Many Americans in Canada have said that FATCA, the Foreign Account Tax Compliance Act, runs afoul of privacy laws and imposes undue hardship. But the act’s here to stay, and you must prepare clients for the July 1 implementation date.
Background and impact
In 2010, the U.S. passed FATCA, which requires non-U.S. financial institutions to provide information to the IRS about bank accounts, mutual funds and other financial instruments. Had Canada not signed an Intergovernmental Agreement (IGA) with the U.S. in February, FATCA would have required our financial institutions—known as Foreign Financial Institutions (FFIs)—to withhold 30% tax from any U.S. income source.
Effective July 1, CRA must inform the IRS about the financial accounts of U.S. persons in Canada. A U.S. person is defined as a U.S. citizen, U.S. green card holder or someone who would meet the U.S. Substantial Presence Test. People in these categories must file annual U.S. income tax returns and report worldwide income to the IRS.
Many Americans in Canada can use foreign tax credits and the Foreign Earned Exclusion (FEI) on Canadian employment income, leaving no additional U.S. tax owing. But there are several other reporting requirements for U.S. taxpayers who hold foreign accounts. And with the new 3.8% Medicare surtax on net investment income, some Americans in Canada might find they still owe U.S. tax beyond what had been offset by the FEI and foreign tax credits.
Many banks and financial custodians in Canada have already taken steps to register with the IRS. And advisors have already seen additional KYC, Anti-Money Laundering (AML) and other documentation requirements for U.S.-person clients.
This includes getting copies of the client’s U.S. passport and certification of U.S. tax status through signing and retention of IRS Form W-9, or signing off on Form W-8BEN. Additionally, many Canadian financial institutions are requiring new self-certification declarations for existing and new accounts. Under the IGA, if client accounts exceed $50,000 (aggregated), the FFI is required to give CRA:
- name, address and U.S. taxpayer identification number for each U.S. person who holds an account;
- account numbers (or functional equivalent);
- name and identifying number of the reporting Canadian financial institution;
- account balances or values (including cash value or surrender value in the case of a cash-value insurance contract or annuity contract) as of the end of the relevant calendar year or other appropriate reporting period; or, if the account was closed during the year, immediately before closure;
- in the case of any custodial account:
- a. the total gross amount of interest, dividends and other income generated with respect to the assets held, in each case paid or credited to the account (or with respect to the account) during the calendar year or other appropriate reporting period; and
- b. the total gross proceeds from the sale or redemption of property paid or credited to the account during the calendar year or other appropriate reporting period with respect to which the reporting Canadian financial institution acted as a custodian, broker, nominee or otherwise as an agent for the account holder;
- in the case of any depository account, the total gross amount of interest paid or credited to the account during the calendar year or other appropriate reporting period; and
- in the case of any account not described above, the total gross amount paid or credited to the account holder with respect to the account during the calendar year or other appropriate reporting period.
FFIs must also scour their records for U.S. persons. Specifically, FFIs must search for:
- whether account holders are U.S. citizens or residents;
- unambiguous identification of a U.S. place of birth;
- a current U.S. mailing or residence address (including U.S. P.O. boxes);
- a current phone number;
- standing instructions to transfer funds to an account maintained in the U.S.;
- effective power of attorney or signatory authority granted to someone with a U.S. address; and
- an “in-care-of” or “hold mail” address that is the sole address the reporting Canadian financial institution has on file for the account holder.
In addition, a Canadian financial institution must treat any high-value account assigned to a relationship manager (including any accounts aggregated with high-value accounts) as a U.S. reportable account if the manager knows the holder is a specified U.S. person.
Under the Canadian IGA, CRA doesn’t have to report to the IRS on RRSPs, RRIFs, RESPs, TFSAs and certain other accounts under $50,000. Nonetheless, Americans in Canada still have to report and pay tax on TFSAs and RESPs, and they must make elections to defer income tax on registered accounts.CRA will be providing this information to the IRS, but Canadian authorities say they won’t collect tax or assess penalties against Americans in Canada on behalf of the IRS.
Encourage your U.S.-person clients to ensure they’re fully compliant with U.S. tax filing obligations. The IRS has two main programs for those who aren’t.
The Offshore Voluntary Disclosure Program is more onerous and punitive. In this case, taxpayers must file the previous eight years’ delinquent tax returns, a Report of Foreign Bank and Financial Accounts (FBARs), and significant supporting documentation. Penalties can be as high as 27.5% on the highest aggregate balance of foreign accounts not previously disclosed. With the streamlined program, clients must file the last three years of delinquent returns and six years of FBARs, and complete a non-filer questionnaire. To qualify for this program, the taxpayer cannot owe more than US$1,500 in tax (excluding penalties and interest) for each of the three filed tax years.
Many advisors suggest U.S. persons should renounce U.S. citizenship or give up their green cards (if held longer than 8 years) to avoid these rules, but without proper advice there could be significant income tax and U.S. lifestyle implications.
IRS rules say that if one or more of the following apply to your U.S.-person clients, they’re considered covered expatriates:
- failed to file previous five years of tax returns; or
- had a worldwide net worth of more than US$2 million; or
- had an average annual net income tax for the past five years of US$157,000.
A covered expatriate is subject to the deemed sale (known as the mark-to-market tax) of all of his property (exclusive of deferred compensation items) at fair market value upon the date of expatriation. An exemption of US$680,000 could be applied to unrealized gains. An additional tax of 30% applies to Deferred Compensation Items such as U.S. and Canadian retirement plans. If your American-in-Canada clients aren’t worth more than $2 million, but haven’t been compliant with the IRS for the last five years, they will be considered covered expatriates and could face these additional U.S. taxes.
Since these taxes are deemed and applied on the date of expatriation in the U.S., and not in Canada, no foreign tax credit would likely be available under Canadian tax rules. And proposed U.S. immigration laws would bar any expatriating U.S. person from returning to the U.S. under any circumstance. So, caution your clients before they consider going this route.
By Terry F. Ritchie, director of Cross-Border Wealth Services for Cardinal Point Wealth Management. He’s also an Enrolled Agent with the U.S. Internal Revenue Service.