(April 6, 2005) U.S. taxpayers who own an RRSP or an RRIF are getting a little bit of help with their tax filing requirements this year. The U.S. Internal Revenue Service (IRS) released a new tax form for reporting Canadian registered retirement accounts to replace older onerous reporting requirements. The catch is filling out the new forms properly to avoid being charged tax on income generated by supposedly sheltered retirement assets. April 15 is the deadline for filing U.S. tax returns.

The new form 8891, also known as the U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, replaces older forms 3520 and 3520a that required transaction reporting and annual information on investment returns. The change also clarifies nearly two years of changing positions and vague direction on the matter from the IRS.

Watson Wyatt Worldwide pension lawyer James Pierlot says the older forms were designed to ensure everyone benefiting from an offshore trust fully disclosed where the trust was located, the income and distributions it generated, contributions made to the trust and which assets were held in the offshore account. “You were required to essentially disclose everything possible about these trusts,” he says. “There were very significant penalties if you failed to comply with those reporting requirements.”

The process however, could sometimes take up to 100 hours to complete. “They were spectacularly unsuited to RRSPs and RRIFs. They were never really intended to apply to those, but legally, they did.”

In the last two years, he says the IRS position changed while it was developing the new forms. During that time, the IRS said filing form 3520 alone with only minimal information like a client’s name and social insurance number was sufficient unless the client was asked for more information. “It was all very vague and a little bit disturbing for the 800,000 people living in the States who have an RRSP or an RRIF,” says Pierlot.

The new form is simpler, but wording in the innocuous two-page document hides an easy mistake that can result in a huge bill for clients who own an RRSP but owe taxes to Uncle Sam.

In most cases, clients who wish to defer U.S. income tax on undistributed plan earnings need to make an election under Article XVIII(7) of the U.S. Canada income tax treaty. To do so, clients need to fill out the form stating they are either the beneficiary of the plan rather than an annuitant receiving distributions from the plan. Although nearly the same definition applies to both words, beneficiaries are able to fill out subsequent sections of the form and make an election to defer taxes on their RRSP earnings while annuitants are directed to another section of the form.

“If you put money into your RRSP and you make interest or capital gains or dividend income, it’s not taxed in Canada. The tax treaty allows for you to get that same tax treatment when you’re living in the United States as a U.S. taxpayer,” says Pierlot. “What really does matter is to make the election. You don’t get the benefit of the treaty unless you claim it — it’s not automatic.”

Filed by Kate McCaffery Advisor.ca, kate.mccaffery@advisor.rogers.com

(04/06/05)