U.S. Citizens and Canadian Tax Free Savings Accounts

I’m a US citizen living in Canada – should I invest in a Canadian TFSA?

This is a great question, and one we get all the time. Let’s consider for a minute the main benefit of investing in a TFSA – income or gains earned under the umbrella of a TFSA will be tax-free. Unfortunately, this tax-free status only holds up on the Canadian side of the border. In other words, the income or gains earned in a Canadian TFSA are taxable on a US citizens’ US income tax return.

Okay, but is this a problem? The answer (as it often is in the cross-border tax world) is perhaps, or maybe even probably. Here are a few reasons why:

1. Compliance concerns. For our US citizen clients with TFSA’s, the simple fact is that holding TFSA’s complicates the task of preparing their US returns. For starters, tax documentation can be elusive since Canadian financial institutions are not setup to report on TFSA income, as they are with typical non-registered investment accounts (i.e. no T5 or T3 slips will be generated). Although extracting the right tax info can be relatively simple if the TFSA only has, say, an investment savings account in it, the task can quickly become daunting if the TFSA holds securities that are bought / sold, or even worse if the investments are considered Passive Foreign Investment Companies (“PFIC’s”).
2. You might pay US tax where you otherwise wouldn’t. Many US citizens living in Canada are accustomed to filing tax returns with both Canada and the US each year, but only paying tax to Canada. Without digressing too much into the mechanics of foreign tax credits, the gist is that without paying tax in Canada on TFSA income, there is often no foreign tax credit available to offset US taxes payable on this income. This can result in an unpleasant surprise for unwary taxpayers when we need to break the news that a cheque must be mailed to the IRS!
3. Risk of TFSA’s being treated as Foreign Trusts. While there are very good reasons why a TFSA would not be considered a foreign trust (that are beyond the scope of this blog), some practioners will file trust disclosure forms for a TFSA out of an abundance of caution. Technically the jury is still out, as the IRS has not definitively commented one way or the other. It seems unlikely at this point that the IRS will rule TFSA’s to be trusts, however, if this were to happen then TFSA holders could face further compliance hurdles.

To conclude, given the reasons discussed above, while a TFSA may not be necessarily “bad”, neither is it as “good” an investment vehicle as it might be for a non-US citizen. Either way the best answer is to consult with a tax professional and get some tailored advice – everyone’s tax situation is different, and there may be additional factors in your situation that should be considered!