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Details on New IRS Streamlined Relief for Americans in Canada

02/09/2012


​​Background

Readers of my blogs are aware that each US citizen and green-card holder is required to file a US tax return and Foreign Bank Account Report (“FBAR”) annually, no matter where s/he lives.

The tax return includes a number of forms which report an American’s interest in foreign corporations, partnerships and trusts. Many Americans living abroad fail to file returns, FBARs, or these other documents.

Most of these people have only recently become aware that they need to comply with US tax law. While they wanted to come clean, the IRS’ options for them have been unappealing. They have had to file returns and FBARs for many years, which could be expensive. Even though most Americans in Canada owed little or no US tax, many still faced significant penalties. So many people waited, not knowing what to do.

The IRS has finally seen the dilemma such people face, and provided an easier way in.

How to get into the system

As of September 1, 2012, there are four main approaches available for such individuals to get back into the IRS’ good graces:

Streamlined procedure for Americans who have not filed returns

This new streamlined program is only for Americans who have been living abroad since January 1, 2009.

If you are like most Americans living in Canada who are remiss in filing, you have filed nothing to the IRS while living in Canada, at least for the last several years. On June 26, the IRS announced if you have lived outside the United States since January 1, 2009 you would be able to get back into the system by filing only 3 years’ tax returns and 6 years’ FBARs.

The IRS will allow you to retroactively claim a deferral of income earned inside a Canadian RRSP, RRIF or LIF as part of this process. Payment of ordinary tax and interest is required with the submission. In most cases, this amount will be zero. For most people, no penalty will be assessed.

Risk assessment

It is important to understand that while most taxpayers should be successful with this approach, there are no guaranties against the IRS levying penalties if you use this procedure.

The IRS will divide the filings into two categories, low and high risk. A low-risk person is one where the IRS does not suspect there may be more tax owed that is not reported on those returns (including tax for prior years).

We expect that the vast majority of filers will be low risk. A low-risk person will receive no response from the IRS. Unlike Canada, the US does not issue a notice of assessment when it agrees with a return, so no news is good news. The IRS will notask for penalties or more information. After three years (for most people), the returns will go statute-barred. There are longer time limits for certain types of disclosures.

A high-risk person may be asked for additional documentation, and may be asked to file returns for earlier years. To help the IRS make this determination, in addition to the ordinary filings, the individual must complete a questionnaire.

The risk level will rise if:

  • Any of the returns submitted through this program claims a refund;
  • There is material economic activity in the United States;
  • The taxpayer has not declared all of his/her income in his/her country of residence;
  • The taxpayer is under audit or investigation by the IRS;
  • FBAR penalties have been previously assessed against the taxpayer or if the taxpayer has previously received an FBAR warning letter;
  • The taxpayer has a financial interest or authority over a financial account(s) located outside his/her country of residence;
  • The taxpayer has a financial interest in an entity or entities located outside his/her country of residence;
  • There is U.S. source income; or There are indications of sophisticated tax planning or avoidance.

It is noteworthy that for a resident of Canada, a connection to a Canadian corporation or trust is not specifically identified as factor increasing risk. The questionnaire includes a number of questions that could pose hidden traps for taxpayers, so people going this streamlined route should consult their MNP tax advisor before proceeding.

FBARs only

If you have filed US tax returns reporting all your income and paid all your US tax, but neglected to file FBARs, you can file the FBARs alone, and the IRS will not penalize you.

The IRS is not clear how many years should be reported, but given that the new streamlined procedure requires 6 years, that is likely the right number, especially since that’s the number required under the statute (older years are statute-barred).

Information returns only

If you have filed US tax returns reporting all your income and paid all your US tax, but neglected to file forms reporting transactions with foreign corporations or trusts, or made elections in respect of Canadian retirement plans (such as RRSPs or RRIFs), you can do so without penalty.

Again, the Service is not clear how many years should be reported, but following the new streamlined relief requirements above, 3 years is likely the right number for most people.

Offshore Voluntary Disclosure Program (OVDP)

The 2012 OVDP is the third in a series designed primarily for people who have been keeping money outside of the United States willfully avoiding US tax – people who had a legitimate fear of being incarcerated for their tax deficiencies. The OVDP requires filing of 8 years’ returns and FBARs, plus a great deal of supporting documentation. The IRS carefully scrutinizes each submission. Going this route is cumbersome, expensive and time-consuming.

I have written about this before:

US 2011 Offshore Voluntary Disclosure Initiative
A New Development in the IFRS Offshore Voluntary Disclosure Initiative Affects Americans in Canada
US Citizens in Canada Have Yet Another Opportunity to Come Clean with the IRS

Conclusion

In my view, the new structure is a significant step in the right direction. It will allow probably 90% or more of Americans in Canada to become compliant, without undue costs. It will still be expensive, because everything that happens in Canada is foreign to the US system, but much less expensive that under the old approach.

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