Some hotels will go to great lengths to attract tourists. In Manhattan, for example, the upscale Marmara offers a "birth tourism" package for expectant mothers. Women can spend a week at the luxury hotel, including medical care, for about $35,000 (U.S.). The real benefit, however, is that when a woman gives birth in the U.S. her child is automatically granted U.S. citizenship. It seems there's no shortage of people who want American citizenship for various reasons.
From a tax perspective, though, U.S. citizenship presents challenges if you're living in Canada – and there are many thousands in that category. U.S. citizens are caught in the U.S. tax "net" regardless of where in the world they live – and this includes U.S. estate tax. Today I want to talk about two common investment vehicles that don't work so well for U.S. citizens living in Canada: Tax Free Savings Accounts (TFSAs) and Registered Education Savings Plans (RESPs).
Jill is a mother of three. She is also a U.S. citizen, and so are her children. Her husband, Richard, is a Canadian citizen, and the family lives in Canada. Both Jill and Richard set up TFSAs for themselves and have each been contributing $5,000 annually to their plans. The couple want to save for the education of their children and so they've been considering an RESP.
Jill's TFSA is a problem for her since she's a U.S. citizen. For Richard's TFSA, all is well; he's reaping the benefits of the tax deferral that the plan offers. They haven't yet established the RESP for the kids.
The problem is that neither TFSAs nor RESPs are considered to be tax-deferred plans in the U.S. In the case of TFSAs, the Internal Revenue Service (IRS) has not provided any guidance on their tax treatment. It's generally believed that the U.S. will treat TFSAs in the same manner as RESPs: As a trust-type arrangement known as a "foreign grantor trust."
If you're a U.S. citizen and you contribute to a TFSA or RESP, then all interest, dividends and capital gains inside those plans must be reported annually on your U.S. tax return. Further, any Canada Education Savings Grants (CESGs) you paid into the RESP are considered to be income to you. This income could create a tax bill in the U.S., which is an additional tax burden unless you happen to be paying Canadian tax on other investments and are able to claim a foreign tax credit for the U.S. taxes paid.
But that's not all. You'll have to file additional tax forms in the U.S. You'll generally have to file U.S. form 3520, "Annual Return To Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts" for any year in which you contribute to, or withdraw from, these plans. In addition, you'll need to file U.S. form 3520-A, "Annual Information Return of Foreign Trust with a U.S. Owner" for any year that the plan exists. You'll have to file separate forms for each TFSA and RESP.
The cost of making these filings can be greater than the taxes saved. Consider Jill's case. She had $15,000 in her TFSA at the start of this year, and has no other investment income. If she earns 5 per cent in her TFSA this year and has a marginal tax rate of 45 per cent, she will save $338 in taxes this year. If she has a U.S. marginal tax rate of 35 per cent, she'll face U.S. taxes of $263 (U.S.) on the income in her TFSA. Her overall net taxes saved is about $75 (Canadian). You can bet that the cost of having her U.S. tax forms prepared will far outweigh that $75 benefit. Most professional tax preparers will charge between $500 and $1,000 for each form that must be filed.
What should Jill and Richard do? Well, it's likely best for Jill to avoid TFSAs – unless she's willing to file the nasty U.S. tax forms herself. As for the RESP, Richard should be the contributor (subscriber) to that plan, since he's not a U.S. citizen. If both spouses were U.S. citizens, it would be best to avoid the RESP or find another non-U.S. citizen contributor.