The Internal Revenue Service recently released Publication 597 (rev. Oct. 2015), which provides information concerning the income tax treaty between the United States and Canada. The publication addresses a number of treaty provisions that affect U.S. citizens or residents who may be subject to taxation in Canada. Most notably, the IRS gives guidance on the taxation of pensions, annuities, social security and alimony, as well as taxation of charitable contributions.
Here are some highlights.
Pensions and Annuities
The publication provides that under Article XVIII of the treaty, pensions and annuities from Canadian sources paid to U.S. residents are subject to Canadian taxation, however the tax is limited to 15 percent of either the gross amount of a pension or the taxable amount of an annuity. The United States may also tax such pensions and annuities, provided that the amount included in income for U.S. tax purposes may not exceed the amount that would be included in income in Canada if the recipient were a Canadian resident.
Roth individual retirement accounts aren’t subject to Canadian tax to the extent it would be exempt from U.S. tax if paid to a U.S. resident. An election to defer tax in Canada is available on income accrued, but not yet distributed, within the Roth IRA, excluding those accruals that result from contributions made after the person becomes a Canadian resident.
Income accrued in certain Canadian retirement plans (for example, registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs)) is subject to U.S. tax, even if it isn’t distributed, but a U.S. citizen or resident can elect to defer the tax until the income is distributed. The publication cautions that “individuals who have previously reported the undistributed income accrued in a Canadian retirement plan (including RRSP or RRIF) on a U.S. federal income tax return aren’t eligible individuals as described in Revenue Procedure 2014-55, and must continue to report the undistributed income accrued in their Canadian retirement plan on their U.S. federal income tax return and pay U.S. tax on the undistributed income. If these individuals want to make the election, they must seek approval from the IRS.”
Based on the treaty, U.S. social security benefits paid to a Canadian resident are to be taxed in Canada as if they’re benefits under the Canadian Pension Plan, except that 15 percent of the amount is privy to an exemption.
Alimony and any similar child support payments from Canadian sources paid to U.S. residents aren’t subject to Canadian tax and are excluded from income to the same extent they would be excluded from income in Canada if the recipient were a Canadian resident.
The IRS explains that certain qualified Canadian charitable organizations may be deducted on an individual’s U.S. income tax return, with one major caveat. The qualified contributions (excluding any contributions to a college or university at which the individual or a family member is or was enrolled) are subject to the overall limits applicable to charitable contributions under U.S. tax law, as well as to the U.S. percentage limits on charitable contributions, applied to the Canadian source income. The catch-22 is therefore that without a Canadian source income on the tax return, the contributions generally aren’t deductible.