Income tax and concerns regarding Revenue Procedure 2014-55

Nov 2, 2014

While not everything is good news, I think that the concerns found in this comment (similar to the ones voiced by Moodys Gartner here) are not always founded. I will elaborate more in-depth below, as well as the US-Canada treaty Article XVIII(7) with emphasis on treaty tax income.

The Rev. Proc. is problematic for a multitude of reasons, including:

1. it substitutes a form for which there is no failure to file penalty (8891) for a form that contains a $10,000 failure to file penalty (8938).

Further, the $10,000 penalty is enhanced if the individual does not respond to requests for further information within 90 days per 6038D(d)(2). If the individual does not respond within 90 days there are additional penalties of $10,000 per 30 days (not to exceed $50,000).

Not true. Form 8938 doesn’t substitute form 8891. The RRSP was already required to be reported on form 8938, except that before it could be reported by reference to form 8891 instead of being on the face of form 8938. Also, form 8891 requires balance on Dec 31 while FBAR required the maximum balance of the year. Now, only the maximum balance is required for both forms.

Granted, if, under the previous procedure, you filed a form 8891 but failed to put the number “1” in the appropriate box on form 8938 (mentioning the number of form 8891), you would probably have a strong case for a reasonable cause. But still…

2. It addresses only income accrual in RRSPs/RRIF/etc. and NOT deductibility of contributions to such plans.

True. But it’s just a revenue procedure – changing the deductibility of contributions to such plans would require a change to the US-Canada treaty (or alternatively to the Internal Revenue Code), which is not within the powers of the IRS.

For reference, here is the article XVIII(7) of the treaty:

7. A natural person who is a citizen or resident of a Contracting State and a beneficiary of a trust, company, organization or other arrangement that is a resident of the other Contracting State, generally exempt from income taxation in that other State and operated exclusively to provide pension, retirement or employee benefits may elect to defer taxation in the first-mentioned State, under rules established by the competent authority of that State, with respect to any income accrued in the plan but not distributed by the plan, until such time as and to the extent that a distribution is made from the plan or any plan substituted therefore.

3. Most catch-up Canadians will NOT be eligible for the simplified procedure and therefore must seek a private letter ruling to defer the tax on income generated by the account.

SECTION 4.01 defines “Eligible Individual” to include only an individual who:

(B) Has satisfied any requirement for filing a U.S. Federal income tax return for each taxable year during which the individual was a U.S. citizen or resident.

Most Canadian residents who are U.S. citizens have missed several years of filing obligations and therefore seek to come current under Streamlined Filing, which requires filing of only 3 years of returns. If an individual has been resident in Canada , say, 30 years, he would have to file 30 years of returns in order to be deemed an “Eligible Individual.”

True. The IRS could have done a better job here and not require a private ruling letter to be required in such a case.

But, in practice, we’re talking about somebody with 30 years of income above the threathold that would require them to file tax return (currently $10,000 – the sum of the standard deduction of $6,100 for single and the personal exemption of $3,900). They likely started making that kind of money when they turned 20 years old. So, now they have to be at least 50 years old, possibly older. Which stage of one’s life is that? Yes, retirement. Ding ding ding

That person might erroneously include a portion of their RRSP withdrawals as taxable income in the US. But since they didn’t request a private ruling, they might face that income to be removed – thereby seeing a decrease in taxable income. Oh my gosh that’s terrible 😉

4. Conflicting direction regarding taxability of distributions from RRSPs/etc.

SECTION 6 and SECTION 4.02 provide that accrued income on RRSPs must be reported by the individual for US tax purposes. Further, SECTION 6 provides that the accrued income must be reported consistent with §72 of the Code. In other words, only the income from RRSPs is taxable in the U.S. when it is distributed.

This result is directly contrary to SECTION 7, which provides that the entire amount of the distribution is subject to taxation in the U.S. This result makes sense IF the contribution to the RRSP is deductible for U.S. purposes but makes no sense if the contribution is not deductible.

Again, this is not subject to interpretation and it is not even up to the IRS to make the rule since the rule is set in article XVIII(7) of the treaty. Only the distribution portion related to accrued income in the RRSP is taxed, the amount of the contributions is not.

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