This week’s question is a follow-up from last week’s blog post but comes from Loretta from Quebec, Canada.
The question is: So, are TFSAs considered trusts for US tax purposes? If so, what are the implications of that?
Is it a trust?
Again, here is the regulation defining operating trusts (the US defines 2 other types of trusts “business trusts” and “investment trust” but TFSAs wouldn’t fall into either category).
The regulations 301.7701-4 defining operating trusts specify that
“Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees’ responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit”
As I mentioned last week, we need to have somebody (a “trustee”) in charge of managing the assets. The trustee will be responsible “for the protection and conservation of property” for beneficiaries who cannot do it themselves.
Here’s what it looks like for out typical TFSA and we have:
- a grantor (somebody who contributed the assets): The taxpayer
- a trustee: Either the taxpayer or the bank, most likely the taxpayer
- a beneficiary: The taxpayer
As for the trustee, that would depend on who is making the investment decisions. In most cases, the taxpayer is making the investment decisions and the bank is merely executing them.
All right, do we have a trustee who is acting for the benefit of a beneficiary who can no act himself/herself? Well, if the trustee is the beneficiary, then clearly the beneficiary is making the investment decisions and we don’t have a trust.
If it is not a Trust, What Would be the Implications?
If it is not a trust, then neither form 3520 nor 3520-A would need to be filed.
That said, the Internal Revenue Code still would not have a provision to make the income tax-free. It is taxable for US tax purposes. And the taxpayer might not be able to offset the related tax with the foreign tax credit since it is not taxable in Canada.