On December 4, 2015, Section 7345 was added to the Internal Revenue Code (IRC). As a result, the U.S. now has the authority to revoke, limit or deny passports of American citizens in certain situations.
IRC Section 7345 only enables the U.S. to revoke, limit or deny a U.S. citizen’s passport when a U.S. citizen owes the IRS “a seriously delinquent tax debt” of more than US$50,000 (to be adjusted for inflation in the future). This type of debt exists when a notice of lien or a notice of levy has been filed by the IRS. If that’s the case, renewals can be denied and current passports can also be revoked.
Exceptions to the section
If a taxpayer is disputing a tax bill with the IRS and is in the middle of legal proceedings related to that dispute, then the section will not apply. In addition, if the IRS and the taxpayer have already arranged a payment plan, and the delinquent taxpayer is paying his bill in increments, Section 7345 will not apply. In emergency cases, the U.S. State Department may issue a temporary passport, even if the citizen has a delinquent debt.
U.S. citizens in Canada
Section 7345 is problematic for the more than one million Americans living in Canada. Since many U.S. citizens living abroad are unaware of their U.S. tax filing and reporting obligations, it’s easy to mistakenly run afoul of the IRS’s filing requirements.
Failure to remain tax compliant can lead to criminal and civil penalties, including hefty fines and interest charges. Since the US$50,000 threshold includes all fines and interest charges, U.S. citizens living in Canada can easily reach this amount; failure-to-file fines may be high enough to push delinquent filers above the amount, even if they don’t owe taxes that exceed that amount.
Some of the consequences of non-compliance, which can ultimately trigger Section 7345, are briefly outlined below.
The U.S. requires its citizens to file annual income tax returns on Form 1040, reporting their worldwide income regardless of their country of residence.
U.S. citizens who file Form 1040 late face a penalty of 5% of the unpaid taxes due for each month or part of a month that the return is late, but a late filing fee penalty will not be more than 25% than the amount of unpaid taxes due. The minimum penalty for a return filed more than 60 days late will either be US$135 or 100% of the unpaid tax due, whichever is less.
U.S. citizens who fail to pay tax that is due face a failure-to-pay penalty of 0.5% to 1% of the amount due per month after the due date. The failure-to-pay penalty can be as high as 25% of the unpaid tax due.
U.S. citizens living abroad are also subject to strict reporting requirements under the Report of Foreign Bank and Financial Accounts (FBAR).
For non-willful violations of the FBAR rule, fines can be as high as US$10,000. Maximum penalties for willful violations can run up to either:
a 50% of an account balance that goes unreported; or
b US$100,000, whichever is greater.
Information sharing between CRA and the IRS began on September 30, 2015, pursuant to the Foreign Account Tax Compliance Act (FATCA) and the intergovernmental agreement signed by Canada and the U.S. on February 5, 2014. Now that the IRS is receiving information about bank accounts held by U.S. citizens in Canada, the IRS will be able to check whether such bank account holders are also filing U.S. tax returns. The chance that the IRS will detect non-compliance is now even greater.
Private collection agents
In addition to passport denial, limitation and revocation, the new rules also amend IRC Section 6306. This section now requires the IRS to use private tax collection agencies to collect “inactive tax receivables,” which are defined as tax debts that:
i. the IRS has stopped attempting to collect because of an inability to locate the taxpayer or because of lack of internal resources;
ii. have not been assigned for collection internally and more than one-third of the statute of limitations has passed; or
iii. have been assigned to an IRS employee for collection, but more than 365 days have passed and the IRS hasn’t communicated with the taxpayer or his third party in order to move debt collection forward.
Section 6306 provides exemptions to the private debt collection rule. For example, if a taxpayer is currently being audited by the IRS, is in litigation, is under criminal investigation or levy, or has made a formal appeal, the IRS cannot enforce private debt collection.
If you have U.S.-citizen clients who live in Canada, ensure that they are compliant with their U.S. tax filing and reporting obligations. If they aren’t, help them to take steps to get compliant so they can avoid Sections 7345 and 6306.
David A. Altro is a Florida attorney, Canadian legal advisor and the managing partner at Altro Levy. He can be reached at 416-477-8155 or firstname.lastname@example.org.