By now many US Citizens (and holders of US green cards) living in Canada are aware that they must file US income tax returns and other forms because of their citizenship status; and that the failure to comply can have ruinous financial consequences. What many don’t know, however, is that the same individuals must also file another annual form or risk losing the tax-free growth in their registered retirement savings accounts (RRSPs).
Article XVIII(7) of the United States – Canada Income Tax Convention (the “Treaty”) provides that an individual may defer taxation on income accumulated in RRSPs, RRIFs, registered pension plans, and deferred profit sharing plans, however, the individual must make an affirmative annual election in order to avail himself of the tax-free accumulation. The election must be made on the US form 8891 and included annually with a timely filed US income tax return. If the individual has not timely filed US returns, or if he has missed a few years, he cannot remedy this problem by simply filing the delinquent returns. A lot of Canadian residents are in this position.
Fortunately there is a solution to the problem of unfiled forms 8891 which allow the individual to retroactively elect tax-free deferral in his RRSP or other retirement account. Unfortunately, the procedure to remedy the problem is complex and granted at the discretion of the IRS, so the results are not a certainty.
Treasury Regulation 301.9100-1(c) gives the Commissioner of the IRS the discretion to grant a taxpayer a reasonable extension of time to make a regulatory election (such as the election to defer income tax on the form 8891) in certain circumstances. Treasury Regulation 301.9100-3 a) provides that the Commissioner may grant such extension provided: a) the taxpayer acted reasonably and in good faith, and b) granting the extension will not prejudice the interests of the US Government.
The process for requesting the extension under the Treasury Regulations is complex and requires the collection of facts, substantiating those facts (with affidavits and by other means), and making legal and factual arguments to support the request. Even if the taxpayer follows all of the formalities to request an extension, the request may be denied. If the request is denied, the taxpayer will have to pursue the matter in accordance with the administrative procedures established by the IRS.
On August 12, 2011 the IRS granted a taxpayer such an extension to elect tax-deferred treatment of his RRSP. Under the facts of that ruling, in year one the taxpayer hired a Certified Public Accountant (the U.S. equivalent of a Canadian Chartered Accountant) to prepare his US income tax return. The CPA failed to file form 8891 with the return and the omission was not detected until year two when the taxpayer hired another professional. Finally, and perhaps most importantly, at the time the taxpayer made his request for an extension the IRS had not contacted the taxpayer regarding the omitted election. The taxpayer was able to substantiate the foregoing and was granted the requested extension.
However, even considering the work involved and the uncertainty in the outcome we are advising our clients (and representing them in the process) to immediately seek an extension of the election, even if they have not filed returns for several years. If taxpayers choose to ignore the problem, it will not go away on its own and they will likely wake up one day with a substantial US income tax bill that may not be so easy to resolve.