According to 2016 U.S. government estimates, there are 825,630 U.S. citizens living in Canada. Nearly all are supposed to file U.S. federal income tax returns — even if they owe no tax — but many haven’t bothered.
To date, the consequences of ignoring these obligations have been fairly marginal. Cases of U.S. tax enforcement against U.S. citizens in Canada have been few and far between, even though the CRA has transferred 900,000 financial records belonging to Canadians to the Internal Revenue Service (IRS) under the U.S. Foreign Account Tax Compliance Act (FATCA). FATCA requires Canadian financial institutions to report accounts held by U.S. taxpayers (or suspected U.S. taxpayers) to the CRA, which turns them over to the IRS.
There are signs, however, of a perfect storm on the horizon that could change the enforcement environment.
The first warning sign is a little noticed change to FATCA. Under both the treaty between Canada and the U.S. relating to FATCA and Canadian income tax rules, Canadian financial institutions are obliged to have a U.S. social security number associated with an account that gets reported under FATCA.
That rule has always been in place, but there was a grace period that expired on Jan. 1. Now, Canadian financial institutions are required to make sure that there is a U.S. social security number associated with the account.
The problem is that many U.S. citizens in Canada, especially those who are “accidental Americans” (see example below) don’t have a U.S. social security number. A social security number is essential to filing a U.S. tax return as a citizen and the IRS will not accept a return without it. That means every U.S. citizen who does not have a social security number is not filing a U.S. tax return.
Consider the following fictional example. Beth was born in the U.S. when her mother was pursuing graduate studies. She returned to Canada when she was one. Under U.S. law she is an American citizen by virtue of her birth, and is easily identifiable as a U.S. taxpayer. But since she left at a young age, she doesn’t have a social security number. And since she doesn’t have a social security number, she has never filed a U.S. tax return.
Canadian financial institutions are now strongly motivated to ensure that they have a social security number on file for people like Beth. If they don’t, they could face a 30% penalty on every dollar they earn from the U.S. Financial institutions can even threaten customers with a CRA fine for failing to provide the U.S. social security number (the amount of the fine — $100 — is often omitted).
Financial institutions may resort to closing the accounts of those who don’t provide the information in order to avoid the penalty from the IRS. The U.S. tax collector recently declined a request from the European Union for assurance that failing to have a social security number on file would not require the financial institution to close the account.
In short, financial institutions will be applying pressure on Americans abroad to provide a social security number — a number many of them do not have. And since they don’t have the number, they can’t file U.S. tax returns.
The IRS will thus soon have at its fingertips a list from banks of Americans abroad who don’t have a social security number and therefore have never filed a U.S. tax return.
The Covid-19 stimulus means the 2020 U.S. budget deficit is projected to be in the trillions of dollars. At some point, the bill will come due. It doesn’t strain the imagination that the IRS will be tasked with filling the budget hole on the backs of non-compliant U.S. citizens abroad — many of whom have horrendous penalty and tax exposure. The March 2020 letter to the European Union hints at this.
For U.S. citizens abroad, catching up on those returns may be easier now than later. Since 2012, non-compliant U.S. citizens have been able to catch up without penalties through the IRS’s streamlined procedure, and the agency recently introduced another program for those who have renounced U.S. citizenship but did not file U.S. tax returns.
The renunciation procedures overlap with the streamlined procedure, but with three key differences:
- a) they require five years of tax returns instead of three years;
- b) you have to renounce U.S. citizenship to take advantage of them; and
- c) the renunciation procedure is not available if you have ever filed a U.S. tax return.
The new program may indicate that the IRS is looking to close the streamlined procedure in favour of the new, narrower relief program. In fact, the IRS commissioner said at a conference last year that the streamlined procedure may be ending sooner rather than later.
These are the storm clouds for U.S. citizens in Canada who do not file U.S. tax returns. Those who want to get caught up ahead of more concerted action may be wise to act soon as the window may be closing.
Max Reed , LLB, BCL, is a cross-border tax lawyer at Polaris Tax Counsel in Vancouver. firstname.lastname@example.org