California Residents: Does your financial advisor tax-manage your RRSPs?

Residents of California that hold RRSPs, LIRAs, RRIFs or other Canadian tax-deferred accounts are subjected to a unique set of tax planning and reporting requirements.  While most U.S. states continue to allow Canadian retirement accounts to grow on a tax-deferred basis, California does not take this position.  Unfortunately, this can present a serious income tax problem for residents of California given the state taxes the annual income distributions (interest and dividends) and realized capital gains inside a Canadian registered plan.
What are California’s Tax Rules?

Under California tax rules, the state requires its tax residents to include annual investment earnings on their Form 540. Unlike the taxpayer’s U.S. federal return, the State of California (Franchise Tax Board) requires that you pay tax annually on your RRSP earnings.You would be responsible for including your interest (line 8), dividends (line 9) and capital gains (line 12) of Schedule CA. They will ultimately appear in Column C for additions to income. If you have a capital loss, the loss would be reported in Column B of line 12.

The State of California’s tax position on this matter is reported in Franchise Tax Board Legal Branch Information Letter No. 2003-0040  The ability to avoid the inclusion of this income for California State tax purposes can be rather difficult given that the State requires that the Taxpayer’s complete tax return including Form 8938 are included. This then would give the Franchise Tax Board the ability to determine whether a taxpayer has an RRSP and has included the accrued income within their Form 540 return. To make matters worse, if a California resident were taking distributions from their RRSP/RRIF where Canadian withholding tax was being remitted to Canada Revenue Agency (under the Treaty), this tax would not be eligible as a foreign tax credit for California State tax purposes.The State does not recognize, nor are they party to the Canada – U.S. Income Tax Treaty.
What can be done to minimize tax?
Unfortunately and all too often, Canadian advisors overseeing Canadian retirement accounts are not familiar with California’s treatment of these accounts.  Nor do they have investment strategies in place to ensure the management style and philosophy employed is uniquely mapped to California’s tax rules. And why would they?  Their core clientele are Canadian residents with RRSPs and not U.S. residents that live in California.  That is one of the reasons we suggest clients living in the U.S. and especially California, work with a Canada-U.S. cross-border financial planning.

At Cardinal Point, we attempt to reduce taxable transactions inside client’s Canadian retirement accounts through a tax managed style of investing.  First, we treat the account as if it is a taxable (non-registered account) and not a traditional tax-deferred retirement account.  In doing so, wealways consider the future tax consequences of each security selected. For example, an RRSP account being managed on behalf of a Canadian resident might typically include higher yielding, income producing securities.  This makes sense under Canadian tax rules for residents of Canada because investment income inside an RRSP plan istax sheltered.  In California, however, the exact opposite is true.  Therefore, we select investment securities that attempt to limit large taxable transactions or distributions inside the account.
Another key component to tax managing a Canadian retirement account is to employ tax loss selling when possible.  When a security with a capital gain is sold, proactively sell a security in the account with an unrealized capital loss to offset the gain where possible.  If a security in the account has a large unrealized capital gain, we may attempt to reduce the holding over a number of years to minimize taxes versus selling out the entire positions at once which could incur a hefty tax bill.

The ultimate goal is to tax manage the account to the greatest degree possible without compromising the integrity of the clients’ overall investment strategy or performance.
Other Considerations for RRSPs
Aside from tax managing Canadian retirement accounts on behalf of California residents, we also provide the following strategies:

USD-Denominated RRSPs:We have the ability to manage your RRSPs in U.S. dollars, eliminating the need to monitor the Canada-U.S. exchange rate.

Cross-Border Account Integration: We offer integration with your U.S. investment accounts so that the investment strategies of your Canadian and U.S. accounts complement each other.

Proper Tax Reporting: Our firm provides Canada-U.S. tax reporting and preparation services to ensure all IRS and state foreign account reporting and disclosures are done correctly.

Discharging Your RRSP: We advise on the best process, timing and tax strategy to distribute your RRSP.

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