Last April, I discussed some of the unique financial tax and estate planning issues your American-in-Canada clients face (see www.
, “Cross-border planning: updated”). Given a recent spate of U.S. tax law and enforcement changes, the ability for most Americans who live or work abroad to hide from Uncle Sam is quickly coming to an end.

The U.S. government needs money — and lots of it — so the IRS is going after U.S. taxpayers living abroad. That’s affecting a number of our clients, as well as Canadian financial institutions with which Americans have accounts.

Through a program that strongly encourages Americans working abroad to comply with annual U.S. tax and filing requirements, the U.S. government is hoping to generate additional revenue through income tax and penalties, with compliance enforcement assistance from financial institutions in those countries.

Contending with complexity

American tax laws are complex. All U.S. citizens are also U.S. residents for income, gift, and estate-tax purposes—irrespective of where they live, where they generate income, where they hold assets, or where they die. And because Canadian dual citizens don’t live in or generate income from the U.S., it’s easy for them not to know these rules.

In 2009, the IRS collected US$780 million from UBS in Switzerland, along with additional information on client accounts. This success suggested a significant number of Americans are likely holding assets abroad and not reporting them.They include those who have lived in Canada for the majority of their lives, such as your 85-year-old client who was born in Iowa and holds a $300,000 RRIF.

Exacting enforcement

The U.S. Congress, IRS and other governmental agencies are getting results. The IRS had hired approximately 3,300 new agents and tax compliance officers in the 2009-2010 tax years.

With the passing of the U.S. Foreign Account Tax Compliance Act (FATCA) and the IRS’s Offshore Voluntary Disclosure Initiative (OVDI) programs, the war has only just begun. According to the IRS, the 2009 and 2011 OVDI programs saw 33,000 U.S. taxpayers remitting an additional $4.4 billion.

There has been significant confusion around whether it would make sense for American citizens who reside in Canada to participate in the OVDI programs.

These programs required overseas U.S. citizens to file original or amended U.S. tax returns for the previous eight years, together with any unpaid taxes, interest and penalties. Further, they were obligated to report any foreign account holdings during the past eight years and then pay a penalty on the highest aggregate annual balance.The penalty under the first program: 20%. Under the second program: 25%. In some cases, individuals could be eligible for a penalty as low as 5% on their highest aggregate balance.

Yet U.S. tax practitioners and attorneys differ as to whether or not people should have participated in these programs.

Legal obligations

Americans in Canada started to learn about their obligations in August 2011, prior to the ending of the second OVDI program. Greater awareness led to pressure on finance minister Jim Flaherty.

As a result of Flaherty’s efforts, the U.S. Ambassador to Canada, David Jacobson, tried to assure Canadians the IRS was only looking for Americans who were purposely evading taxes.

In December 2011, the IRS released a fact sheet called “Information for U.S. Citizens or Dual Citizens Residing Outside the U.S.” (FS-2011-13) to clarify the filing requirements of U.S. citizens in Canada.

It made clear that dual citizens are required to file U.S. federal income tax returns and FBARs. The announcement also stated if a dual citizen files returns, and owes no tax because of the foreign-earned income exclusion or foreign tax credits, he or she will not be subject to failure-to-file or -pay penalties. The fact sheet further states taxpayers should state why their tax returns and FBARs are being filed late.

Unfortunately, this was only clarification of what we already knew and what we have been advising for years. A majority of Americans in Canada, after the application of the U.S. foreign-earned income exclusion and foreign tax credits, generally pay no additional U.S. income tax. However, it’s the additional level of tax compliance and reporting on foreign assets and accounts that can cause problems.

Voluntary disclosure

On January 9, 2012 the IRS announced it had reopened the Offshore Voluntary Disclosure Program (OVDP). The program is similar to the previous ones, but with a few key differences.

First, it will be open indefinitely. Second, the overall penalty structure will be similar to the 2011 OVDI program, with the penalty being increased from 25% to 27.5%. The 5% penalty that can be applied in limited situations is still available under the new program.

So what’s a non-compliant American to do? Unfortunately, every situation needs to be looked at separately. And you will likely get differing opinions from a variety of practitioners. At minimum, given the impact of FATCA kicking in in 2014 and the new U.S. taxfiling requirements for the 2011 tax year (see “U.S. tax law requires strategic planning” and “Tax planning and dual citizenship”) it’s vital to become compliant with the IRS.

Life for Americans in Canada will continue to get more complicated as these laws develop. Mercifully, the CRA and the Canadian government have publicly acknowledged they won’t be party to the enforcement or collection of tax or penalties brought about through the failure to file FBARs.

That said, the U.S. Senate has unanimously approved a provision to a highway transportation bill that would revoke the passports of people with seriously delinquent tax debts.

This addition would allow the State Department to deny, revoke or limit a passport for any individual whom the IRS has certified as having tax debt in excess of $50,000.

Guess the War of 2012 is just beginning.
Terry Ritchie and Brian Wruk are Canada and U.S.-based cross-border financial planners with expertise in both American and Canadian tax regimes, and authors of The Canadian Snowbird in America, The Canadian in America, and The American in Canada.