3 exceptions for deducting cross-border retirement plan contributions

Unfortunately for cross-border clients, Canada and the U.S. generally do not allow taxpayers to deduct contributions made to a retirement plan in the other country from their taxable income. There are, however, three exceptions.

These three exceptions became effective in 2009 as part of the Fifth Protocol of the Canada-U.S. Tax Treaty. The changes benefit three categories of people:

• workers on short-term cross-border assignments;
• cross-border commuters; and
• U.S. citizens living and working in Canada.

In all three categories, the changes to cross-border deductibility only apply to qualifying retirement plans (QRPs).

Before moving on, it’s important to note that Americans living in Canada can generally benefit from making RRSP contributions, even though they can’t deduct those contributions on their U.S. returns. That’s because while RRSP contributions may lower Canadian taxable income below the U.S. level, the higher Canadian tax rate will usually still provide enough foreign tax credits to fully offset the U.S. tax payable. That said, U.S. taxpayers should avoid making RRSP contributions that are so large that they would cause U.S. tax to become payable due to insufficient foreign tax credits—doing so would cause double taxation.

Read: How U.S. personal tax changes affect estate planning

Qualifying Retirement Plans

QRPs must be employer-sponsored pension plans, so individual retirement plans such as Canadian RRSPs and retirement compensation arrangements (RCAs) don’t qualify. Neither do U.S. individual retirement arrangements (IRAs).

In Canada, QRPs include registered pension plans (RPPs), group RRSPs, deferred profit sharing plans (DPSPs), and any RRSPs/ RRIFs funded exclusively by rollover from one of the preceding plans.

In the U.S., QRPs include 401(a) & 401(k) plans, simplified 408(k) plans, 408(p) Simple retirement plans, 403(a) & 403(b) plans, 457(g) plans, the Thrift Savings Fund, and any IRA funded exclusively by rollover from one of the preceding plans.

Next, let’s examine the three exceptions.

Exception 1: workers on short-term cross-border assignments

The first category applies to people who participate in their home country’s plan and are on short-term assignment in the host country. Under specific conditions, the Treaty allows assignees to deduct contributions made to the home country’s plan from taxable income earned in the host country.

Let’s take the example of a U.S. employee on assignment in Canada. Before 2009, she would only have been able to deduct her 401(k) contributions on her U.S. tax return, with Canada not allowing the deduction. Under the Fifth Protocol changes, she can also deduct her 401(k) contributions on her Canadian tax return, provided she meets several qualifying conditions.

These conditions are numerous. The employee must:

• have participated in the 401(k) prior to starting work in Canada;
• have been a non-resident of Canada prior to the assignment;
• be taxable in Canada on the assignment earnings;
• be on assignment in Canada for no more than five years;
• deduct contributions attributable only to work performed in Canada; and
• not participate in a Canadian plan (no double dipping).

The deduction is limited to the amount allowed under the home country’s domestic law to its residents. For U.S. workers in Canada, the deduction is limited to the 401(k) employee contribution limit ($18,500 in 2018 for those under age 50). For Canadian workers in the U.S., the deduction is limited to the person’s RRSP room.

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Exception 2: cross-border commuters

The second category applies to people who live in one country, commute to work in the other country and participate in the work country’s plan. Previously, no deduction was available in the home country for the contribution to the work country plan.

Let’s take the example of a Canadian resident who commutes to the U.S. daily for work and participates in the U.S. employer’s 401(k) plan. Under the changes, he can deduct the 401(k) contributions on his Canadian return. There are two conditions:

• the person must perform services as an employee in the U.S., with the remuneration from those services taxable in the U.S. and paid by a U.S. employer;
• the contributions and benefits must be attributable to those services and must be made or accrued during the period in which the person performs those services.

Similar to the first exception, the tax relief is limited to the deduction limit of the home country: for Canadian residents, the deduction is limited to the RRSP limit; for U.S. residents, the deduction is limited to the U.S. qualified plan limit.

Exception 3: U.S. citizens living and working in Canada

Finally, the third category applies specifically to U.S. citizens who reside in and work in Canada. Under the changes, contributions to a Canadian QRP will be deductible on the U.S. tax return provided again that two conditions are met:

• the U.S. citizen must perform services as an employee in Canada, with the remuneration from those services taxable in Canada and paid by a Canadian employer;
• the contributions and benefits must be attributable to those services and must be made or accrued during the period in which the person performs those services.

The deduction will be limited to the lower of the RRSP limit or the U.S. qualified plan limit.

Read: What the IPP numbers look like in 2018

Conclusion

While contributions to individual retirement plans in Canada are not deductible in the U.S. and vice-versa, some cross-border relief is available to workers for contributions to employer plans thanks to the Canada-U.S. Tax Treaty. That said, cross-border tax is a complex area which interacts with other cross-border planning areas such as retirement planning, investment planning and estate planning. To sort through the complexity, holistic analysis is recommended via a comprehensive cross-border financial plan.

Jonah Ravel, B.A., F.Pl., CFP, is a cross-border financial planner with MCA Cross Border Advisors and Matt C. Altro, B. Comm., F.Pl., CFP (Canada), CFP (US), TEP, is president & CEO of MCA Cross Border Advisors.