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Phil Hogan, CPA, CA, CPA (CO)
Cross-Border Tax and Investment Specialist
Whether you’re a US citizen or a non-resident Alien US custodians are required to withhold US tax on payments of IRA and other related pensions to Canadian residents.
Under the Canada-US income tax treaty non-residents of the US are liable for a 15% US tax withholding and US citizens are subject to tax on the US pension up to a maximum of 15%. For the purposes of this article we will only be discussing periodic pension payments. We will also assume the the taxpayer is old enough not to incur any penalties on the pension withdrawals.
Most of this article will outline how to deal with over or under withholdings on US pension payments for non-resident US aliens. This is because regardless of what withholdings are done for US citizens, the taxpayer will be filling a US 1040 return each year and therefore can self-correct for any withholding deficiencies or excesses.
This is not the case for US non-resident aliens as they are not required to file US tax returns if the amount of withholdings on US source income is appropriate. For example, if the custodian of the US pension payments properly withholds 15% US tax pursuant to the tax treaty this is the final tax requirement for the non-resident of the US. However, when the custodian of the account does not properly withhold tax the taxpayer will need to correct this error by filing a 1040NR (non-resident US income tax return) and either paying any deficiency or requesting a refund for any amounts over the 15%. This article will deal exclusively with US pension payments (article XVIII of the Canada tax treaty), however the same idea applies to under or over withholdings on payments such as US dividends and alike.
We are discussing in the article to how correct these potential deficiencies, however if you can simply avoid having to file a 1040NR this would be ideal. Before you decide to actually pull from your US IRAs or pensions make sure to reach out to the custodian to ensure they are properly withholding and remitting the 15% to the IRS as required.
Ok, that being said, what do you do if the custodian of the account fails to properly withhold?
First, you’ll need to assess if you actually have a US individual Tax Identification Number (ITIN). If you have an IRA or other pension in the US you likely have an ITIN that you can use to file your 1040NR.
If you don’t already have a US ITIN you’ll need to file a W7 application to obtain your new ITIN. It can be tough to get approved for the ITIN, therefore it’s important to file the W7 with the 1040NR to ensure you increase your chances of successfully obtaining the ITIN.
The W7 can seem overwhelming at first, however with some proper instruction it should be relatively easy to complete:
Part 1 of the form will only require 2 inputs:
- check the box for “apply for a new ITIN”
- check box b. to select “nonresident alien filing a U.S. federal tax return”
For part 2 of the form you’ll want to enter you full name, mailing address, DOB, country of birth, gender, countries of citizenship, optional foreign tax ID and type of US VISA if applicable. You’ll also need to include details of your passport as discussed below.
In order to receive a successful ITIN you’ll need to submit appropriate government issued identification.
You can either have a registered acceptance agent verify your ID and submit disclosure documents with the W7, or as I often recommend, obtain a certified copy of your passport from your local passport office. If you can obtain a certified copy from the actual passport office you’ll be able to attach it to the W7 and not have to worry about using an acceptance agent.
For part 3 of the form all you’ll need to do is sign and date the form. If you’re using an acceptance agent they will also need to sign and date the form.
Make sure to submit this form with the 1040NR and include the words “applied for” in the box for “Your identifying number”:
Ok, so now that that you’ve completed the W7 we can move on to the actual 1040NR.
For purposes of this example I’ll use both a situation where the custodian of the account has under-withheld and one where they have over-withheld. Let’s assume the following:
- $100,000 USD periodic pension payments made in the year to a Canadian tax resident
- The taxpayer is not a US taxpayer
- Example #1 – the custodian withheld only 10% or $10,000
- Example #2 – the custodian withheld 20% or $20,000
In order to correct both of these examples you’ll want to do the following:
For both examples you’ll want to start with:
- complete filing status – assume single for now
- enter name, address and ITIN (or applied for as above)
- check individual
- answer crypto question
- In most cases simply leave the dependent section blank
Next you’ll want to skip to schedule NEC and add in the $100,000 of pension income (IRA or other) on line 7 column (b) 15%. Assuming you’re using software this will automatically calculate $15,000 of required tax on the $100,000 of US pension income on line 14.
The $15,000 on line 14 will be transferred to line 15 then to line 23a on page 2 of the 1040NR and then to line 24:
Now, this is where it will be different for example #1 and example #2. In both cases you’ll enter in the amount original withheld by the custodian of the pension on line 25b of page 2 of the 1040NR. You should have received a 1099-R (US taxpayer) or 1042-S (non-resident alien) reporting the taxable amount of your pension payment and the amounts withheld:
For example #1 because the amounts original withheld are less than the actual amount of tax required (15%) the taxpayer will be required to pay an extra $5,000 of tax to the US government on the $100,000 pension payments.
For example #2 the withholdings were more than the required 15% tax and therefore the taxpayer will be requesting a refund of tax on the 1040NR of $5,000.
Although we won’t get into the specifics on how to complete the form, you’ll also need to attach form OI to the 1040NR before filing.
Now that you’ve correctly calculated and paid the amount of tax required on the US pension payment you can use this 15% amount as your foreign tax credit on your Canadian return. I write a lot about this on the blog, however to recap for those of you that are not familiar with the process:
- The full amount of the taxable portion of the US pension payment will be converted to Canadian dollars at the average US-Canadian exchange rate for the year and reported as foreign pension income on the Canadian T1 income tax return
- You’ll be able to take a foreign tax credit equal to the 15% US tax paid converted to Canadian dollars
- The actual amount of the foreign tax credit will be the lesser of the 15% US taxes paid and the amount of Canadian tax you actually paid on the US pension income
I hope that this has been helpful to anyone that has experienced a situation where the custodian of their IRA has incorrectly withheld US tax on their pension income. Once again, the procedures above can certainly be avoided if you ensure the custodian withholds the appropriate 15% US tax withholdings.