THERE has been an amazing amount of publicity and hype in the last few weeks about the U.S. Internal Revenue Service (IRS) and the Aug. 31 deadline for U.S. taxpayers -- including those living in Canada -- to participate in the latest IRS voluntary disclosure program.
Let's try to sort through all the noise and lay out some facts and suggestions.
If you are a U.S. citizen or green-card holder, you are required to file a U.S. tax return each year. America taxes people based on citizenship, not residency, so it doesn't matter where you live or even what country you name as your residence for tax purposes.
This is not new. This has been the situation for at least the 30 years I have been a financial planner.
The deadline for U.S. tax filing is April 15, but non-residents of the United States are granted an automatic extension to June 15.
As well, such "U.S. persons" who have foreign bank and financial accounts with a total aggregate value more than $10,000 at any time during the year are required to report the account details and highest yearly balance of each account for that year to the U.S. Treasury Department. This is called the FBAR filing (Report of Foreign Bank and Financial Accounts) -- form TD F 90-22.1
This is perhaps more important than the tax return, as the penalty for not filing can be $10,000, or up to $100,000 and possible criminal prosecution for "wilfully failing to file.".The deadline is June 30 each year, which may be extended by application.
Usually, these filings by U.S. citizens living in Canada result in no or very little U.S. tax owing. The IRS wants to keep track of their taxpayers, though, and clearly there are thousands who have been avoiding U.S. taxes illegally by hiding money in foreign bank accounts.
Most of the estimated one million U.S. citizens residing in Canada are not in that category. Many file the required U.S. returns and many remain unaware of the filing requirements. Others can't believe such an illogical tax regime exists.
My advice is to get compliant if you intend to keep travelling in the United States. In 2012, FATCA (the Foreign Account Tax Compliance Act) comes into effect. Under this initiative, all Canadian banks and financial institutions have agreed to report to the IRS the presence of any accounts held by U.S. citizens at their institutions.
Yes, you heard that right. As well, the IRS and the U.S. Border Service are getting better at talking to each other and may soon start asking U.S. citizens about their tax-filing status as they cross the border.
The "rehabilitation" process is to file several past years' returns (many practitioners suggest six years; we have had success with three), apologize and explain that you were unaware until now of your obligation to file. Then hope for the best. We call this "quiet disclosure," as opposed to the formal voluntary disclosure process.
If the IRS finds you first, they can require you to file all missing returns, deny the foreign tax credit that prevents you from paying your taxes twice and then apply interest and penalties to your unpaid taxes.
So what's all the hype around Aug. 31? That's the deadline for the IRS 2011 Offshore Voluntary Disclosure Initiative. This allows delinquent taxpayers who have "undisclosed income from offshore accounts" to come clean and avoid possible criminal prosecution and huge fines if the IRS catches them first.
However, penalties will still apply, making it a pretty expensive proposition for many people. The best-case scenario is five per cent of the balance of all foreign accounts; worst-case is a 25 per cent fine plus all outstanding taxes (if any) and interest on those taxes.
The IRS website gives an example of a taxpayer with a total of $1 million in foreign accounts,who had not filed since 2003. Total cost to come clean under the voluntary reduced-penalty schedule would be $518,000 plus interest.
Doesn't sound like much of a deal until you compare it to the regular penalties of $4,543,000 plus possible criminal prosecution. But remember, this is for someone who used non-disclosure to avoid taxes. Most U.S. citizens living in Canada don't owe taxes and have therefore have not avoided them. They have only failed to file and disclose. CRA announced this week it will not collect filing penalties for the IRS but will continue to collect taxes for them as required by the tax treaty.
I can't advise U.S. citizens on their best course of action, just make them aware. However, I can say we have a very good success rate (so far) with "quiet disclosure" and compliance.
Above all, get good professional advice tailored to your situation. Just don't expect any U.S. tax-preparers to be able to answer their phones until well after Aug. 31!
David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).