Index investors in the US have always had it easier than Canadians, thanks to lower costs and more choices. Unfortunately, if those investors move to Canada, their plight becomes much more difficult.
Unlike Canada (and virtually every other western country), the US requires its citizens to file an annual return and potentially pay taxes even if they live abroad. The rules may apply even if you were born in Canada and have never lived in the US, since it’s possible to inherit citizenship from US-born parents. For tax purposes, “US persons” don’t even need to be citizens: they can also be Canadian green card holders or snowbirds.
Tax implications for US persons living in Canada are complex and often controversial: if you’re in this situation, you should seek help from an advisor who specializes in cross-border issues. But here’s a heads-up on two issues that have recently come up with clients of our DIY Investor Service who had no idea they were flirting with danger.
Don’t open a TFSA or an RESP. Tax-Free Savings Accounts (TFSAs) and Registered Education Savings Plans (RESPs) offer significant tax benefits for Canadians. But the US government may consider them foreign trusts that require additional reporting. US tax filers are also obliged to report all investment gains from these accounts (interest, dividends and capital gains) on their annual returns.
As a US citizen in Canada, it’s likely not worth it to open a TFSA at all. If you do have one, you should hire a professional to make sure you’re compliant, and that expense could offset any tax savings you might get from the account. If you’re married to Canadian, remember you can give a spouse money to contribute to his or her own TFSA: this is a simple solution for couples who are not able to contribute the maximum anyway.
For RESPs, too, the situation is easier if you’re married to someone who is not a US person for tax purposes. Simply make sure your spouse is the plan’s subscriber.
Don’t hold Canadian funds in non-registered accounts. The US imposes punitive taxes on income from what are called Passive Foreign Investment Companies (PFICs). Canadian mutual funds and ETFs are considered PFICs, and US persons who hold them in a non-registered account are now required to file Form 8621 every year. (Holdings under $25,000 may be exempt.)
Reporting PFICs is an odious task (the instructions are 13 pages long) and a tax advisor will charge a significant fee to prepare the paperwork. Moreover, you may be required to obtain an annual information statement from the mutual fund provider, and this may prove difficult or impossible. Some firms, such as Dimensional Fund Advisors, provide them on their websites (sample here), but ETF providers don’t seem to do so. [2016 Update: Some ETF providers now make these available on their funds’ web pages.]
Note that holdings in an RRSP don’t need to be reported as long as you have filed Form 8891, but if you ignored the advice against opening a TFSA or RESP, you would need to report holdings in these accounts.
If you’re a US citizen living in Canada, the easiest thing to do is simply avoid Canadian mutual funds and ETFs in non-registered accounts. If possible, hold any Canadian index funds and ETFs in your RRSP and use US-listed ETFs for your equity holdings in non-registered accounts. Even if you pay too much for currency conversion, the expense is likely to be far lower than the cost of complying with US tax law.