Under Canadian tax rules, a Registered Education Savings Plan (RESP) is an amazing tool for deferring tax while saving for your child’s education. A move south of the border may wipe these benefits out! Why? The income earned on a Canadian RESP is included on a U.S. return in the year the amounts are earned, as the RESPs of a U.S. person do not enjoy the Canadian status of being tax deferred. The flip side is also true. The earnings on a U.S. 529 savings plan of an individual resident in Canada, would be included on their Canadian income tax return as taxable income.
Potential for Double Taxation
Now, while both the U.S. and Canada generally allow for the recognition of credits for taxes paid in the other country, timing differences on when the amounts are taxed may cause issues. These foreign tax credits allowed to be taken on a tax return for taxes paid in another country are often claimed in the year they are paid or accrued, with some limited provisions to carry these amounts to another year. With the income earned on an RESP taxed annually in the U.S. and generally not taxed in Canada until a much later taxation year when the funds are withdrawn, this can be an issue. The likely result – double taxation on the same income.
Additional Costs of U.S. Tax Compliance
In addition to the issue of potential double taxation of the same income, an RESP is usually captured under U.S. grantor trust rules – meaning, there is some extra paper work that must be completed annually, to avoid a hefty fine from the U.S. Internal Revenue Service. So, in addition to the risks of double taxation on the same income, there are additional compliance costs that should be considered.
Consider Appointing a Canadian Subscriber
Once you leave Canadian soil, even a skilled tax preparer may not be able to avert these potential pitfalls. So, before departing Canada, consider appointing a Canadian subscriber to your child’s RESP. The subscriber is treated as the owner of the plan under U.S. grantor trust rules. If the subscriber to the plan is not a U.S. person, they will not be subject to U.S. taxation. As such, the tax-deferred status of a Canadian RESP is maintained.
The views expressed in this article are those of the author and should not be relied on to make decisions. Consider discussing your specific circumstances with an appropriate specialist.