How is my Canadian RRSP Taxed in the U.S.?

I have good and bad news for those of you that live in the U.S. but have a Canadian RRSP from when you lived in Canada. The good news is that there is a really good chance your taxation here in the states will be lower than if you took the same distributions in Canada. The bad news, trying to figure out just how much taxes you will pay, can be a pain in the butt. This article is meant to discuss the taxation of your RRSP, while living here in the U.S.  

DISCLAIMER: I strongly suggest talking to your international tax expert before taking any RRSP distributions.

Can I keep my RRSP while I live in the U.S.?

A few years back the IRS made it very clear that not only can you keep your RRSP, you don’t need to fill out a bunch of forms and declare the assets each year. You can read more about the ruling here. Although you typically can’t contribute to a RRSP while living in the U.S., keeping the assets in the RRSP while working here in the U.S. may be your best strategy.  I have written another article here about different RRSP strategies while living in the U.S.

Foreign tax credits

If you are living in the U.S. as a citizen or resident, you need to file taxes on any worldwide income. Which means that if you take a RRSP withdrawal, you will need to include that as income and you need to pay taxes on the income in Canada and the U.S. So, you have to pay taxes two times?! Not necessarily. In order to avoid double taxation, you are able to take a tax credit for any Canadian taxes that you pay in the year. For example, let’s say that you take a $20,000 withdrawal from your RRSP. You will have $5,000, more on this later, withheld to pay Canadian taxes. The $20,000 will be added to your income here in the U.S.  You will then be able to take a credit for up to $5,000 on your U.S. taxes, hopefully offsetting the higher income you now have to report on your taxes. Confused yet? Well, we’re just getting started.

The amount of the foreign tax credit that you can apply is the lesser amount of foreign taxes paid or the U.S. tax liability on the foreign income. For example, if you have a $5,000 tax credit but only had $2,000 of U.S. tax liability, you would only be able to use $2,000 of your tax credit. The remaining $3,000 can be used to offset prior or future tax liability for up to ten years. Of course, using the tax credit on previous tax returns, would require you to complete an amended return. Now that I have thoroughly confused you, let’s talk about the actual taxation of RRSP distributions.

Federal Taxation of RRSP distributions

If you are living in the U.S. and take a distribution from your RRSP, there is an automatic 25% withheld to pay Canadian taxes. For example, as I discussed above a $20,000 withdrawal would require $5,000 to be withheld for taxes and you would receive $15,000. This 25% should be good for your Canadian tax liability but may or may not be enough to cover your U.S. federal taxes. Below are the 2018 tax tables if you file single or married filing jointly (MFJ).

2018 Tax Rates.png

Source:  Forbes

As I mentioned before, you have to include all worldwide income here in the U.S.  This worldwide income is added onto your adjusted gross income (AGI) and you are taxed here at the same rate as if you earned it here. Of course, the foreign tax credit helps offset this extra income. So, if your marginal tax bracket is under 25%, you should have no additional taxes due as the foreign tax credit is higher than your actual tax liability. If your marginal tax bracket is over 25%, you will actually owe additional taxes on the withdrawal than what was withheld. For example, if you are in the 32% tax bracket, but you only get a credit for 25% of your withdrawal, you will need to pay another 7% to the government in taxes.

I know, not confusing at all. We haven’t even gotten to state taxes.

State taxes on RRSP distributions

It can vary from state to state but in all likelihood, you will also have to pay state taxes on the income. Of course there are some states that don’t have income taxes,  but here in Michigan you will need to pay state taxes on the RRSP income. Michigan relies on the federal 1040 to determine state taxes. Foreign income, including RRSP withdrawals, flow right into the 1040. In Michigan, the state tax rate is 4.25%.

Taxation on RRIF distributions

If you have an RRSP, you have the option to convert to an RRIF and start yearly distributions. The benefit of doing this is that there is only a 15% foreign tax withholding on the RRIF. This is a significant benefit, especially if you are in the lower 10% or 12% tax rate. Instead of paying taxes at 25% on RRSP withdrawals, and not use all of your foreign tax credit, you can just pay taxes at 15%. Now for folks in the higher tax brackets, there is not as much of a benefit. This is because you will probably have to pay additional taxes, if your tax bracket is over 15%.  Again, let’s say that you are in the 32% marginal tax bracket. Yes, you are only having 15% withheld to pay for Canadian taxes, however, this distribution needs to be added to your income and you will have to pay U.S. taxes at 33%.

A quick summary:  

RRSP Distributions – 25% Foreign Tax Withholding

Tax Rate Total Taxes Paid
Under 25% Marginal Tax Bracket 25%
Over 25% Marginal Tax Bracket Marginal Tax Bracket

 

RRIF Distributions – 15% Foreign Tax Withholding

Tax Rate Total Taxes Paid
Under 15% Marginal Tax Bracket 15%
Over 15% Marginal Tax Bracket Marginal Tax Bracket

 

Taxes are confusing and dealing with taxes from two countries can be downright brutal.  The good news is that moving from Canada to the U.S. is probably the most tax beneficial thing that you can do.  Lower taxes and the proper use of foreign tax credits can make distributions from the RRSP and RRIF not as painful as you may think.  

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