Don’t ignore new U.S. RRSP tax laws, experts say

(July 8, 2003) Tax experts are warning Canadians with RRSPs who live in the United States not to ignore an upcoming filing deadline set by the Internal Revenue Service (IRS). Those who made contributions to or received distributions from an RRSP or RRIF in 2002 must file two complex forms — one six pages and the other four pages — by August 15, or face the possibility of a stiff penalty. The rule also applies to Americans with RRSPs living in Canada.

Failure to comply could result in three separate fines: 35% of the amount of the distribution, 35% of the contribution and 5% per year of gross assets in the account.

“The penalties are unbelievably severe,” says Jim Yager, treasurer of the American Chamber of Commerce in Canada and a partner in KPMG’s tax practice, who estimates that as many as 500,000 U.S. and Canadian citizens could be affected. “To be honest, I can’t imagine even a small fraction [of those people] complying with the rules,” Yager told Advisor.ca. “But the penalties are out there and there is potential exposure.”

Yager uses the example of a U.S. citizen who invested $10,000 in an RRSP on January 1, 2002, fails to file the necessary forms and withdraws the full amount at the end of 2006. The individual would be hit five times, he says, twice with 35% fines for failing to file on contributions and distributions, a 5% annual penalty on the total amount in the account, plus U.S. income tax on the distribution and interest charges.

“The total cost of U.S. taxes and penalties on the original $10,000 would be $13,917, even though no income was earned,” Yager says.

RRSP holders can apply for an exemption under the U.S./Canada income tax treaty so they do not have to file a return for contributions to the plan, only for distributions. “It’s important that people are aware of the filing requirements so they can at least make this treaty election or else file the tax return by August 15,” Yager explains.

Yager calls the new rules “onerous” and says the forms are unnecessarily complex. “If you have six accounts, you’d have to file 60 pages a year, which is crazy.” He says the system could easily be simplified and still provide the same level of monitoring the IRS requires. He recently led a delegation to Washington, accompanied by members of IFIC and the IDA, to lobby for just such a change.

“We met with both the IRS and the U.S. Treasury and they both agree these forms cause a lot of problems,” he says. “But they felt it was difficult to make changes before the August 15 deadline.”

The delegation presented simplified filing alternatives, which Yager believes will eventually be accepted. “They thought these were good ideas, they just need more time to evaluate them and this is probably not a high priority for them, even though it’s affecting a lot of Americans with RRSPs.”

How will this new law affect your client base? How will you approach clients it affects? Share your thoughts and strategies with your fellow advisors in the Talvest Town Hall on Advisor.ca.

Filed by Doug Watt, Advisor.ca, dwatt@advisor.ca