This article by Marsha Laine Dungog, Jennifer Silvius and Jonathan Garbutt was originally published in Tax Notes on October 17, 2022.

In this article, the authors consider the use of Canadian registered plans (the Canadian tax-free savings account and the retirement compensation arrangement) by U.S. persons working in Canada and whether those plans should be treated as foreign trusts in the United States, arguing that the United States should provide clear administrative guidance on the U.S. tax treatment of such plans. This article is one in a series of proposals sponsored by the California Lawyers Association Taxation Section and presented to various policymakers and government officials. The comments in it reflect the individual views of the authors who prepared them and do not represent the position of the California Lawyers Association.

* * *

The ongoing pandemic has made mobility a necessity for many families and professionals around the world. Cross-border migrations between the United States and other countries are usually wrought with tax complexities. These migrations are particularly complex when foreign retirement and savings plans are maintained by an individual relocating to the United States or by a U.S. expatriate returning home after many years. The competitive advantage of the United States regarding trade and commerce is being silently eroded by adverse U.S. tax classification and treatment of these foreign retirement, pension, and savings plans that benefit U.S. persons (USPs). Many have opted to renounce U.S. citizenship to preserve the financial wealth they have accrued abroad, and those who have achieved professional success in the United States resort to terminating their lawful U.S. permanent resident status and return to their home countries to discontinue the extraterritorial reach of U.S. tax laws after they depart the United States.

The U.S. taxation of contributions, accruals, and distributions from foreign pensions and retirement plans (collectively, foreign plans) owned by USPs remains a controversial area of U.S. tax law that requires definitive guidance as the number of USPs residing outside the United States is large and steadily increasing. Complexity arises in part because foreign plans often do not fit squarely with the types of plans available to USPs living in the United States. Until the U.S. tax classification and treatment of such foreign plans are addressed by Congress or the Department of the Treasury, annual U.S. tax reporting of foreign pensions remains fraught with proverbial "traps for the unwary." In the absence of conclusive guidance from federal tax authorities, many tax practitioners have resorted to reporting foreign plans owned by USPs (directly and beneficially) as either IRC section 402(b) nonexempt employees' trusts, which are not subject to disclosure on Form 3520 and Form 3520-A under IRC section 6048, or as foreign grantor trusts under IRC sections 671-679. These entities are also subject to reporting on the foreign bank account report as required by the Foreign Account Tax Compliance Act. This repetitive reporting increases the administrative burden on USPs living abroad and U.S. taxpayers living in the United States who have a beneficial interest in these accounts. The annual reporting, enforcement, and collection of information, taxes, and penalties on these accounts places additional strain on IRS resources with no corresponding increase in the revenue generated.

It is no secret that many U.S. executives and athletes have pursued more lucrative careers just across the border in Canada during the pandemic. Being employed in Canada means active participation in the robust Canadian retirement and savings environment that offers more opportunities for an individual to maximize retirement savings during the most profitable years of their career. However, the favorable tax treatment of Canadian retirement and savings plans do not extend beyond Canada's borders. U.S. tax laws do not provide any definitive guidance on the treatment of Canadian tax-free savings accounts (TFSAs) and retirement compensation arrangements (RCAs). As foreign trusts, TFSAs and RCAs would be subject to annual information reporting under IRC section 6048, which is made by filing Form 3520, "Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts," and Form 3520-A, "Annual Information Return of Foreign Trust With a U.S. Owner."

However, there is no consensus among cross-border tax practitioners on whether these two plans should be subject to any foreign trust reporting. On one hand, a TFSA is functionally more similar to a Roth IRA, which is taxed under IRC section 408A, than it is to a traditional trust taxed under subchapter J of the IRC. A Roth IRA is not subject to any Canadian taxation as long as no contributions are made to the Roth IRA while the USP is a resident of Canada. On the other hand, the RCA has no direct U.S. equivalent. This type of arrangement is structured to encourage athletes and executives to work in Canada by (1) reducing the amount of Canadian-source compensation income that would be subject to Canadian ordinary tax rates; and (2) allocating a portion of such individual's Canadian-source earnings to a Canadian trust that generates no taxable income. In the rare case an RCA does generate taxable income, it will be highly taxed in Canada and consequently not subject to U.S. tax after the application of foreign tax credits for Canadian taxes paid on such amounts. Similarly, in retirement, the distributions from RCAs will be taxed in Canada at ordinary income rates, which are likely to result in no U.S. tax payable under relief that is provided under the Canada-U.S. income tax convention and protocols (the tax treaty).1

For Canadian tax purposes, the TFSA is a tax-deferred Canadian registered plan initially intended to provide additional retirement savings to individuals already benefiting from Canadian registered retirement plans. It is primarily a contract between a subscriber and a financial institution that will hold the TFSA on behalf of the subscriber. Under the agreement, the subscriber contributes a maximum of C $6,000 per year in after-tax dollars to the TFSA. The subscriber's contribution may earn income inside the plan without any current taxation on such accruals. Canadian income tax is also not triggered when distributions are made by the financial institution to the subscriber. The TFSA is very similar to a U.S. Roth IRA when the USP takes a qualified distribution.2 There are some subtle differences between the two plans (there is no income threshold as a condition for eligibility to contribute to a TFSA, unused contributions may be carried forward to future years, and TFSA funds may be withdrawn without penalty); however, these differences could be mitigated by providing an exemption from trust reporting until a distribution is made under the plan.

Canadian RCAs also are intended to provide additional retirement savings for cross-border athletes and executives. It is a contract between an individual (the holder) and a participating financial institution (the custodian) under which the holder or their employer makes contributions to an RCA trust. These contributions are deductible from the income of the respective contributor, but all contributions are subject to a 50 percent refundable tax at the time of contribution. Moreover, any income earned in the RCA is also subject to a 50 percent refundable tax in the year such income is earned in the RCA. No tax is paid by the holder until benefits are received at retirement, but all such distributions are subject to tax in Canada. The refundable 50 percent tax imposed on contributions and earnings are then refunded to the RCA trust at a rate of C $1 for every C $2 distributed until the refundable tax has been entirely repaid.

Contributions to an RCA may not exceed the amount required to fund retirement benefits based on the generally accepted guidelines for pensions, equal to about 70 percent of pre-retirement income for an employee with 35 years of service for a defined benefit plan.3 Failure to follow the generally accepted guidelines increases the risk that the Canada Revenue Agency could deem the RCA not to be an RCA but rather a salary deferral arrangement with additional substantial tax and penalties payable.4 To ensure the RCA continues to qualify under the CRA's generally accepted guidelines, the involvement of a qualified actuary may be required. There are substantial Canadian tax compliance obligations imposed on RCAs; the custodian must apply for and obtain both a contribution account number before any contributions are made and a distribution account number before any distributions are made. The distributions are also subject to withholding by the custodian and subsequent reporting to the CRA.

Because of the absence of specific administrative guidance on the U.S. tax treatment and reporting of TFSAs and RCAs, these foreign plans have been subject to inconsistent tax treatment by tax practitioners and USPs. Many USPs and their tax advisers do not view these plans as subject to disclosure. Some view the plans as foreign employees' trusts under IRC section 402(b) that are exempt from disclosure on Form 3520 and Form 3520-A. Others report the plans as foreign grantor trusts and file forms 3520 and 3520-A each year. Because enforcement against foreign entities can be difficult, U.S. tax laws make the USP accountable for filing and liable for any taxes and/or penalties on such filings or for a failure to file. However, these penalties apply inconsistently because of divergent reporting approaches. The civil penalties imposed on inaccurate and untimely filed foreign trust reporting under IRC section 6677 are substantial. Therefore, the USP donor/contributor or USP beneficiary faces a very high risk of incurring penalties for failing to correctly report an interest in a TFSA or RCA in any given year. This issue is particularly problematic, not because of the low annual contribution limits on the TFSA, but because of the potentially substantial carryforward of unused contributions to future years.

The accurate and timely filing of forms 3520 and 3520-A was one of six additional international compliance campaigns rolled out by the Large Business and International Division5 on May 18, 2018. Although this campaign has ended, the impact of the Form 3520/Form 3520-A campaign on USPs abroad and in the United States continues to be perpetuated with a flurry of IRS notices issued to taxpayers assessing IRC section 6677 civil penalties for failure to comply with IRC section 6048 reporting requirements regarding foreign trusts. Because the statute of limitations for assessing IRC section 6677(a) and (b) penalties ends three years after a complete and accurate Form 3520/Form 3520-A is filed, the statute of limitations may remain open indefinitely. Foreign retirement, pension, and savings accounts (including Canadian TFSAs and RCAs) are within the category of foreign trusts that are subject to Form 3520/Form 3520-A filing and therefore are subject to penalties for failure to timely file.

Treasury regulations promulgated under IRC section 6048 require grantors of foreign trusts and beneficiaries of foreign grantor trusts to file Form 3520 (in the case of an ordinary transfer to the trust) and Form 3520-A (foreign grantors) to report their activities and interest. We propose that TFSAs be exempt from annual foreign trust reporting under IRC section 6048 until withdrawals or distributions are received by a USP, similar to reporting requirements for Canadian registered retirement savings plans (RRSPs), registered retirement income funds (RRIFs),6 registered education savings plans (RESPs), and registered disability savings plans (RDSPs).7

Exempting TFSAs from annual foreign trust requirements also alleviates administrative burdens and costs for the foreign trust reporting program. TFSAs usually have small balances, but they are subject to substantial civil penalties for inaccurate or untimely filed forms 3520 and 3250-A, in addition to FBAR disclosure. However, the potential for TFSAs to carry substantial balances is far from remote because the TFSA regime provides for unused contributions to be carried forward to future years. This fact, combined with the ability of a USP taxpayer to exercise discretion and control over TFSA investments, as well as withdraw amounts from the TFSA for any reason without penalty, would support continued foreign trust reporting obligations for USP account holders of TFSAs in the year withdrawals or distributions are made.

Although more significant amounts are involved for RCAs than for TFSAs, such amounts are subject to a substantial 50 percent tax on contributions and 50 percent tax on earnings in Canada. Withdrawals and distributions can be made only after the employee reaches retirement, and such amounts would be taxed at ordinary rates. Therefore, it would be unlikely that a USP would avoid payment of U.S. taxes on RCA amounts on distribution. We believe that USPs' compliance burden and the IRS's administrative burden can be relieved if the foreign trust reporting exemption available for IRC section 402(b) plans is extended to RCAs. Foreign trusts that constitute IRC section 402(b) nonqualified deferred compensation trusts are exempted from this tax filing requirement under IRC section 6048(a)(3)(B)(ii). These provisions state that contributions made to a nonqualified foreign trust under a plan that provides for pensions, profit-sharing, stock bonus, sickness, accident, unemployment welfare, and similar benefits, or a combination of such contributions, are not required to be reported under IRC section 6048. Consequently, a USP beneficiary of a Canadian RCA should have no affirmative obligation to file Form 3520 until withdrawals or distributions are made by the RCA trust to the USP beneficiary.

We recommend that regulations under IRC section 6048 be amended, or further administrative guidance be issued, to clarify the annual foreign trust reporting requirements for Canadian TFSAs and RCAs on Form 3520 and Form 3520-A.

Click here to continue reading . . .


1. Convention between the United States and Canada with respect to Taxes on Income and Capital, signed on Sept. 26, 1980, as amended by protocols signed June 14, 1983, Mar. 28, 1984, Mar. 17, 1995, July 29, 1997, and Sept. 21, 2007.

2. IRC section 408A(d).

3. See Jack Bernstein, "RCA Planning," 6(9) Canadian Tax Highlights 70-71 (1998); David Harding and Kevin Dunphy, "Individual Pension Plan," 2018 St. John's Tax Seminar 5:1-10 (2018).

4. We note that if this reclassification for Canada Revenue Agency purposes were to occur, there would be Canadian income tax consequences, which will have a corresponding effect on the U.S. taxable income reported by the USP taxpayer. However, this will likely be resolved through the application of FTCs.

5. IRS, "IRS Announces the Identification and Selection of Six Large Business and International Compliance Campaigns" (May 21, 2018).

6. See Rev. Proc. 89-45, 1989-2 C.B. 596, superseded by Rev. Proc. 2002-23, 2002-1 C.B. 744.; Rev. Proc. 2014-55, 2014-44 IRB 753, at section 2, subparagraph.01.

7. See Rev. Proc. 2020-17, 2020-12 IRB 539.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.