What is the proper way to report distribution from an inherited annuity?

[mrwa11eye1]

I was beneficiary of death benefit from mothers annuity from USA.  I can keep it in place for up to 5 years in her name.  I can take distributions.  How are these distributions recorded on my T1 ... does Canada tax me on the full amount I take out or just on the interest that has accrued?

[TurboTaxKim]

There are many factors to consider here in determining if and how this particular annuity would be taxed in Canada. As a general rule, inheritances are "not taxable", only the interest or income you earn on it. However, there are quite a few rules regarding a US Inherited Annuity received by a Canadian beneficiary. 

• Are you actually receiving the distributions, or are they being held in an estate or trust under your mother's name? As you stated "I can keep it in place for up to 5 years in her name", it appears it may well be held in her estate. This description of the "Five-Year Rule" also leads us to think it may be:
• Five-Year Rule – The five-year rule requires the inherited beneficiary to receive the full distribution within five years of the annuitant’s death. The beneficiary can take smaller amounts during the five-year period until the full annuity has been disbursed, take the full annuity at the fifth year, or take all disbursement payments immediately following the annuitant’s death. The five-year rule is the only disbursement option available to estates, charities or trusts named as beneficiaries.

• Was this a Qualified or Non-Qualified Annuity?
• A non-qualified annuity is an investment purchased outside of a work-related retirement plan using after-tax dollars. These annuities have already been subject to income tax, however, any interest earned will be taxed upon withdrawal. If a beneficiary inherits this type of annuity, they will be required to pay taxes on the growth.
• When an IRA (Qualified Annuity) is inherited by a beneficiary living in Canada, the amount paid from the IRA to the individual is typically taxable in Canada—in addition to being subject to U.S. tax. When filing a tax return in Canada, you must include the distribution from the IRA with your income. This will allow you to claim a foreign tax credit for the taxes paid to the U.S, including any U.S estate taxes paid on the IRA.

Once you have some more information on the type of plan the annuity comes from, if the distributions are being held in a trust or estate and if they are going to withhold tax on the distributions, it will be easier to advise you on the tax implications in Canada. 

There is some great information in the following links describing different scenarios involving Foreign Inherited Annuities:

https://cbcsettlementfunding.com/annuities/types/inherited-annuity/

https://cardinalpointwealth.com/2014/08/06/u-s-iras-can-be-a-taxing-issue-for-canadian-beneficiaries...

http://madanca.com/articles/entry/tax-on-foreign-inheritance-canada/

[mrwa11eye1]

It was a non qualified annuity, it is being held under the 5 year rule, I took a distribution ... claimed the accrued interest for that year.  I had to pay tax on the full amount in the USA (till all interest is taxed).  I just reported it on Schedule D.  A so called cross border tax fellow said I should be reporting the full amount.  Not sure if he meant to report the full amount on 1099R and make a deduction or what?  I decided to just ask you folks as I doubt you will post incorrect info so it could be trusted.

[TurboTaxKim]

Thanks for clarifying that information. Just to make sure I'm understanding this correctly, you need to know how exactly this needs to be reported on the Canadian tax return? Or are you still wondering about how it should be reported on the US side as well?  Also, if you would prefer, I can reach out to you via email to further discuss this. I've come across a ton of information, but nothing that actually says "This is the amount you need to report on your Canadian Tax Return or do not report at all".

I look forward to finding a definite answer for you, and soon hopefully. 🙂  Kim

[mrwa11eye1]

USA side I am clear on just not the Canadian.  If I have a 1099R for $5000 from the USA .. I had to pay tax on the full amount in the USA as interest accumulated since contract started exceeds $5000.  This money is inheritance and since I received it I accumulated $2000 in interest for the tax year.  I thought I would just claim the 2000 interest on my tax return .. on Schedule D.... but this tax fellow I talked to who was not charging a consulation fee and was in a hurry said the full amount should be recorded?  That would mean I would be paying taxes on an inheritance so ........ that is where it is at.  How and what dollar amount should I be reporting.  It is basically a 5 year GIC that can be withdrawn from, it is no longer an annuity.

[TurboTaxKim]

On the Canadian side, you only need to report any interest you earn from that inheritance. So all you should be reporting is the $2,000 interest earned. You will report this amount in Canadian Dollars on Schedule 4 or as "Interest & Other Investment Income", and it will carry over to Line 121 of your T1 General Canadian Tax Return.