What Canadians living in the U.S. need to know about TFSAs

I moved from Vancouver to San Francisco about nine months ago, and still have two tax-free savings accounts (TFSAs) in Canada. One TFSA has $11,000 in it (and has an unrealized loss of $6,000) and is held at a local bank. The second has $23,000 in it and is held through a robo-advisor.

However, just recently, I learned that my TFSA accounts are no longer “tax-free,” and income from them must be reported by U.S. residents on their tax returns. Based on the amount of time I’ve lived here, I pass the “substantial presence test” and also meet the definition of what makes a “resident alien” in the United States.

My question is, what I can do to avoid more taxes and penalties next year when I file my return for the income received this year in those two TFSAs? Should I close the accounts?
–Matheus

The tax-free savings accounts (TFSAs) is a uniquely Canadian savings vehicle that allows you to contribute up to a specified maximum amount annually and earn interest or capital gains tax-free. If you have never contributed before, the accumulated limit for 2022 is $81,500. The TFSA is not a tax deferred-account like the registered retirement savings plan (RRSP), which requires you to pay tax on withdrawals. Canadians can withdraw amounts from a TFSA at any time without having to pay tax, and will also regain contribution room in doing so.

As a resident alien, Matheus, you are taxed in the United States as if you were a citizen of the U.S., which means you must report your worldwide income to the Internal Revenue Service (IRS). You are correct in stating that TFSAs are not “tax-free” in the U.S. In fact, the U.S. treats them as if they are a foreign trust and require complicated filings with tight reporting deadlines and onerous penalties if you fail to report them on time.

More importantly, the income generated by the TFSA is taxable each year on your U.S. tax return. The prevailing wisdom amongst tax professionals is to withdraw your TFSA funds. This will not trigger taxes in Canada but your TFSA room will remain and can be used effectively at a later date if you return to Canada, or if the IRS changes its stance on Canadian TFSAs sometime in the future.

Theresa Morley, CAP, CA, is a partner with Morley Chartered Accountants in Barrie, Ont. She blogs at MorleyCPA.

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