Canadian Treatment of U.S. Roth IRA’s Is Changing

“The election is invalid on a go-forward basis.”

Canadian residents with US Roth IRA accounts have until April 30, 2011 to elect to defer the Canadian taxation of the income earned within the account.

For US tax purposes, Roth IRA accounts generally provide no deduction in the year of contribution, but income within the Roth IRA is not taxable. Similarly, the distributions are not included in income. Some Roth IRA’s are set up as custodial accounts, while others are set up as trusts, annuities or endowment contracts.

Historically, with certain exceptions, income earned in a Roth IRA account and withdrawals from the account were generally not taxable in Canada where they would also not have been taxable in the US if the individual were resident there. Prior to the Fifth Protocol to the Canada/US Tax Convention entering into force on December 15, 2008, it was recommended that a taxpayer make a “protective claim” (i.e., a written statement) with their Canadian tax return, annually, to defer Canadian taxation on income accruing in a Roth IRA.

The procedures for making a “protective claim” were removed as of 2009. Instead, a Canadian resident taxpayer generally has until April 30, 2011 to make a one-time irrevocable election, in respect of each Roth IRA account, to defer Canadian taxation on income earned in the Roth IRA (provided the income would not otherwise be taxable in the US if the individual were resident there). By electing in letter format, as noted below, to defer Canadian taxation with respect to any income accrued within the Roth IRA, income and withdrawals from the Roth IRA will continue to be tax-free in Canada.

Taxpayers should be aware, however, that where contributions have been made to the Roth IRA account after 2008 by a Canadian resident (a “Canadian Contribution”), the election is invalid for the future, and subsequent elections on this account will not be available. All income earned in the Roth IRA after that time will be reportable for Canadian tax purposes, and the Canadian resident may be required to file forms T1135 (Foreign Income Verification Statement), T1141 (Information Return re Transfers or Loans to a Non-Resident Trust) and/or T1134B (Information Return re Controlled Foreign Affiliate) each year.

Individuals who were resident in Canada before 2010 who are allowed to file the election must do so no later than April 30, 2011.

For individuals who became or become resident on or after January 1, 2010, the election is due on the filing due-date of the tax return for the first year of residence. In either instance, the election will be valid for all later years, until such time as a Canadian Contribution is made.

The election should be made in the form of a letter for each Roth IRA and, in addition to various administrative information, should include a statement signed by the taxpayer indicating that they “elect to defer Canadian taxation under paragraph 7 of Article XVIII of the Canada-US Income Tax Convention with respect to any income accrued in the Roth IRA for all taxation years ending before or after” the date of the election, “until such time as a Canadian Contribution in made.”

Each of the letters should be sent to the Canadian Competent Authority Services Division in Ottawa, postmarked no later than the due date.

If you have any questions regarding this election and whether it affects you, please contact your TSG representative.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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