2020-0846401E5 Tax Treatment of Roth 401(k) and Roth IRA

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: (1) What is the Canadian tax treatment of a Roth 401(k)? (2) Is a Roth 401(k) a “foreign retirement arrangement”? (3) Can a Canadian contribution to a Roth IRA be rectified or reversed? (4) What are the foreign reporting requirements for a Roth IRA?

Position: (1) Follows the underlying 401(k) plan. (2) No. (3) No. (4) Comments provided.

Reasons: (1) a Roth 401(k) is simply a feature of the underlying 401(k) of which it is a part. (2) Only traditional IRAs are prescribed to be a foreign retirement arrangement. (3) There are no provisions in the Act or the Canada-U.S. income tax treaty to reverse or rectify a Canadian contribution. (4) See below.

Author: Koh, Kah Foo

Section: 233.2; 233.3; 233.4; 248(1); Article XVIII of Canada-U.S. Treaty

XXXXXXXXXX                                                                                                                 2020-084640
                                                                                                                                         Kah Foo Koh

 

November 9, 2020

 

Dear XXXXXXXXXX:

Re:   Canadian Tax Treatment of Roth 401(k) and Roth IRA

We are writing in response to your inquiry of April 20, 2020 regarding Roth IRAs and Roth 401(k) accounts. Specifically, you asked us to comment on the following:

1.    the Canadian income tax treatment of a Roth 401(k);

2.    whether a Roth 401(k) is a “foreign retirement arrangement” (“FRA”) as defined in subsection 248(1) of the Income Tax Act (the “Act”);

3.    whether a contribution to a Roth IRA after December 31, 2008, by or on behalf of an individual who is the owner of the Roth IRA (the “Owner”) and while the Owner is resident in Canada (a “Canadian Contribution”), can be reversed or rectified in order for the Roth IRA to remain a pension under the Canada-United States Tax Convention (1980) (the “Treaty”); and

4.    the foreign reporting requirements with respect to Roth IRAs pursuant to the Act.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R10, Advance Income Tax Rulings and Technical Interpretations.

The CRA’s general views regarding certain aspects of the income tax treatment of Roth IRAs and other U.S. retirement arrangements (including Roth 401(k) accounts) are set out in Income Tax Folio S5-F3-C1, Taxation of a Roth IRA (the “Folio”).

1)    Canadian Income Tax Treatment of a Roth 401(k)

It is our understanding that the U.S. Internal Revenue Code (the “Code”) allows for the creation of a separate Roth 401(k) account within a 401(k) plan where some or all of the elective contributions of an employee-participant of the 401(k) plan can be designated as Roth contributions, which are generally included in that individual’s gross income for U.S. tax purposes in the year in which the contributions were made. Accordingly, a 401(k) plan could contain both pre-tax contributions and post-tax Roth contributions. Since a Roth 401(k) is simply a feature of a 401(k) plan, it is our view that the Canadian tax treatment of a Roth 401(k) follows the Canadian tax treatment of the underlying 401(k) plan of which it is a feature. See paragraphs 1.26 and 1.27 of the Folio for information on the characterization of a 401(k) plan under the Act.

2)    Foreign Retirement Arrangement

A FRA is defined in subsection 248(1) and section 6803 of the Income Tax Regulations as a plan or arrangement to which subsection 408(a), (b) or (h) of the Code applies. The plans referred to in these provisions are limited traditional IRAs. Roth IRAs or Roth 401(k) accounts are established pursuant to sections 408A and 402A of the Code, respectively, and therefore are not a FRA.

3)    Reversal or Rectification of a Canadian Contribution

Subparagraph 3(b) of Article XVIII of the Treaty provides that the term “pensions” generally includes a Roth IRA, within the meaning of section 408A of the Code. However, if a Canadian Contribution is made to a Roth IRA, subparagraph 3(b) also provides that part of the Roth IRA will cease to be considered a “pension”, potentially resulting in negative tax ramifications for the Owner (see paragraphs 1.12 and 1.13 of the Folio). Neither the Act nor the Treaty provides any mechanism by which a Canadian Contribution, or the negative tax ramifications of a Canadian Contribution, can be reversed or rectified. 

4)    Foreign Reporting

As noted in paragraphs 1.22 and 1.23 of the Folio, if an election under paragraph 7 of Article XVIII of the Treaty has been filed with respect o a Roth IRA and no Canadian Contribution has been made to the Roth IRA, the CRA does not require information relating to the Roth IRA to be reported in the following forms:

*    Form T1135, Foreign Income Verification Statement;

*    Form T1141, Information Return in Respect of Contributions to Non-Resident Trusts, Arrangements or Entities; and

*    Form T1134, Information Return Relating to Controlled and Not-Controlled Foreign Affiliates.

In the absence of an election, or if a Canadian Contribution has been made, information regarding the Roth IRA must be included (as applicable) when filing any of the forms listed above.

Yours truly,

 

Dave Wurtele
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2021

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2021


Monthly Tax Update

For additional commentary on Technical Interpretations, court cases, government releases, and conference materials in a single practical document specifically geared toward owner-managed businesses, see Video Tax News Monthly Tax Update newsletter.

This effective summary and flagging tool is the most efficient way to ensure that you, your firm, and clients are fully supported and armed for whatever challenges are thrown your way.

Packages start at $399/year.

Learn More