Inherited IRA from Brother in Texas

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Each year I help over 500 clients file their Canadian and US tax returns as well as plan for both their Canadian and US investment accounts. I also regularly help new US clients plan for their move to Canada.

Feel free to reach out via email at phil@philhogan.com or by phone or text here 250-661-9417.




Question

My husband and I live in a small town in rural Canada. In 2019 my husband’s brother, who lived in Texas, passed away and left my husband as beneficiary of an IRA account. Now we are in a frenzied dilemma!

Not sure what to do – we have talked with accountants in Canada who were no help at all. We understand that my husband must claim this money this year as “income” on his tax return.

Do we have to file taxes in Texas? Do we get some of the money back that was taxed in the states before we received it? What do we claim? – the amount before or after federal withholding in the states? We have no idea where to start or how to go about it.

Greatly appreciate any advice you can dispense

Thanking you in advance
XXXXX XXXX

Answer

Hi XXXXX

Thanks for the email. The answer to your questions depends on a few factors, however, based on the information below I think I have a pretty good idea of what happened.

When your husband inherited the IRA there would have not been any immediate tax consequences to the transfer. If he didn’t take a distribution from the IRA the account would have remained tax-free until any distributions were made. However, considering you mentioned “withholdings” below it sounds like he’s already liquidated the account.

I’m going to assume that the full account was liquidated and nothing is currently left in the IRA, please let me know if that is incorrect.

In that case, the full amount of the IRA will be taxable in Canada (converted to Canadian dollars) at full marginal rates. That being said, you will get a credit on your Canadian returns for any US taxes paid on the IRA withdrawal. Assuming you are not a US citizen (please let me know if you are as this will change the answer) the correct withholding on the IRA withdrawal should be 15%. This is the correct US tax required under the US-Canada income tax treaty. I also want to confirm that this is a traditional IRA and not a ROTH IRA. Once again, if this is a ROTH IRA the answer will change.

Also note, that although he held a US account in 2019/2020 the IRA will not need to be reported on a T1135.

You mention state tax withholding in your question below which is a little concerning. There shouldn’t be any state withholding on the IRA distribution. If there was State tax withholding you could get this recovered by filing a state tax return, however, it would be challenging if you don’t already have a US ITIN.

You mentioned below that this happened in 2019. Was the IRA fully distributed in 2019 or 2020?

I hope the information contained within has been helpful, please let me know your thoughts.

Cheers

Phil

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