you can catch up your filings for past years. As long as you do this before the IRS comes knocking on your door. You have to provide a reasonable cause for the delay, but if you do, you likely won’t be penalized. If the IRS does determine that you wilfully failed to report, and comes chasing after you, the penalties can go as high as $100,000 USD or 50% of the value of the accounts that you didn’t disclose. You obviously don’t want to get caught on the wrong side of those penalties!1
On to TFSA and RESP accounts. As a US tax filer, you are not forbidden from holding these accounts. The problem is, you’ll likely lose most of the advantage of them because of the way the IRS treats them. The Canada-US Tax Treaty considers these accounts to be foreign Grantor Trusts. As such, you are required to file extra forms, forms 3520 and 3520-A, for each of these “trusts” when you file your US tax returns1. These forms are essentially mini tax returns, to report all the income generated inside these accounts. The IRS will tax the income you generate, which makes their tax-free nature in Canada a moot point. Even if you have enough foreign tax credits from your Canadian income tax return to cover the IRS tax generated by these accounts, it is still an onerous extra filing requirement on the part of your tax preparer. You’ll be paying a “tax” in the form of extra tax preparation costs! The recommendation then is not to hold these accounts if you are a US tax filer. If your spouse, or parents, or siblings are not US tax filers, maybe ask them to open the RESP for your kids and you provide the funds for it.
Finally, there is the thorny issue of Passive Foreign Investment Companies or PFICs. Any mutual fund, ETF or Real Estate Investment Trust issued in Canada will be considered a PFIC. If you hold one of these and file US taxes, you’ll have to fill out a form 8621, or an Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund3. Like for the TFSA and RESP, this form is a mini tax return for each and every PFIC you own. Many fund companies don’t even provide the information you need to fill this form out each year.
How do you hold a well diversified portfolio of low-cost index ETFs as a US tax filer?
There are a few options. First, your RRSP, LIRA or RRIF and LIF accounts can hold PFICs without having to file the form 8621 for each PFIC held inside them. That’s because the Canada-US Tax Treaty recognizes the tax deferred nature of these accounts. Second, for the investments you hold outside of an RRSP, LIRA, RIF or LIF account, you should choose from the many ETFs that are listed on the US stock exchanges. If the ETF trades in the US, you won’t have to file a PFIC election. Building a portfolio of US listed ETFs will mean slightly less tax efficiency on your Canadian tax return, and likely more US dollar exposure in your portfolio, but these are small prices to pay to avoid the complexity of the IRS filings you would otherwise have to produce.
So, to sum it all up, if you are a US tax filer, make sure to submit your FBAR every year, avoid holding TFSA or RESP accounts, and avoid PFICs in your non-registered accounts. Do all these things and your US tax preparer will thank you, and probably charge you a lot less
What type of investment situations have you run into as a non-Canadian citizen? Let me know in the comments below.
1 https://www.irs.gov/businesses/small-businesses-self-employed/report-of-foreign-bank-and-financial-accounts-fbar
2 https://www.irs.gov/forms-pubs/about-form-3520
3 https://www.irs.gov/instructions/i8621