Your American clients and the IRS

Cross-border tax advisors say they are seeing more American clients come through their doors, many of whom have become aware of their U.S. tax obligations only recently. Says David Altro, managing partner with Altro Levy LLP, a law firm in Montreal: “They’re often extremely upset, frustrated and angry.”

That’s also partly because many such clients have been in denial for some time. But that denial is now a recipe for trouble. “For people who aren’t filing [their U.S. tax returns and] thinking, ‘I’m a small fish; they’re never going to get me’,” says Christine Perry, a lawyer with Keel Cottrelle LLP in Toronto who specializes in cross-border tax law, “I think that’s just a naive way of looking at it. Their accounts will be reportable accounts, and banks will turn over all that information to the [IRS].”

The U.S. Foreign Account Tax Compliance Act (FATCA), passed in 2010, is meant to prevent Americans from using accounts held at financial services institutions outside the U.S. from evading their tax obligations. FATCA requires global financial services firms, including those in Canada, to provide the U.S. government with the names and account numbers of clients who are American citizens, starting on July 1, 2014. Global banks that choose not to provide this information will be assessed a 30% withholding tax on all U.S.-source payments.

Andrea Taylor, director with the Toronto-based Investment Industry Association of Canada, advises that financial services firms and financial advisors must play a crucial role in educating their American clients and providing them with support.

“There are few things that are more terrifying to clients,” says Taylor, “than finding out that they are U.S. persons [for tax purposes] and that they are delinquent with the IRS, when they may not have even been aware of their U.S. citizenship or tax status or the requirements that go along with that. Advisors and firms need to have a strategy for the clients who are U.S. persons to ease their fears and let them know that the IRS has programs in place to waive penalties for persons who are low-risk.”

Roughly a dozen countries so far, including the U.K., Germany and Switzerland, have signed intergovernmental agreements (IGAs) with the U.S. to implement FATCA. The IGAs both allow non-U.S. banks to report to their domestic tax agency, which then passes on the information to the IRS, and provide for reciprocity of information-sharing between the U.S. and the other signatory country. Canada is in the late stages of negotiating an IGA with the U.S.

“The timing [for implementing FATCA] is still very tight,” says James Carman, senior policy advisor for taxation at the Toronto-based Investment Funds Institute of Canada. “The sooner the financial services industry has all the information [in the upcoming IGA] and can dig into it, the better.”

Implementing FATCA is both a significant challenge and cost to Canadian banks, brokerages, insurers and other firms, all of which must review and make changes to their account-opening processes, compliance structures and tax-reporting systems, among other steps, in order to be ready for the July 1 deadline.

For Americans and green-card holders (treated by the U.S. government as permanent U.S. residents) who live in Canada and may not have been keeping up with their U.S. tax-filing obligations, FATCA could mean the days of remaining quietly in the shadows have come to an end.

The U.S. tax system is based on citizenship, not residency, meaning U.S. citizens and green-card holders must file a U.S. tax return every year. The tax treaty between the U.S. and Canada typically prevents double taxation, so there often are no actual taxes due to the U.S. However, there are other filing obligations, including forms declaring each account held outside the U.S., that must be submitted annually. Potential penalties for failure to file are steep.

From a policy point of view, Perry contends, FATCA represents the second stage in the U.S.’s wider two-part strategy of combating offshore tax evasion. The first part, which started roughly a decade ago, has been about offering Americans amnesty and other voluntary disclosure programs to encourage self-reporting. FATCA, the most recent step, represents a form of “involuntary” disclosure via third-party reporting.

“With the amount of information the IRS is going to be receiving [via FATCA],” Perry says, “to a great extent, it can really compare the two tiers of reporting and can see where there are gaps. What capacity [the IRS] has to sift through all that information is another question. But with today’s technology, you have to think it’ll get there eventually.”

However, Altro says, most U.S. citizens’ circumstances aren’t as dire as they may think.

Finding the best strategy usually involves assessing each client’s particular circumstances, preparing previous years’ U.S. tax returns and other tax reporting, then choosing the best option from the several available for disclosing to the U.S. government.

“The IRS is not really trying to nail regular people,” says Altro, adding that in many situations, potential penalties can be waived due to reasonable cause.

“They’re trying to nail people,” Altro says, “who have done things to avoid their fair share of taxes.”

© 2013 Investment Executive. All rights reserved.