Let the games begin. Parliamentary approval of the federal budget legislation in June cleared the way for financial advisors and clients to consider how to use the tax-free savings accounts slated for introduction Jan.1.

But advisors should take care in doing analysis for U.S. citizens living in Canada and non-Americans who hold “green card” permits that entitle them to live and work in the U.S., warns Jennifer Horner, executive director and cross-border tax planning specialist in the Kitchener, Ont., office of Ernst & Young LLP. As a high-tech centre, the Kitchener-Waterloo area attracts many Americans.

The TFSA will let each adult Canadian resident invest $5,000 a year without facing taxes on either compounding earnings or withdrawals. But Americans and holders of green cards face U.S. taxes on their worldwide income, even if they live and work in Canada full-time. Horner does not expect Uncle Sam to respect the Canadian tax shelter.

She says that the RRSP tax shelter is recognized by the U.S. because the Canada-U.S. Income Tax Treaty covers it. The TFSA is not in the treaty and Horner expects it won’t be added for years, if ever. Although TFSA is similar to the Roth individual retirement account in the U.S., the two plans differ significantly because TFSA withdrawals can be made at any time for any purpose.

“So, the TFSA can be beneficial for U.S. citizens living here,” Horner says. “But it won’t be as good a deal as for Canadians.”

This will depend on whether there are credits from Canadian taxes paid on other income that can offset Uncle Sam’s levy on the TFSA’s earnings, she says.

Also, U.S. tax rates tend to be lower than those in Canada. “Even with taxes due,” she says, “a TFSA could still benefit a high-income Ontario resident who would face U.S. taxes on interest at about 30% instead of Canadian taxes at 46%.”

Americans could also reduce their tax hit by doing capital-gains investing in their TFSA if the U.S. Internal Revenue Service looks through the trust and ties the tax treatment to the type of earnings. “That’s what we expect,” Horner says, “but I’d be cautious until the rules are known.”

An IRS spokesman in Washing-ton, D.C., says the agency will not comment on how it will tax TFSA earnings. He also says the IRS does not maintain statistics on how many U.S. tax filers live in Canada.

Horner says the clarity of the RRSP’s treaty protection gives it an advantage when a U.S. citizen or holder of a green card debates whether to contribute to a TFSA or to an RRSP.

Could an American avoid Uncle Sam’s taxes by contributing $5,000 to a TFSA for his or her Canadian spouse, so the couple puts a total of $10,000 in one plan instead of two? The RRSP rules allow that, but the TFSA rules don’t, Horner says. One spouse may contribute to the other’s TFSA only to the extent that the receiving spouse has not used his or her own room; they can’t double up.

A federal Finance Department official in Ottawa says the TFSA spousal contribution provision is intended only to make it clear that the plan does not face the attribution rules that normally restrict one spouse from giving investment money to the other.

Would it be worthwhile for a younger American, perhaps aged 35 or 40, to renounce U.S. citizenship to benefit fully from a TFSA’s long-term growth?

Under legislation recently passed by Congress, those with high incomes or US$2 million in wealth could face an exit tax on total assets — including tax-sheltered retirement plans. In any event, Horner says, she finds that Americans are “very reluctant” to give up their U.S. citizenship.

“There has to be a significant win for them,” she says, “to overcome the emotional attachment.” IE