So your favorite Uncle Sam died in California and he named you as the beneficiary of his traditional IRA. You are a Canadian resident and the only time you spend in the United States is two weeks a year in January to visit Uncle Sam in Palm Springs. Now you’ve just inherited a $150,000 lump sum distribution from Uncle Sam’s IRA and you’re thinking you get to receive that money tax free because it’s an inheritance. Before you rush out to put that $150,000 towards a down payment on that cottage in Bobcaygeon you’ve been dreaming about, you should be aware of the tax implications on both sides of the border.
First, an IRA is similar to a RRSP in the sense that contributions are tax deductible, the amounts contributed grow tax-free inside the plan, and tax is only payable when the money is withdrawn from the plan.
Therefore, where an IRA is inherited by an individual who resides in the U.S., any amount paid out of the IRA to the individual, either directly or through the decedent’s estate, is generally taxable in the U.S.
Generally, in the case where the beneficiary is a nonresident alien, the beneficiary of the IRA has to pay US income tax on the distribution at a flat rate of 30%. Furthermore, a nonresident alien beneficiary is subject to 30% federal US income withholding at the time he/she receives a traditional IRA distribution. The Canada-US tax treaty, however, lowers the tax and withholding rates to 15%. To take advantage of the lower rate, you will need to properly complete and submit IRS Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, to the IRA custodian/trustee.
In addition to being subject to US tax, where an IRA is inherited by an individual who resides in Canada, an amount paid out of the IRA to the individual is generally taxable in Canada in the hands of the individual. While Canada has the right to tax IRA distributions received by a resident of Canada, the amount taxable by Canada is limited to the amount that would not be excluded from taxable income in the U.S. if the recipient were a resident of the U.S.
Therefore, when you file your tax return in Canada, you must include in income the distribution from Uncle Sam’s IRA and you will get to claim a foreign tax credit for the taxes paid to the U.S, including any U.S estate taxes paid in respect of the IRA.
One other thing to note. While Uncle Sam’s generosity is encouraged, it generally makes sense to name a U.S. beneficiary, instead of a nonresident beneficiary, because a U.S. beneficiary can inherit the IRA and, under certain circumstances, continue taking advantage of tax deferred growth in the IRA.
If you inherited an IRA as a resident of Canada, then Gedeon Law & CPA is available to assist you with properly reporting the inheritance in Canada and the U.S.
Gedeon Law & CPA
A Professional Law & Accountancy Corporation
Office: (424) 254 9529