The Tax-Free Savings Account (TFSA) is a favourite for Canadian savers, but when Canadians head south, things get messy. Many tax advisors these days err on the side of caution by treating the TFSA as a foreign trust and recommending Form 3520 filings. While this approach might check all the compliance boxes, it’s far from straightforward, and usually means hefty filings costs ($$$). The reality is that a TFSA may not fully align with the IRS’s definition of a trust, meaning Form 3520 filings could, in some cases, reflect cautious over-compliance rather than an absolute necessity
The Trust Question: Why the TFSA Differs
To determine whether a TFSA is potentially a trust for U.S. tax purposes, we need to dig into the mechanics of what a trust is under U.S. law. The IRS defines a trust in Treasury Regulation § 301.7701-4(a) as an arrangement where a trustee takes title to property for the benefit of its beneficiaries. This definition assumes a clear transfer of ownership and responsibility for managing the property to the trustee.
Here’s the wrench: banks and financial institutions that administer TFSAs don’t formally take title to the property within the account. Instead, the account holder retains full ownership and control of the assets.
Let's look at the fine print:
- Ownership and Control. Imagine Andrea, a Canadian living in the US on a TN visa, has a TFSA holding 50 shares of Apple stock. Generally she can sell those shares directly through her online account, vote at shareholder meetings, and receive dividends. These actions would appear to indicate she retains ownership of the shares. The Canadian broker doesn’t own the shares; they “administer” the account.
- Property Transfer. Under Canadian tax law, a key feature of a TFSA is the account holder’s ability to transfer their assets to another TFSA at a different institution. This would be impossible if the financial institution held title to the property.
The Business Purpose Test
The IRS typically looks at whether an arrangement serves a business purpose when classifying entities. Under Canadian legislation, the TFSA can't exist for any business purpose. Its primary role is to offer individuals a tax-advantaged savings account, and very specifically is NOT to ever operate as a separate entity for business or investment purposes.
CRA’s treatment of TFSAs under audit aligns with this interpretation. When account holders generate significant returns, CRA has frequently argued that such accounts are "carrying on a business," (See Canadian Western Trust Company, among many others). These audits underscore the intent behind the TFSA: it’s designed for personal savings, not business-like operations.
Moving to the other side of the border: Revenue Ruling 2004-86, which addresses entity classification, supports this perspective. Entities like Delaware Statutory Trusts, created for legitimate business purposes, are recognized as separate entities for U.S. tax purposes. A TFSA, however, likely doesn’t fit this treatment (It's not created for business purposes, after all.)
Are TFSA's Separate Entities?
Even if we set aside the Is-This-Even-A-Trust question, the TFSA may not meet the broader criteria for entity classification under U.S. tax law:
- No Liability Protection. Unlike a corporation or trust, there's an argument that a TFSA may not shield its owner from liabilities. If a lawsuit arises from investments within the TFSA, the account holder could kind-of/sort-of/maybe have personal liability. (Note: there's a ton of legal nuance here, that's well beyond the scope of this post.)
- No Legal Status. A TFSA generally cannot sue or be sued; only the account holder or the administering financial institution can.
- No Separate Purpose. The TFSA has no distinct legal or economic identity separate from its owner.
What Does This Mean for U.S. Filers?
It's arguable that a Canadian TFSA operates more like a personal savings or investment account than a formal trust or separate entity under U.S. tax definitions. Its also apparent that its structure and purpose likely don’t align with the characteristics typically required for US classification as a trust or taxable entity. This distinction matters because treating a TFSA as a foreign trust is what triggers additional IRS filing requirements, such as Forms 3520 and 3520-A, both of which carry significant penalties for non-compliance. (These filings are also expensive $$$ and an admin nightmare.)
So the good news is that the IRS is aware of the confusion, and has published specific instructions on how to treat a TFSA, right? Of course not. To date, the IRS has issued zero public or formal guidance as to how TFSAs should be classified, leaving the issue floating in the usual grey area that is cross-border tax.
In the absence of a definitive ruling, many taxpayers—and the firms advising them—default to filing the additional forms. While this might seem like the "safe" choice, it’s hard to ignore that this approach may stem more from a fear of ambiguity than solid reasoning.
Final Thoughts
If you’re a U.S. taxpayer with a TFSA, it’s worth noting that a trust classification isn’t as straightforward as it might seem. The IRS has never issued any formal guidance on how TFSAs should actually be treated, and the cpnservative status quo around "Foreign trust" may not be appropriate in today's tax landscape.
To put this another way: Filing a 3520 in the case of a TFSA sort of feel like the tax world’s equivalent of wearing a belt and suspenders: overkill, and arguably unneccessary, but at least no one can accuse you of being unprepared.
At its core, there’s an underlying argument that a TFSA isn’t a trust at all, and instead is simply a glorified savings account wrapped in a web of overly complicated rules. And, given recent appeals cases coming out of the US, treating a TFSA as something other than a trust may be a perfectly reasonable and defensible filing position.
(Pro-tip: Don't forget to put the TFSA on your FBAR filing.)
Usual Disclaimer: What is written here is not formal tax advice. I'm not a tax lawyer. I’m not your CPA. It’s possible, or dare I say even probable, that the comments and opinions expressed here contain material errors, are out of date, or that important stuff has been left out. Don’t use this info to make tax decisions. Hire a pro to help you.