Is Your TFSA a Foreign Trust? Form 3520, Form 3520-A, and What 'Tax-Free' Costs in the U.S.

Ask a Canadian what a TFSA is and you'll get a proud answer: the one account where growth is never taxed. Ask the IRS and you'll get a shrug — the U.S.–Canada treaty protects RRSPs, but it says nothing about TFSAs. The moment you become a U.S. tax resident, your "tax-free" account becomes, in American eyes, an ordinary taxable foreign account. And possibly something worse.

The baseline cost: taxable income, reportable account

Even in the best case, a U.S. resident's TFSA produces three things every year:

• Taxable income on your U.S. return. Interest, dividends, and gains inside the TFSA are U.S.-taxable as earned — the Canadian exemption is invisible to the IRS. And because Canada isn't taxing that income, there's no foreign tax credit to offset the U.S. bill. You pay full freight.
• Account reporting. The TFSA counts toward your FBAR threshold and, where thresholds are met, Form 8938.
• A PFIC risk on the contents. If the TFSA holds Canadian mutual funds or ETFs, each fund can be a passive foreign investment company — its own punitive regime with its own form (8621), fund by fund, year by year.

That's the good scenario. The heavier question is whether the account itself is a foreign trust.

The foreign trust question — and why "it depends" is the honest answer

A TFSA is a Canadian legal arrangement, and Canadian TFSAs come in different legal wrappers — some are deposit accounts, some are arrangements structured as trusts. For years, the prevailing conservative view among U.S. practitioners was that trust-form TFSAs are foreign trusts, dragging in:

• Form 3520 — the owner's annual return reporting transactions with, and ownership of, a foreign trust; and
• Form 3520-A — the trust's own annual information return, which as a practical matter the owner must ensure gets filed.

These are two of the most unforgiving forms in the U.S. system: filed separately from the 1040, on their own deadlines, with penalties starting at $10,000 for late or incomplete filing — penalties the IRS has historically assessed automatically, against people whose accounts held a few thousand dollars.

In recent years the pressure has eased somewhat: court decisions and IRS litigation losses in this area have pushed practice toward relief for some account holders, and many practitioners now take the position that a garden-variety TFSA doesn't require trust reporting. But the law has not been settled with a bright line, positions differ between firms, and the structure of your specific account matters. Anyone who tells you there's a one-word answer for every TFSA is selling confidence, not analysis.

a penalty equal to the greater of $10,000 or 35 percent of the gross reportable amount

What this means in practice

For a U.S. resident holding a TFSA, the realistic options are:

1. Keep it and report it fully — pay U.S. tax on the income annually, file the account reporting, take a defensible position on the trust question (with advice, in writing), and accept the ongoing compliance cost. For a large account this can occasionally be worth it; for most, the paperwork outweighs the shelter that no longer shelters.
2. Collapse it before U.S. residency begins. Closing the TFSA while you're still exclusively a Canadian resident is clean: no U.S. tax on the accumulated growth, no reporting question, and Canada charges nothing on TFSA withdrawals. This is why "deal with the TFSA before the move" appears in every serious pre-departure checklist.
3. Already a U.S. resident with an unreported TFSA? Don't panic and don't quietly amend. Depending on the years and forms involved, the right path may be delinquent information-return filing or the streamlined procedures — and choosing the right door matters as much as walking through it.

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Related reading: - FBAR for Canadians Living in the U.S. - I Moved From Canada to the U.S. — How Do I File My Taxes?