6

Registered Retirement Plans, Pensions, and Social Security

In this chapter, we will discuss how the US taxes the following types of accounts:

• Registered Retirement Savings Plan (RRSP)

• Registered Retirement Income Fund (RRIF)

• Locked-In Retirement Account (LIRA)

• Registered Education Savings Plan (RESP)

• Tax-Free Savings Account (TFSA)

• Registered Disability Savings Plan (RDSP)

• Individual, company, and government pension plans

• Canadian Pension Plan (CPP)

• Quebec Pension Plan (QPP)

• Old Age Security (OAS)

• US Social Security

1. Registered Retirement Plans

The US has certain types of pension plans that allow the deferral of interest, dividends, and capital gains earned inside the plan. The treatment of these US plans is very similar to Canadian RRSPs and other registered retirement plans in Canada; tax is deferred until you actually distribute the money. Tax-deferred US pension plans are referred to as “qualified plans” because they qualify for tax-free treatment by satisfying a myriad of tax and labor-law issues. Canadian RRSPs and other Canadian registered plans are not, and cannot be, qualified plans as defined by US tax law, which requires qualified plans to be created and organized in the US. Thus, income earned in an RRSP or other Canadian registered plan cannot be tax deferred or tax exempt in the US because the Canadian plans do not meet the requirements under US tax law.

So how does the IRS view Canadian registered savings plans? Article XVIII(7) of the Treaty allows for the deferral of Registered Savings Plans (RSPs). While the Treaty does not define what an RSP is, the Diplomatic Notes of the Fifth Protocol state that RSPs are registered retirement savings plans, deferred profit sharing plans, and registered retirement income funds.

Note: Nowhere does the Treaty or the IRS mention locked-in retirement accounts (LIRAs), locked-in retirement income funds (LRIFs), locked-in funds (LIF), etc., but we believe these accounts fall within the meaning of the law.

Because Canadian retirement plans do not meet the requirements of US qualified plans, they cannot be tax deferred and are therefore taxed like a non-qualified (non-registered) account. This means that they are taxed the same as any other non-registered account such as your bank or brokerage account would be taxed. However, the Treaty allows for relief from current taxation by electing under the Treaty, to defer taxation of any income earned in an RRSP (and the other accounts mentioned earlier) interest, dividends, and capital gains until the money is withdrawn. In other words, the accounts continue to be tax deferred, just like they are in Canada.

1.1. Deferral

In 1995, Article XVIII(7) was added to the Treaty to give a US citizen or resident alien the option to elect to defer the tax on the income earned and accrued in certain Canadian retirement plans until the monies were distributed. The article was put in place to address the mismatch between the timing of tax for Canada and the US, which would likely result in double taxation when the money was withdrawn.

Note: Some advisors believe that all US citizens and resident aliens owning these plans are obligated to report their clients’ interests using Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts (Form 3520), and Annual Information Return of Foreign Trust with a US Owner (Form 3520-A). This is not correct; the IRS has issued statements notifying taxpayers that those forms are not required. In fact, the instructions to US Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans (Form 8891) states “… annuitants and beneficiaries who are required to file Form 8891 will not be required to file Form 3520 …”

Normally the Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b) (Form 8833) must be filed whenever you are taking advantage of the Treaty, but the IRS has in the Form 8891 the election and therefore, Form 8833 is not needed and should not be used when making the election to defer the earnings on your RRSPs and related accounts. A separate Form 8891 is required to be filed for each RRSP account (and other the eligible plans listed earlier) that is owned by a US citizen or resident alien. The Form must be filed annually and attached to your tax return when filed. (Note: You must file Form 8891 to make the Treaty election. No form, no election!)

Once this election is made, the election cannot be changed in any subsequent year. In other words, you cannot choose to defer income and then choose to pay tax in a subsequent year; an election to defer tax on unearned and undistributed income is a permanent and irrevocable election as long as the accounts exist. Without making this election, all income earned in a Canadian RRSP (and related accounts), whether or not it is distributed, is subject to US tax in the year the income was earned.

1.2 Distributions

When a distribution is made from an RRSP, you must report the total amount and the taxable amount of the distribution on Form 8891. Canadian withholding tax is imposed on distributions from the plan, and a foreign tax credit may be available to offset US tax that is imposed. While the total amount is easy enough to figure out, the taxable portion is more of a challenge.

From the US perspective, any Canadian retirement plan account is treated just like any other brokerage or investment account, except for the ability to elect to defer the income using Form 8891 for eligible plans. This is an important distinction because, when monies are withdrawn from an eligible plan account, the amount that was originally invested (the principal) will not be subject to US income tax. If you are a Canadian (but not US citizen) who is now a US resident taxpayer, the amount that was contributed, as well as any interest, dividends, and realized capital gains accrued up until the date you became a US taxpayer (typically the day of entry into the US), is considered principal (cost basis) for US tax purposes. What is not considered part of your principal is the unrealized capital gain at the date of entry. For a US citizen or a green card holder who has been a resident in Canada, only your contributions are considered principal.

If you live in a state that has an income tax, state income tax may be due on the income earned on an RRSP every year, regardless of whether you have filed the election with your federal tax return. The reason for this is that states are not party to the treaty or its elections.

Interestingly, in April of 2003, California made it clear when it issued a statement stating that it does not permit the deferral of earnings in Canadian retirement plans. This means that all California residents are required to include income from their RRSPs in their California taxable income each year. Fortunately, some state tax systems (e.g., Arizona) complement the federal tax system and allow the deferral. Also, certain states allow for offsetting the foreign tax credit for the Canadian federal and provincial taxes paid, and other states may allow for an offsetting credit for just the provincial taxes paid. These are good reasons to make sure you know how the RRSP (and related accounts) will be taxed and how foreign tax credits will be handled in the state you live.

Note: The description of taxation on withdrawal of your RRSPs is our interpretation of the law. Based on a sampling from our colleagues, it is the majority opinion, but in no way is it a unanimous opinion. Some cross-border tax experts believe that you have no principal (cost basis) in your RRSP and upon withdrawal the proceeds will be 100 percent taxable in the US. A discussion of the technical issues involved in this disagreement is beyond the scope of this book. However, here is how we look at it. We have a legitimate professional disagreement, we are in the majority, and when in doubt take the position that benefits the client.

From a Canadian perspective, there are two types of distributions — lump-sum and periodic. The only thing the Treaty says about this issue is that periodic distributions are taxed at a 15 percent withholding tax rate. In Canada, the default withholding rate (unless reduced by the Treaty) is 25 percent. The Treaty does not define either lump-sum or periodic, so all we know from the Treaty is that lump-sum payments will have a 25 percent withholding tax applied and periodic payments will have 15 percent applied. However, we can go to the Income Tax Conventions Interpretation Act for the definitions. The definition of lump-sum is any payment that is not a periodic payment. The definition of a periodic payment is the amount that would be the greater of —

• twice the amount of the required minimum payment; and

• 10 percent of the fair market value of the property at the beginning of the year.

1.3 Planning

In planning for what to do with your RRSPs (and related accounts) as a US tax resident, there are basically three options:

• You can make the election on Form 8891 to defer the tax and pay tax on the accumulated income when distributed.

• You can report the income each year.

• You can withdraw the funds entirely.

There is one additional option that many US taxpayers with RRSPs are unknowingly choosing — doing nothing and assuming that there is no tax on their RRSPs in the US and no reporting requirements in the US. This can be a very costly option that could result in unnecessary tax, penalties, and interest owing for failure to report the income and report the accounts. In some cases, a request for relief can be made through a request for a private letter ruling. The relief may sometimes be granted if the taxpayer acted reasonably and in good faith, and the government’s grant of the relief would not prejudice the government’s interests. The request for relief is a long and costly process that you should try to avoid, if at all possible.

Caution: What you think you know about the taxation of RRSPs and RRIFs is probably wrong. The reason for this is that what you know or have been told is most likely based on the laws as if you were a Canadian resident. As we discussed in Chapter 4, the laws that apply to nonresidents of Canada are different.

As a US resident taxpayer who exited Canada with RRSPs, we recommend that you determine your cost basis as of the date of exit. For Canadian purposes, the cost basis is of no concern for you because the entire account is tax deferred and becomes taxable when distributed. However, as mentioned earlier, you are not taxed on your cost basis, which is the amount you contributed to an RRSP, plus any interest, dividends, and realized capital gains, up until the date you exited Canada.

Note: The method to calculate of cost basis for a US citizen is different that the method used for non-US citizens; read carefully to make sure you are using the correct method.

The first option we mentioned is to make the election to defer the tax until the money is withdrawn. If you choose to do this, you will need to consider both the Canadian and US tax perspectives. Canada will continue to defer the tax until the money is withdrawn, then tax 100 percent of the distribution when it is paid out; the default withholding rate of 25 percent for lump-sum payments.

There are two things you need to know regarding your RRSP and RRIF withdrawals. First, you cannot make periodic distributions from an RRSP, regardless of the amount withdrawn. You must convert your RRSP to an RRIF in order to make periodic payments. Second, you can convert your RRSP to a RRIF at any time. The catch is that you must begin periodic payments in the year you convert.

On occasion, a financial institution will withhold 25 percent even though you do everything right and 15 percent tax rate should have been withheld. In that case, you will need to file a Application by a Nonresident of Canada for a Reduction in the Amount of Nonresident Tax Required to be Withheld (Form NR5) with the CRA to request the lower withholding; once approved the CRA will send you a refund check for the difference.

As you can see from Table 6, the withdrawal percentage is less than 5 percent until you reach age 70. Therefore, if you want to withdraw the maximum amount at the 15 percent withholding rate, 10 percent will be the amount you can withdraw each year until you are age 71 and older. At age 71, twice the annual percentage will be 14.76 percent (7.38 x 2) and since it is greater than 10 percent, you can withdraw this amount at the 15 percent withholding rate. Be careful to round down and not up when calculating the amount of the distribution qualifying as a periodic distribution; going over by $1 makes the entire distribution a lump-sum and subject to 25 percent withholding.

Table 6: RRIF MINIMUM WITHDRAWALS BY AGE

Age as of Jan 1Minimum WithdrawalAge as of Jan 1Minimum WithdrawalAge as of Jan 1Minimum Withdrawal
11.12%331.75%654.00%
21.14%341.79%664.17%
31.15%351.82%674.35%
41.16%361.85%684.55%
51.18%371.89%694.76%
61.19%381.92%705.00%
71.20%391.96%717.38%
81.22%402.00%727.48%
91.23%412.04%737.59%
101.25%422.08%747.71%
111.27%432.13%757.85%
121.28%442.17%767.99%
131.30%452.22%778.15%
141.32%462.27%788.33%
151.33%472.33%798.53%
161.35%482.38%808.75%
171.37%492.44%818.99%
181.39%502.50%829.27%
191.41%512.56%839.58%
201.43%522.63%849.93%
211.45%532.70%8510.33%
221.47%542.78%8610.79%
231.49%552.86%8711.33%
241.52%562.94%8811.96%
251.54%573.03%8912.71%
261.56%583.13%9013.62%
271.59%593.23%9114.73%
281.61%603.33%9216.12%
291.64%613.45%9317.92%
301.67%623.57%9420.00%
311.69%633.70%95+20.00%
321.72%643.85%

You may run into Canadian brokers who are unwilling to hold an RRSP for nonresidents of Canada. This is because there are rules that are set out by the US Securities and Exchange Commission (SEC) restricting securities brokers and dealers to provide services only to residents of their own country. The SEC recognized that these rules caused an undue hardship on US residents who hold RRSP accounts and issued an order to offer reprieve to this problem. If you have a broker or dealer that is unwilling to hold RRSP assets for you as a US resident taxpayer, you should refer the broker or dealer to the SEC’s website for Release No. 34-42906; International Series Release No. 1227 at www.sec.gov/rules/other/34-42906.htm.

As part of the IRS regulations under the Foreign Account Tax Compliance Act (FATCA), US taxpayers with specific types and amounts of foreign financial assets or financial accounts, which include all Canadian retirement plan accounts, must file an information disclosure, IRS Statement of Specified Foreign Financial Assets (Form 8938) each tax year. Reporting threshold amounts vary according to filing status. Failure to file can subject a taxpayer to a US$10,000 penalty as well as other sanctions.

In addition, any resident taxpayer who owns accounts, including Canadian retirement accounts, in countries outside of the US, is required to file a Report of Foreign Bank and Financial Accounts (Form TD F 90-22.1) with the Department of the Treasury in each year that the total of all foreign accounts exceeds US$10,000, at any time during the year. There are two key points here; $10,000 in aggregate and at any time during the year. If you have five accounts, none of which exceed $10,000 on its own, but in total exceed $10,000, you must file Form TD F 90-22.1 for each account. The other point is that the total of your accounts may not typically exceed $10,000, but they exceed $10,000, even for a moment, you must file Form TD F 90-22.1 for all foreign accounts. The most frequent reason for accounts spiking for short periods of time is when a house is sold; the proceeds come to you and you turnaround and write a check for a new home.

As pointed out in the book The Border Guide: A Guide to Living, Working and Investing Across the Border, written by Robert Keats, there are many reasons why it may be wise to cash out your RRSPs (and related accounts) once you are in the US. There are a number of risks that arise that were not present when you were a Canadian resident, assuming you are not a US citizen. We will highlight some of the risks here, but I suggest you read The Border Guide for more details. The major risks include the following:

• Tax compliance is more complicated and therefore costly.

• The additional complexity creates a risk that a form is not filed or filed properly, leaving you open to potentially large penalties.

• You have exposure to currency exchange risk. While you are holding on to your accounts so that you can defer the tax to a later date, while you are holding those accounts, you run the risk of the Canadian dollar falling relative to the US dollar. The currency market is not a free market, so regardless of how smart you think you are, or your advisor is, you have no idea what currency prices will do because the government could step in at any time and cause their currency to go higher or lower depending on what objective they are trying to reach. Why take the risk?

• If you die still owning an RRSP or similar account, you could be subject to double tax. The US estate tax exemption is scheduled to drop to $1,000,000 per person, indexed for inflation (approximately $1,300,000 after inflation). This means that if your net worth is greater than approximately $1.3 million, you will be subject to US estate tax. While the Treaty has a provision that generally provides for a foreign tax credit on taxes due at death, there is one exception; the Canadian tax must be due to capital gains. Canadian tax on your RRSP is at ordinary rates and is not classified as a capital gain, and therefore no foreign tax credit is allowed.

• If you die still owning an RRSP you could be subject to double tax in the US. If you are subject to US estate tax, discussed above, the US will impose an estate tax at death and the beneficiary will have to pay income tax when the money is withdrawn (assuming the beneficiary is a US taxpayer). This is double tax. Add the Canadian tax above and you have triple tax. If your net worth is large enough to be subject to US estate tax, this should be reason enough to cash out your RRSP type accounts.

• States like California will tax your RRSP each year even if you made the election to defer per the Treaty.

• Canadian mutual funds are the most expensive in the world. Canadian mutual funds are generally twice as expensive as the equivalent US funds. So if you are paying 1 percent more a year in mutual fund expenses, in ten years you would exceed (with compounding) the 10 percent saving in the difference in the lump-sum and periodic withdrawal strategies.

In summary, the decision to hold onto your tax-deferred accounts and defer paying taxes for as long as possible is not clear cut, and possibly the wrong thing to do once you move to the US. When you are living in Canada (assuming you are not a US citizen), the only factor to consider is whether you should pay tax now or pay later. As we all know, the answer to that question will almost always be to wait as long as possible. However, when you move across the border, the issues become more numerous and more serious. You need to break away from you old way of thinking and address the very real risks of leaving your RRSP in Canada, as a US resident.

1.4 How the taxes work

To determine the US tax on distributions from your registered retirement accounts, you first must determine your cost basis (principal) for US purposes. We discussed this in section 1.2, but it is the fair market value of the accounts, less any unrealized capital gains, on the date you became a US taxpayer. The amount of US income you would have to report from any distribution is equal to percentage of the account withdrawn (e.g., 100 percent, 10 percent) times the fair market value of the account on the date of the distribution, less your US cost basis. If you are a US citizen that has been living in Canada and contributing to an RRSP, your cost basis will generally be limited to the amount of your contributions. However, this could be different because the Treaty was amended a few years ago to allow for RRSP contributions to be deductible on your US tax return, with some limitations. If you deducted contributions to your RRSP on your US return, those contributions do not increase your cost basis. Here is an example:

• You moved to the US on January 1, 2010, and the value of your RRSP on that date was $300,000. You had $20,000 of unrealized capital gains in your account as of that date. This means that your US cost basis is $280,000. If you were to cash out your RRSP on that day, you would have had to report $20,000 of income on your US return. However, if you had a distribution of 10 percent of your account value on that date, you would have to report 10 percent of $20,000, or $2,000. Another way of looking at this is that you used up $18,000 of your US cost basis, therefore your cost basis going forward is reduced from $280,000 to $262,000.

Note: In states that allow for the deferral of tax on your RRSP type accounts (e.g., Arizona), your US and Arizona cost basis is the same and there is nothing special you need to do. However, if you live in a state that does not allow for the deferral (e.g., California), your cost basis will increase, for California but not US purposes, each year you pay California tax. This means that you will need to keep two sets of cost basis records.

The withholding taxes that are paid to Canada are eligible as a foreign tax credit in the US. These taxes can only be used to the extent that there is foreign source income, and to be more specific, passive foreign source income, which is generally all income except income from employment and company or government pension related earnings. The distributions that you receive from your RRSPs are deemed to be passive foreign source income, but only to the extent that the distributions are taxable in the US. The credit is calculated on the Form 1116 (Foreign Tax Credit) and can be complicated, but in its most simple form, it is a credit against your US taxes using a percentage allocation based on a ratio of foreign source income to worldwide income. (See Chapter 5 for a more thorough discussion of foreign tax credits.)

The second option is to pay the tax each year. Instead of deferring the income by making the election on Form 8891, you would instead report and pay tax on any interest, dividend, and capital gain income earned each tax year. From a US tax perspective, this option could be appealing: The income is taxed based on the character of the income. Interest income is taxed at a taxpayer’s ordinary income tax rates, and dividends and capital gains are generally taxed at 15 percent (2012). Compare this to how your income is taxed if you decide to defer the tax: The income accrued in the account is taxed when distributed, and it is taxed at your higher ordinary income tax rates. There is no tax break from the type of income that generated the earnings in the account. However, there is the problem of the mismatch of when the income is taxed by Canada, potentially resulting in double taxation. Because Canada will tax you when distributions are made and the US will tax you as income is earned (assuming you do not elect to defer). Only in very rare circumstances would this option make sense.

As a US tax resident, you have a third option which is to take a lump-sum withdrawal from your RRSP. To do this, all of the positions would be liquidated in the Canadian retirement plan and the funds would be withdrawn in a one-time lump-sum distribution and transferred into a US bank or brokerage account. You would incur a 25 percent withholding tax payable to CRA upon withdrawal. If you elected to defer your taxes on Form 8891, you will be taxed in the US when the money is withdrawn, but only on the earnings in the account since the date you exited Canada plus any unrealized earnings on investments in the account at your exit date, and at your ordinary tax rates.

Whenever you pay more Canadian tax than US tax, you will have unused credits that can be carried forward for up to 10 future years, and back 1 year (for a total of 12 years, including the current year), as necessary. By investing some or all of your proceeds into foreign securities that produce foreign passive income, it may be possible to use your unused credits to fully offset the taxes on your investment earnings from foreign passive investments for years to come.

Caution: Be sure to work with investment professionals who know how to manage a portfolio designed to utilize foreign tax credits because generating foreign passive income is not as easy as it sounds. The challenges to generating foreign passive income include the following:

• You cannot generally invest in foreign securities as a nonresident because of securities laws.

• Even if you were to find a firm that would allow you to invest in foreign securities, you have to be concerned with the potentially high costs, lack of diversification, currency risk, and foreign tax being withheld on those earnings (analogous to taking two steps forward and one step back).

• US mutual funds that invest in foreign securities will solve most of these problems but have one critical flaw; the income is not considered foreign because the mutual fund takes the foreign tax credit at the fund level. This means that the investor cannot claim the income as foreign and take the credit for it; otherwise, a foreign tax credit would have been taken twice on the same income.

Because the Canadian tax paid usually exceeds the US tax, you may end up with excess foreign tax credits available to carry forward and apply to other foreign passive taxable income over the next 11 years. It is important to mention that when you take a lump-sum withdrawal, your marginal US tax rate may increase because of the additional income. You should take this into consideration when determining a strategy for liquidating your RRSPs.

There are currently six provinces that allow nonresident Canadians to unlock their LIRAs: British Columbia, Alberta, Saskatchewan, Ontario, Quebec, and New Brunswick. If you have a LIRA in these provinces you can request to unlock your LIRA by providing evidence that you are a nonresident of Canada, specifically in the form of a confirmation from CRA that you are a nonresident. The CRA written confirmation can be obtained by filing the Determination of Residency Status (Form NR73). It usually takes about eight weeks to receive an answer.

There is also relief for LIRAs held by former employees of federally regulated industries, such as airlines, railroads, and communications companies. To qualify, the employees must be currently a nonresident of Canada and have been a nonresident for at least two years.

Note: Once the NR73 is approved and the CRA certifies that you are a nonresident, you can break the lock. In most cases, you cannot make a partial withdrawal of the LIRA; you must make a full withdrawal immediately.

When dealing with RRSPs and LIRAs as a nonresident of Canada, we recommend that you seek the advice of an experienced and qualified cross-border professional.

Many Canadians have locked-in retirement accounts (LIRAs) that were created through an employment-pension plan regulated at the provincial level. All provinces and territories have legislation where employer-funded pension plans can be locked until retirement age, even after an employee has left the company. In 2000, the CRA recognized that an undue hardship was being imposed on nonresident Canadians who held locked-in accounts, including LIRAs and LRIFs (hereinafter collectively referred to as “LIRAs”). The hardship was a result of the potential double taxation resulting from a timing mismatch between the Canadian tax system and other countries’ tax systems. As a result of lobbying from the CRA and other countries, many provinces provided relief for nonresident LIRA owners.

1.5 Other types of accounts

Unfortunately, for other types of Canadian retirement plans, such as tax-free savings accounts (TFSAs), registered education savings plans (RESPs), and registered disability savings plans (RDSPs), the simplified reporting requirements using Form 8891 do not apply. For these non-eligible plans, there is a significant risk of double taxation. The election to defer is not permitted, and for US resident aliens or citizens who own these types of plans, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts (Form 3520) and/or Annual Information Return of Foreign Trust with a US Owner (Form 3520-A) must be filed every year for RESPs and RDSPs, but apparently not for TFSAs. These burdensome filing requirements are just the beginning; what’s worse is that the income earned in these types of plans is taxable in the US in the tax year for which the income is earned, even if the income is not distributed. The same income that is taxable in the US is not subject to Canadian tax until distributed from the plan. The timing mismatch between the two countries will most likely cause the individual to suffer double taxation.

Don’t forget that in addition to potentially having to file Forms 3520 and 3520-A, you are definitely required to file Forms TD F 90-22.1 and 8938 if the total of all of your foreign accounts exceed $10,000 at any point during the year.

For those taxpayers who have accounts that cannot be deferred (e.g., TFSAs, RESPs, RDSPs, you should seriously consider the option of taking the lump-sum withdrawal to minimize the double taxation issue as well as the onerous reporting requirements.

2. Pensions

In this context, the term pension means a retirement benefit provided by an employer (including the government) to an employee for services provided to the employer over a period of years. This does not include Canadian Pension Plan or Quebec Pension Plan; these plans are a form of social security and are discussed in section 3.

For years, pensions were treated very similar to RRSPs in that they had a US cost basis, but about a decade ago the law was changed and a new section to the Internal Revenue Code (IRC) was added. That section is 72(w). In general, section 72 lays out the laws surrounding annuities. Below is a quote from IRC 72(w) Application of Basis Rules to Nonresident Aliens:

“In general — notwithstanding any other provision of this section, for purposes of determining the portion of any distribution which is includable in gross income of a distributee who is a citizen or resident of the United States, the investment in the contract shall not include any applicable nontaxable contributions or applicable nontaxable earnings.”

What this is saying in English is that there is no US cost basis and therefore 100 percent of the pension is taxable in the US

Pensions are classified as general limitation income for foreign tax credit purposes. This means that you will have two separate foreign tax credit forms (Form 1116) and because they are different types of foreign income, they cannot be used to help offset the other’s foreign tax credits. Withholding on pensions or annuities is 15 percent regardless of the size of the pension or annuity; we have had clients who have had pensions that paid them more than a million dollars per year and they still had 15 percent withheld.

3. Social Security

As a US tax resident, you are entitled to receive the benefits that you earned through the Canadian Pension Plan (CPP) or Quebec Pension Plan (QPP) and Old Age Security (OAS) systems while you were a Canadian resident, there are no unique requirements for eligibility because you are now a nonresident of Canada.

There are unique tax advantages for you as a nonresident of Canada verses being a Canadian resident when it comes to receiving benefits from CPP or QPP and OAS. As a US resident, your CPP or QPP and OAS are taxed only in the US and no longer taxed in Canada. As a US resident, you will receive the full benefit payment, without withholding and without any further tax reporting requirements. As a US resident, you are no longer subject to the OAS claw-back rules and you will receive your benefit regardless of your income. This is an ironic benefit for Canadians who leave Canada — it took you many years of living in Canada to earn the OAS benefits, but if you stayed in Canada, the benefits would have been taken away from you. Only by leaving Canada can many people actually receive their OAS benefits.

Note: Depending on how long you lived in Canada prior to leaving, you may receive full, partial, or no OAS benefits. To receive full benefits, you must have lived in Canada at least 20 years after the age of 18. To receive partial benefits, you must have lived in Canada at least 10 years after the age of 18. Less than 10 in Canada after the age of 18 and you are not eligible for benefits. Eligibility for CPP or QPP is the same as it is if you were still a resident of Canada, it is based on years of work and payment into the system.

Instead of being taxed in Canada, the income from CPP or QPP and OAS is taxed in the US in the same way that US taxpayers report social security income. The benefits are generally not taxable if your income (including the CPP or QPP and OAS) is less than US$25,000 if you are single, or US$32,000 for a married couple. If your income exceeds US$34,000 for singles (or $44,000 for a married couple), then 85 percent of your benefit is subject to income tax, and 15 percent is tax free. If you fall somewhere between the upper and lower limits, then your percentage of taxable benefits varies between 0 percent and 85 percent.

3.1 The Windfall Elimination Provision

While the Windfall Elimination Provision (WEP) is not a tax issue, it is an area of concern and confusion so we want to spend some time discussing the basics. For more information on WEP you can go to the Social Security Administration website at www.ssa.gov and read the book The Border Guide, where substantially more time is devoted to this subject.

WEP may apply whenever you worked in a job that you earned foreign social security benefits (CPP or QPP), without paying US social security taxes. If the WEP applies to you, your benefits can be reduced by as much as 60 percent. The good news is that the WEP rules don’t apply to you because of the Canada-US Agreement on Social Security. The bad news is that the Social Security Administration employees have little to no training on this subject. We have taken on a couple of these cases in the past and have won at the internal appeals level, but the results of those cases never make it into the training. The real problem is that the cost of fighting is greater than the benefit lost, so it is not cost effective to fight the issue.

If the Social Security Administration is telling you that you are subject to the WEP, our suggestion is to read the Canada-US Agreement on Social Security carefully and appeal your own case. Information can be found at Service Canada website www.servicecanada.gc.ca. The Agreement can be found at www.socialsecurity.gov/international/Agreement_Texts/canada.html.