The long reach of the U.S. taxman

Looking to boost tax revenue, the U.S. government has cast a wide net in recent years, hoping to catch those Americans who are hiding money offshore, and to encourage all other non-filers to come back into the U.S. tax system.

However, it’s important that American taxpayers resident in Canada — there may be up to a million people in Canada who have U.S. tax-filing obligations — seek good advice regarding their best strategy for becoming compliant, cross-border experts say. An American taxpayer’s pertinent facts — how many financial or other connections the citizen retains with the U.S., for instance — may have an effect on how the IRS deals with that individual’s case. A carefully chosen strategy for becoming compliant will increase the American taxpayer’s chances of minimizing or avoiding hefty penalties.

“For most people, the decision on how to proceed will be based ultimately on their own risk factors,” says Christine Perry, a lawyer with Keel Cottrelle LLP in Toronto who specializes in cross-border tax law.

The U.S. government taxes its citizens on their worldwide income, regardless of where in the world they reside. While American taxpayers in Canada must file a U.S. tax return annually, in addition to their Canadian return, the tax treaty between the two countries provides taxpayers relief from double taxation. With tax rates in Canada generally higher than those in the U.S., the American in Canada usually owes no U.S. taxes.

However, Ameri-can taxpayers also must fill out forms annually to declare all of their foreign accounts that hold more than US$10,000. These include bank accounts and RRSPs. The penalty for even a “non-willful” failure to file is stiff: $10,000 a year per account.

People in Canada who have a U.S. tax-filing obligation include Canadian citizens who have dual citizenship; anyone born in the U.S.; those persons born in Canada to two U.S. parents; or holders of green cards. Many dual citizens in Canada have been unaware of their U.S. tax-filing and compliance obligations, or have chosen to ignore them.

Recently, however, the U.S. has begun to use its considerable leverage to make it harder for Americans abroad to remain non-compliant. For example, some Americans attempting to enter the U.S. are being asked by border officials if they’ve filed their U.S. tax returns. The U.S. government is becoming more vigilant, too, in collecting data to identify non-compliant taxpayers.

And, beginning in 2014, when the Foreign Account Tax Compliance Act comes into force, the U.S. government will ask Canadian and other foreign banks to report on U.S. citizen accountholders who hold more than US$50,000 with that institution. Backing up the request is a tough new penalty: foreign financial services firms that refuse to report on their Ameri-can clients will be assessed a 30% withholding tax on the firm’s income from U.S.-based sources.

More so than any other initiative, FATCA will provide Ameri-can non-filers with strong motivation to come clean. “FATCA is the big one,” says Beth Webel, partner in the tax services practice of Pricewaterhouse Coopers LLP in Toronto. “If you’re a U.S. person [for tax purposes], you need to be in the U.S. tax system before a Canadian bank turns your name over to the IRS.”

That’s because, as in any tax system, Webel suggests, taxpayers who come forward voluntarily tend to receive greater leniency than those who are approached by the tax authority.

In February 2011, the U.S. government launched the Offshore Voluntary Disclosure Initiative, an “amnesty” program for Ameri-can taxpayers. In exchange for amnesty from the harshest penalties, the taxpayer had to file any non-filed returns going back to 2003, and pay any taxes and interest. There was also a penalty of 5%, 12.5% or 25% levied, depending on how the IRS assessed the taxpayer, on the highest balance of any non-reported foreign account.

Although the OVDI was introduced to bring in Ameri-can tax evaders with hidden offshore accounts, the program also attracted some ordinary non-filers who had otherwise been compliant with their tax-filing requirements in Canada. “For some people, it provided peace of mind,” Webel says. “Most Canadians qualified for the 5% penalty regime.”

Still, for some Canadians who chose to enter the OVDI, it meant paying a penalty on money that may have been earned in Canada and held here. “[Even at 5%], that’s a tough cheque to write to the IRS,” says Prashant Patel, vice president of high net-worth planning services with Royal Bank of Canada’s wealth-management division in Toronto.

The OVDI program closed on Sept. 9 — it was a limited time offer — and dual citizens who are looking to become compliant now have two basic options: a “quiet” disclosure or a “noisy” one.

A quiet disclosure involves the taxpayer filing outstanding U.S. returns — many experts suggest filing for the past six years — along with any foreign account compliance forms, without the taxpayer formally informing the IRS that he or she has been non-complaint. In some cases, the IRS will process the returns without ever coming back to the taxpayer to assess further penalties.

The noisy route involves the making a formal voluntary disclosure to the U.S. government — a long-standing program that exists outside the OVDI. In many cases, if the taxpayer has a compelling case for leniency, penalties may be waived altogether.

The choice of whether to make a quiet or noisy disclosure will have a lot to do with the facts in each taxpayer’s situation. It also will depend on what kind of precedent the IRS begins to establish in how it deals with non-filers now that the OVDI has closed. “The penalties the IRS has applied in the past,” says Perry, “are not necessarily reflective of the penalties they’ll assess in the future.”

Some Ameri-can citizens living in Canada may choose to remain non-compliant. After all, if a Canadian doesn’t intend to visit the U.S., go there for school or business or own property there, he or she may be out of the U.S.’s reach. Canada’s Department of Finance, which has been working behind the scenes to try to encourage the U.S. to ease up on elements of FATCA, has made it known it won’t collect penalties on behalf of the U.S. government.

Still, most advisors suggest that coming clean is the best option. Each year a taxpayer remains non-compliant is another year of added penalties.            IE