The United States has enacted laws that require extensive disclosure of foreign items by U.S. taxpayers, and has authorized the Internal Revenue Service to impose harsh, even confiscatory penalties for failure to comply. This paper will discuss the more significant foreign items, with an emphasis on Canadian income and assets. The format for discussion will be a review of the relevant forms that are required to be filed or included with a U.S. Income Tax Return.
Form 1040 Schedule B
This is the schedule to report Interest and Dividend income. At the bottom of the form is a question about having an interest in a foreign bank account. If you have an interest in such an account and the question is not answered, the tax return is incomplete–an issue that could have significant future tax consequences.
Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts
This is not a schedule in your tax return, but a separate report to the United States Treasury Department. The report must be received by the Treasury Department by June 30, with no provision for extension of time for filing. There are harsh penalties for failure to comply.
If the maximum value of the sum of all of your foreign bank and financial accounts exceeds $10,000 during the year, you are required to file this form. Included in the definition of the relevant accounts is any account over which you have signature authority, including accounts you do not own, such as an account over which you are a trustee or which belong to your employer. Also included are brokerage accounts, Canadian registered accounts such as RRSP, RESP and TFSA (tax free savings) accounts.
Form 8938 Statement of Specified Foreign Financial Assets
Form 8938 is required if you meet the filing threshold. You meet the filing threshold if the total value of your specified Foreign Financial assets exceeds either the year-end value or maximum annual value. Those thresholds are:
|Filing Thresholds||Year-End||Annual Maximum|
|Unmarried or filing separately Living in the United States||$50,000||$75,000|
|Married or filing separately Living in the United States||$100,000||$150,000|
|Unmarried or Married filing separately Bona fide resident of a foreign country||$200,000||$300,000|
|Married filing jointly Bona fide resident of a foreign country||$400,000||$600,000|
The information on this form will probably duplicate the information reported on the Report of Foreign Bank and Financial Accounts. The Specified Foreign Financial Assets include:
Any financial account maintained by a foreign financial institution.
Other foreign financial assets, which include the following assets that are held for investment and not held in an account maintained by a financial institution
Stock or securities issued by someone other than a US person,
Any interest in a foreign entity, and
Any financial instrument or contract that has an issuer that is other than a US person
Form 3520 Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
Foreign trusts are a very complex area. If you have any transactions with a foreign trust–a transfer to, a distribution from, or are a named beneficiary, executor or trustee, you probably need to file this form. If you receive a gift or inheritance from a foreign person during the year in excess of $100,000, you must file this form.
A Canadian Registered Education Savings Plan is a foreign trust and therefore you must file this form for an interest in a RESP. The income earned in a RESP, while not taxable in Canada, is currently taxable in the US.
Because of the complexity of the foreign trust rules and the potential of unintended US income and estate tax results, we should discuss the issues before you take any action.
Form 3520-A Annual Information Return of Foreign Trust with a U.S. Owner
This is the return of the Trust reported on Form 3520. It is rather straight forward, except for interests in pooled accounts such as a RESP. The information for completing this form is not usually provided by the RESP, so the approach usually taken is to use the information available to prepare an incomplete return, making sure the account is “marked-to-market,” meaning that the change in value from the beginning of the year will be considered ordinary taxable income.
Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
A Passive Foreign Investment Corporation (PFIC) sounds esoteric, but is quite common. The intent of the PFIC rules is to prevent a taxpayer artificially deferring the taxation of current passive income through the use of a foreign investment company. Where the PFIC provides the relevant information, the income retains its character as it is currently taxed, and future capital gains tax treatment is preserved. Where the relevant information is not provided by the PFIC, the alternative is to use a “marked-to-market” approach to determine current taxable income, resulting in the loss of future capital gains treatment. If the issue is ignored, there is potentially confiscatory tax treatment.
Although there is no direct ruling on the matter, most commentators believe that a Canadian mutual fund is a PFIC. As these are not marketed to Americans, the detail is generally not available and the current income must be determined using the “marked to market” approach. This is a real issue with U.S. taxpayers who are Canadian residents.
Form 5471 Information Return of U.S. Persons with Respect to Certain Foreign Corporations
This is a complex form, but it primarily deals with holding 10% or more of a foreign corporation, changes in such ownership or service as a director or officer of the corporation. The form requires extensive financial information from the corporation and may result in current taxation to the US shareholder of certain passive income of the corporation. Penalties for failure to comply can be severe.
Form 8858 Information Return of U.S. Persons With Respect to Foreign Disregarded Entities
A disregarded entity is an entity such as a corporation or limited liability company that is disregarded for tax purposes and all of the income, deductions and credits are reported individually in the tax return of the owner(s). In the Canadian context, the only disregarded entity would be a Nova Scotia, Alberta or British Columbia Unlimited Liability Company.
Form 8865 Return of U.S. Persons With Respect to Certain Foreign Partnerships
This is the Partnership equivalent of Form 5471. It deals with holding a 10% or more interest in a foreign partnership, or changes in such ownership.
Form 8891 U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans
A Canadian RRSP or RRIF is not a qualified plan under U.S. tax rules. Therefore the default rule is that the income earned in the RRSP would be taxed currently in the US, and taxed when distributed by Canada–an undesirable situation that could result in double taxation. The Canada-United States Income Tax Treaty provides that a US taxpayer can elect to defer the taxation of the income of the RRSP until it is distributed. Form 8891 provides the means to comply with the treaty provisions to elect to defer the US taxation of the income earned within the RRSP.
Form 8891 is also used to report distributions from an RRSP or RRIF. To determine the US taxation of such distributions, it is necessary to determine the amount invested in the RRSP, and the value of the RRSP at the time you became a US resident if you are not a US citizen.