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IRS Relief for Americans in Canada Isn't What We Hoped For-- Or What We Were Promised

09/12/2011


In previous posts, I have discussed the ongoing saga of Americans in Canada who haven’t filed US returns, but want to come clean. The IRS keeps coming up with new “incentives” for these people to file. David Jacobson, the US Ambassador to Canada said more relief would be on its way, and the IRS followed through promptly.

The IRS issued a news release on  December 8, 2011 here and I'm quoted in a related Globe & Mail article on December 9 here.

Initial reactions

I have to tell you I’m not impressed. The release raises more questions than it answers. It gives us an indication of what the IRS is thinking, but provides no meaningful comfort for individuals wanting to come forward. It almost boils down to “Pay your money, and take your chances".

Filing requirements clarified

The release provides one important piece of information to non-compliant individuals:
Generally, the IRS will request only six years returns (unless there are major red flags raised on their end).

Since the end of the 2011 OVDI in September, there has been no guidance in this area. Since unfiled tax returns never become statute-barred, the only legal answer for me to give was “file every year you have missed”. This could have been 20, 30, or in one case of mine, 50 years – clearly unreasonable, not to mention impossible. So this information, while only a return to pre-2011 status, is welcome.

Penalty abatement

The IRS says it will abate penalties where there is “reasonable cause”. There are two avenues to establish reasonable cause:

  • Exercising ordinary business care and prudence, and
  • lack of awareness of tax obligations.

If you want to establish that you exercised ordinary business care and prudence, the IRS will consider factors such as:

  • Your reasons given for not meeting your tax obligations;
  • Your compliance history;
  • The length of time between your failure to meet tax obligations and subsequent compliance; and
  • Circumstances beyond your control.

It is interesting that the IRS will (sometimes) consider a lack of awareness to be reasonable cause. Most times they would say ignorance is no excuse. The IRS now says: “You may have reasonable cause for noncompliance due to ignorance of the law if a reasonable and good faith effort was made to comply with the law or you were unaware of the requirement and could not reasonably be expected to know of the requirement".1

Perhaps this is the piece directed to Americans living in Canada (and other countries), but it’s not made very clear. In determining whether it was reasonable for you to not have known about your obligation to file, the IRS will look at:

  • Your education;
  • Whether you have previously been subject to the tax;
  • Whether you have been penalized before;
  • Whether there were recent changes in the tax forms or law that you could not reasonably be expected to know; and
  • The level of complexity of a tax or compliance issue.

Problems with the notice

The notice says there will be no late-filing or late-payment penalties where there is no tax due. But so what? Those penalties are (with a minor exception) calculated as percentages of the tax owing. Zero tax, zero penalty. There’s nothing new here.

It does not mention:

  1. What conditions are sufficient for “reasonable cause” to have penalties abated.
    1. We were hoping to have a number of criteria that would provide comfort to individuals considering coming forward. The determination of reasonable cause remains “based on a consideration of the facts and circumstances”.
    2. This is true even for individuals residing outside the United States, with no US tax payable. They still may have FBAR penalties, and these are the ones causing most of the problem for Canadians. Given what the US Ambassador said December 1, this notice is a huge disappointment.
    3. The notice seems to imply that individuals with no US tax are likely to be treated leniently, but there’s nothing to hang your hat on.
    4. And individuals who have interests in Canadian corporations, partnerships and trusts are still exposed to penalties of $10,000 or more simply for failure to report these things.
  2. Whether individuals who come forward voluntarily will avoid criminal prosecution.
  3. Whether individuals who have filed under the 2009 OVDP or 2011 OVDI will automatically be given relief if reasonable cause is established.
    1. A participant in the 2011 OVDI would have a penalty of 5%, 12.5%, or 25% of foreign assets. This penalty was non-negotiable within the program (one could drop out and ask for relief, but then would risk higher penalties). Can this penalty now be waived within the program? The Ambassador implied it would.
    2. Does a participant need to apply for this relief, or will it apply automatically?
    3. Do they need to drop out of the OVDI/P to be considered? This step would put them at risk to potentially higher penalties.

Where the IRS should be heading

What I think the IRS needs is a permanent voluntary disclosure program similar to Canada’s. Canada’s objective is to get people into the system on their own initiative.

In Canada, an individual who comes forward before CRA reaches her can file all missing returns and forms, or amend previous incorrect ones. There are no significant bars to participation. The individual has to pay the tax, but she will not be prosecuted, and all penalties will be waived. Interest is often abated as well – generally for tax years more than four years old.2 Since long-running interest can easily run to figures as large as the tax liability (or bigger), this is a major plus. It is an incentive to come clean before CRA comes calling. The IRS would do well in adopting this approach.

For more information in this regard, please contact me, Kevyn Nightingale, CA, CPA (IL), TEP, at 416.596.1711

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References

1http://www.irs.gov/newsroom/article/0,,id=250788,00.html
2
http://www.cra-arc.gc.ca/gncy/nvstgtns/vdp-eng.html