RESP Account And Tax Deferral
It is quite common that U.S. citizens living in Canada hold a Registered Education Savings Plan (RESP) on behalf of their children.
A RESP account allows money deposited for a child’s post-secondary education to grow on a tax-deferred basis. Unfortunately, unlike RRSPs, the RESP is not a tax-deferred plan for U.S. tax purposes. They don’t have the same tax-deferral election under the US-Canada Treaty as an RRSP.
RESP Income Is Taxable In The U.S.
Income earned in the RESP is taxable to the subscriber (generally the parent) on their U.S. return in the year the income is earned. It is important to note that any grant received from the Government of Canada, such as Canada Education Savings Grants (CESGs) in the RESP is also considered income, and is taxable in the U.S. in the year it is received. Thus, you should report all interest, dividends and capital gains inside those plans annually on your U.S. tax return.
Further, if any holdings in the account include foreign mutual funds, it is likely that they are considered PFICs and would require additional disclosure on the Form 8621.
U.S. persons must report this income on their U.S. tax return, despite the fact that they are not required to do so for Canadian tax purposes.
In the case of RESPs, this can result in double taxation on the RESP– once in the hands of the parents on their U.S. tax return, and again in Canada in the hands of the child when the funds are withdrawn from the RESP several years later.
Foreign Trust Treatment Of A Registered Education Savings Plan
In addition to these negative consequences, the IRS considers RESPs to be a foreign trust. The RESP subscriber will have to file Form 3520, Annual Return To Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts for any year in which they contribute to, or withdraw from, these plans.
In addition, the subscriber will need to file Form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner for any year that the plan exists. A separate set of each form will be necessary for each RESP account.
The Form 3520 and Form 3520-A foreign trust returns are complex to prepare; thus, the compliance required for these investments can become very costly. Not to mention that there can be significant penalties for failure to file the forms.
One practical solution to these issues is to transfer the RESP into the hands of a non-U.S. citizen/resident subscriber. Typically, a non-U.S. parent, grandparent or other relative becomes the subscriber. This transfer does not, however, address the filing requirements of the U.S. citizen for the tax years in which they were still the subscriber. However, it will provide relief on a go-forward basis for future years.
It is important to recognize that the U.S. tax rules treat certain items differently than they are treated under Canadian tax rules (the same can be said for any other country for that matter). In the case of RESP accounts, they are never treated as tax-deferred vehicles in the U.S., and are generally subject to U.S. foreign trust tax filing obligations.
FBAR Reporting For RESP Accounts
Finally, it is important to note that you should disclose all of the accounts discussed in this article on the FinCen Form 114 (FBAR) and IRS Form 8938, Statement of Specified Foreign Financial Assets, if you meet the respective filing thresholds for these two forms.
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