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June 13, 2024

Tax Tips

Innocent Non-Compliant U.S. Tax Filers
Subject: U.S. Tax Returns
Number: 11-06
Date: 2/18/2011
These changes will make it easier for the IRS to find citizens living in Canada

The U.S. taxes its citizens and green card holders (U.S. persons) no matter where they reside. For example, U.S. tax laws apply to U.S. persons even if they are Canadian residents and/or citizens. The U.S. State Department has estimated that there may be up to 1,000,000 U.S. persons in Canada.

Our experience has shown that many U.S. persons in Canada are not aware of their U.S. tax obligations. As the population ages, more of these people will become aware of their U.S. tax problems since typical Canadian estate and succession planning discussions will highlight the problem. Proper Canadian planning cannot be implemented if the U.S. obligations are not addressed and rectified.

In addition, starting with 2013, the U.S. will impose a 30% withholding tax on foreign financial institutions’ (e.g., a Canadian bank’s) U.S. source income unless they enter into an agreement with the IRS to disclose all of their U.S. accountholders. Many banks are already in the process of developing internal programs to track, monitor and report their U.S. account holders. Finally, the IRS has issued new requirements requiring that U.S. tax return preparers register with the IRS. Unregistered Canadian tax advisors are no longer be able to prepare U.S. tax returns.

All these changes will make it easier for the IRS to find citizens living in Canada and elsewhere. It is better for a non-compliant U.S. person to come forward voluntarily. They should not procrastinate. As the IRS becomes more aggressive with its methods of finding non-compliant U.S. citizens it seems to be increasing penalties.

The IRS’ latest initiative, the Voluntary Disclosure Offshore Initiative (VDOI) was announced on February 8, 2011. This program was explained in last week’s Tax Tip 2011-05 and seems to contain penalties that could apply to innocent non-compliant U.S. citizens.

While, in the past, innocent non-compliant foreign U.S. persons were usually able to bring their U.S. tax filings up to date with little risk of penalties, there is growing concern that the IRS is becoming less lenient. Historically, delinquent U.S. tax filers were able to file their last six years' worth of U.S. returns to “re-enter” the system.

If any penalties are assessed, the IRS can waive them if the taxpayer can demonstrate that they had a “reasonable basis” for not filing. It is unclear, with the new VDOI initiative, if the IRS will allow taxpayers to file under this process anymore.

Our informal discussions with the IRS indicate that the previous process should still be available and that penalties will not be imposed where no U.S. tax is ultimately payable. In the event, however, that automatic penalties are imposed, taxpayers may be able to negotiate with an IRS agent to either reduce or eliminate the penalties.

The TSG has professionals who can assist U.S. persons in determining the most appropriate strategy for complying with their U.S. tax obligations.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.