What is a TFSA?
A TFSA, or tax free savings account is different to other savings accounts that exist because it can be an investing account as well as a savings account, and allows for the money made on it to be tax free. However, for American expats living in Canada, this is actually not the case because the interest gained on a TFSA would come under the worldwide earnings of that person and as such would have to be included on their personal tax return form every year.
What are the forms 3520 and 3520-A?
The forms 3520 and 3520 A are both completed annually as part of a person’s tax returns, but are slightly different.
US citizens file the form 3520 to report any transactions with foreign trusts and large gifts or bequests from non US citizens who reside abroad such as inheritance. It is also filed to make the IRSaware of the ownership of any foreign trusts under the rules of sections of internal revenue code 671 through to 679.
The form 3520-A is slightly different as it is filed by a foreign trust and essentially reports on the trust and any of its US beneficiaries, as well as any US citizen who has ownership of any part of the trust.
The two types of TFSA
There are two types of tax free savings accounts in the eyes of the IRS, and the forms 3520 and 3520-A only actually need to be filled out for a minority of accounts.
The first type of account is a standard TFSA, wherein you have complete control of all of the money in your TFSA and can choose to save and invest it as you would like. In this account type, you are the sole beneficiary from the account and must actively invest your funds if you choose to go through this route of growing your funds.
However, there is also another type of TFSA, where your savings account is held “in trust”. This means that there is a third party, typically known as a trustee, who holds partial control of your account and takes care of your money for you. In this type of TFSA, your money is held in a separate fund, and requires less active decision making on the behalf of the owner and beneficiary as this partial control will allow the third party to make investment decisions for you in order to grow your savings account. However, having a trustee on your account makes your tax free savings account a “foreign trust” in the eyes of the IRS (international revenue service), meaning that you have to file for the forms 3520 and 3520-A.
One way to know whether or not your TFSA is a foreign trust is to look at the initial documentation that you received from the bank or other financial institution with which your TFSA is held. If there is any mention of a third party or an additional trustee in these documents, then it is likely that your account counts as a foreign trust in the eyes of the IRS.
Why do I now need to file the forms 3520 and 3520-A
There was a new revenue procedure released at the beginning of the year called “revenue procedure 2020-17”. It covers the exemption from filing for the forms 3520 and 3520-A for certain non US based savings accounts such as a retirement fund. However, because the funds in the majority of TFSAs are not directed for a specific purpose in this way, they do not become exempt under this revenue procedure. As such, US citizens living abroad, for example in Canada will still have to file for the forms 3520 and 3520-A
However, until this announcement, many US expats were unaware that it was a requirement for them to be filling out these forms for their foreign trust TFSAs. Regardless of if you have been filing for these forms in the past, you now need to file for them, and can make use of the Streamlined Tax Amnesty Service so as to avoid penalties for your previous non compliance with US tax laws.
What else do I need to do if I don’t need to fill out the forms 3520 and 3520-A?
If you don’t need to fill out the forms 3520 or 3520-A for your tax free savings account, there are still some other steps that you will need to take in order to correctly file your taxes. One of these steps is to add any interest that you have gained through your TFSA to your personal tax return form, as this counts as a stream of income and as such needs to be taxed.
Additionally, if the total value of all of your foreign accounts and TFSAs is over $10’000, you will need to also fill in the FBAR, also known as form 114, report of foreign bank and and financial accounts, which must be filed through the Financial Crimes Enforcement Network. This is not technically a part of the annual tax return, and so must be done separately, however this is still an essential task.
What if I have been filing forms 3520 and 3520-A when I didn’t need to?
If you have been filing the forms 3520 and 3520-A every tax year, but through the revenue procedure 2020-17 have now found out that this was unnecessary, you may choose to continue to file these forms. One reason for this could be for the peace of mind that filing these forms can bring. The international revenue service issues large penalty fees for citizens and green card holders who fail to complete their tax forms correctly. As a result of this, many people may choose to file the forms 3520 and 3520-A as an insurance policy to ensure that they avoid these penalty fees.
If this applies to you, and you have had no issue in the past with filing these forms, the safest route in terms of avoiding penalty fees would be to simply continue filing the forms 3520 and 3520-A.
What help can I get with filing the forms 3520 and 3520-A?
If you wish to seek professional advice to aid you in filing these forms, there are many ways in which you can be assisted. If you are unsure over whether or not your TFSA actually qualifies as a trust, a professional can go over the bank’s documentation with you to work out whether you actually need to file these forms. Additionally, if filing these forms is difficult for you, or you want to ensure that you are filing them correctly to avoid any penalties by the IRS, consulting a professional can help with that.
A summary of things to remember when considering taxation on your TFSA
If your TFSA is considered to be “in trust”, meaning that it has a trustee on the account, then you will have to file for the forms 3520 and 3520-A as part of your annual tax return. If your TFSA does not come under this umbrella, then you do not have to file forms 3520 and 3520-A, but may still choose to if you wish. Even if you do not need to file the forms 3520 and 3520-A, there are still several other things that you have to consider when it comes to your TFSA, such as ensuring that it is included in your personal tax return form, and that you fill in the FBAR if necessary.
Contact us at Expat Tax Online to find out some of the general rules around the new revenue procedure and see if you meet the criteria for not fling and 3520 or 3520-A.