New IRS guidance exempt RESPs and RDSPs, but not TFSAs from annual US information reporting requirements. Our view remains that TFSAs are not foreign trusts and thus not subject to 3520 + 3520-A reporting (read more). All told, with this Revenue Procedure US taxpayers with Canadian registered plans will not have to report them on these complex forms. It also allows those who have been assessed penalties for late filing Form 3520 and 3520-As for RESPs and RDSPs to apply for a refund or abatement of the penalties under the new procedures.
On May 21, 2018, the IRS Large Business & International division announced the rollout of six new campaigns, including a campaign for Form 3520 and Form 3520-A non-compliance. Since that time, there has been a tremendous increase in substantial penalties being assessed under IRC section 6677 for Form 3520 and Form 3520-A non-compliance. We previously wrote about that here. Of particular concern, penalties at a minimum of USD $10,000 appear to have been applied indiscriminately for Form 3520s and Form 3520-As which were filed late or incorrectly for such mundane arrangements such as Canadian RESPs. That is welcome news to those who have had to deal with the onslaught of penalties.
In response, the IRS has announced today (March 2, 2020), a new revenue procedure (Rev. Proc. 2020-17; https://www.irs.gov/pub/irs-drop/rp-20-17.pdf) which provides penalty relief for taxpayers who have been assessed section 6677 penalties on qualifying tax-favored foreign retirement trusts and qualifying tax-favored nonretirement savings trusts. Rev. Proc. 2020-17 also announces an exemption from the Form 3520 and Form 3520-A filing requirements for qualifying tax-favored foreign retirement trusts and qualifying tax-favored nonretirement savings trusts. A more technical discussion of the Revenue Procedure follows.
Relief qualification requirements:
In order for a taxpayer to qualify for Rev. Proc. 2020-17 penalty relief:
- Eligible individual. The taxpayer applying for relief under the procedures must be an individual US citizen or resident. The individual must also be in compliance (or come into compliance) with their US tax obligations for tax years within the section 6501 period. Note: In determining the applicable section 6501 period, section 6501(c)(8) is disregarded. Therefore, the applicable period does not include tax years which remain open solely by virtue of section 6501(c)(8), e.g. a year which remains open solely because a taxpayer failed to file Form 3520 and/or Form 3520-A.
- An eligible individual may apply for penalty relief and receive a Form 3520 and Form 3520-A filing exemption for certain qualifying trusts. There being:
- Tax-favored foreign retirement trust. These are trusts which are established under foreign law for the provision of pension or retirement benefits and ancillary or incidental benefits. Due to the already existing exemption for Canadian RRSPs, the exemption for tax-favored foreign retirement trusts would have limited benefit for most Canadian residents. As qualification as a tax-favored foreign retirement trust requires that contributions to the trust be income tax exempt or otherwise tax-favored in the trust’s jurisdiction, and that contributions be limited to income earned from the performance of personal services, TFSAs would be precluded from inclusion in this category.
- Tax-favored foreign non-retirement savings trust. These are trusts which are established under foreign law to operate exclusively or almost exclusively to provide medical, disability, or educational benefits. For a trust to qualify:
- It must be generally exempt from income tax or be otherwise tax-favored in the trust’s jurisdiction;
- Annual information reporting with respect to the trust (or about the beneficiary or participant) must be provided, or be otherwise available, to the relevant tax authorities in the trust’s jurisdiction;
- Contributions to the trust must be limited to either USD $10,000 or less annually or USD $200,000 or less on a lifetime basis. The determination of whether a trust meets this requirement is made on the last day of the tax year based on the US Treasury’s published foreign exchange rate; and
- Withdrawals, distributions, or payments from the trust must be conditioned upon the provision of medical, disability, or education benefits, or non-qualifying distributions subject to penalties.
RESPs and RDSPs, but not TFSA should qualify as tax-favored foreign non-retirement savings trusts. RESPs and RDSPs are both Canadian tax exempt. Annual information with respect to RESPs and RDSPs is available to the CRA. Lifetime RESP contributions are limited to CAD $50,000 per beneficiary, and lifetime RDSP contributions are limited to CAD $200,000 per beneficiary. Finally, while non-qualifying RESP and RDSP withdrawals are not subject to Canadian penalties per se, non-qualifying withdrawals do result in:
- Loss of government grant money in the case of both RESPs and RDSPs;
- and Higher withholding tax on non-educational accumulated income RESP withdrawals.
Previously, we had expressed the view that the RESP was not a foreign trust for US federal tax purposes and thus no 3520 or 3520-A reporting was required. While we still hold that view, this Revenue Procedure has made the question moot.
Applying for relief of previously paid penalties:
Relief is available for any open tax year to eligible individuals who have been assessed section 6677 penalties on qualifying tax-favored foreign retirement trusts and tax-favored foreign non-retirement savings trusts.
To apply for relief, taxpayers should file Form 843 by mail to Internal Revenue Service, Ogden, UT 84201-0027. Under line 7 of Form 843, eligible taxpayers should indicate that they are filing for relief under “Relief pursuant to Revenue Procedure 2020-17” and include an explanation of how they meet the requirements of an eligible individual and the relevant trust the requirements of either a tax-favored foreign retirement trust or a tax-favored foreign non-retirement savings trust.