Tracking Income In Your TFSA, ISA Or Other Account That Is Not Taxable In Your Country Of Residence

Introduction and purpose

This is a quick “public service” post. Please think carefully about the general message.

Spoiler alert:

U.S. citizens living in Canada should take the initiative to track the income earned in their TFSAs every year.

U.S. citizens living in the U.K. should take the initiative to track the income earned in their ISAs every year.

U.S. citizens living in other countries with tax advantaged accounts should track the income earned in them every year.

As explained below, I suggest that you do this without regard to whether you are currently in the U.S. tax system.

In addition (see below) the time has come to pressure Canada’s “Competent Authority” to agree with U.S. Treasury that a Canadian TFSA should be given the same treatment as the U.S. ROTH IRA gets under the treaty. 

The difficulty of U.S. tax compliance for U.S. citizens living in Canada

U.S. tax compliance for Americans abroad is somewhere between difficult and impossible. There are many reasons. The reasons include (but are not limited to):

• U.S. taxation of income sourced in your country of residence that is NOT taxable in your country of residence. Some well known examples include the tax free capital gain on the sale of a principal residence and income earned inside an TFSA, UK ISA or financial account that is not taxable in your country of residence
• The difficulty of characterizing various investment products for U.S. tax purposes. Is your foreign mutual fund a PFIC? Is your TFSA a trust? How is a trust defined for U.S. tax purposes? What about your company pension plan, etc. In some cases these issues are dealt with through treaties and others not. For example there is a huge difference beween how a U.S. citizen living in Australia (“All Roads Lead To Renunciation”) is treated by the U.S. tax system and a U.S. citizen living in Canada (very difficult but not as difficult as Australia).
• The “saving clause” in all U.S. tax treaties which presume to deny individual U.S. citizens the benefits of the tax treaties. I believe that with the “saving clause” the correct position is that tax treaties guarantee the double taxation (or at least the potential) of U.S. citizens abroad.
• The problem of having to report all of your transactions is U.S. dollars and how this can create “phantom” (fake) capital gains
• The problem of mismatches in timing when it comes to the receipt of income (examples include: Subpart F, GILTI, transition tax, etc.)
• The complexity and cost of filing the numerous IRS forms required of Americans abroad

All things considered, the United States imposes a more punitive form of taxation on its citizens living outside the United States than on its residents inside the United States! For what this means in the life of an American abroad, and how to live outside the United States In an FBAR and FATCA world see …

“How To Live Outside The United States In An FBAR And FATCA World”

Four principles for how to think about the Canadian TFSA (and similar accounts in your country of residence):

Principle 1: TFSAs (gains taxed never) are a better investment (I think by far) than an RRSP (gains taxed later). This is worth a separate post. But, I believe the thinking is valid.

Principle 2: Yes, U.S. citizens living in Canada SHOULD have a TFSA. What follows is a post a wrote a few years ago explaining why you should have one and why this should NOT cause a problem for you. If your tax preparer says that you should not have a TFSA, just get another tax preparer.

Principle 3: The U.S. ROTH IRA is the functional equivalent of the Canadian TFSA. Interestingly the U.S. Canada tax treaty carves out favourable tax treatment by the Canada RevenueAgency for the income earned inside the ROTH IRA for Canadian tax residents. (There are conditions. Read the treaty carefully.) The Treaty also contemplates that a similar Canadian product should get favourable U.S. tax treatment by the IRS.

I would be willing to work with somebody to incentivize Canada’s “Competent Authority” to get this deal done!!

Here is what the Canada/U.S. tax treaty says in Article XVIII:

(b) The term “pensions” also includes a Roth IRA, within the meaning of section 408A of the Internal Revenue Code, or a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007 that the competent authorities have agreed is similar thereto. Notwithstanding the provisions of the preceding sentence, from such time that contributions have been made to the Roth IRA or similar plan or arrangement, by or for the benefit of a resident of the other Contracting State (other than rollover contributions from a Roth IRA or similar plan or arrangement described in the previous sentence that is a pension within the meaning of this subparagraph), to the extent of accretions from such time, such Roth IRA or similar plan or arrangement shall cease to be considered a pension for purposes of the provisions of this Article.

Note that the treaty says that a plan created after September 21, 2007, that Canada and the United States have agreed is similar to a ROTH IRA (notice it says “similar” and NOT “identical”) should be treated as a pension under the treaty. This would create the opportunity for favourable tax treatment for the TFSA (and presumably FHSA) for U.S. citizens in Canada.

Principle 4 (and the real purpose of this post): At present income inside the TFSA is considered to be reportable on your U.S. tax return. Financial institutions do NOT usually provide annual information returns detailing the income earned. Or at least most don’t. Note also that you should (as a general principle) avoid holding non-U.S. mutual finds inside your TFSA. This will avoid the PFIC problem (double taxation, Form 8621, etc.).

Therefore, it is very important that you keep track, on an annual basis, of income earned (interest, dividends or capital gains) inside your TFSA each year. This is true whether you file U.S. tax returns for not.

Those who are required to file U.S. tax returns will need to report the income earned inside the TFSA on their U.S. returns.

Those who are not currently filing U.S. tax returns may want to file down the road (example “Streamlined” or “Relief Procedures For Former Citizens“)  to renounce U.S. citizenship, etc.). It would be very helpful to have this information organized and available. I cannot overstate how difficult it is for some people to go back in time and retrieve this information!

I am writing this post because in the last month I have spoken with three separate people who are having difficulty filing U.S. tax returns because of the difficulty of tracking and identifying income earned inside the TFSA. Seriously, this can be a BIG problem. It occurs to me that there may be some financial institutions that may provide an annual income summary. This is a good reason to use that financial institution for your TFSA.

Again, this is a public service post. By tracking the income in your TFSA you will make your life a lot easier.

As a side benefit you will pay more attention to how your TFSA is performing!

Closing suggestion:

Beware of the financial advisor who wants to “churn” the contents of your TFSA!

Here is my post explaining why you should have a TFSA.

To TFSA Or To Not TFSA, Whether Tis Better For A US Citizen Living In Canada To Open A TFSA Or Not

John Richardson