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New IRS Relief for Americans in Canada

27/06/2012


​​The IRS has provided new details on this plan. See my new post Details on New Streamlines IRS Relief for Americans in Canada.

Background

Readers of my blog 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. Many Americans living abroad fail to file these forms. Readers also know that the IRS has had a number of programs designed to ferret out Americans hiding money offshore, and evading US tax. The vast majority of such “cheaters” reside in the United States.

Where these facts intersect is that the IRS’ approach to find cheaters focuses on Americans with financial accounts located outside the United States. And which Americans hold most of these accounts? Why, Americans living outside the US, of course.

The IRS’ crackdown on cheaters has the tangential effect of scaring ordinary Americans who live outside the United States (about a million of whom live in Canada). These people rarely owe US tax, and if they do, it’s generally because of some glitch in the way the two tax systems measure unusual types of income, not because of a concerted plan to avoid or evade US tax. Yet many of these people found out within the past year or so that they are at risk for large penalties because of their failure to file.

Prior filing approaches

Prior to today, these non-filers had but two alternatives:

The OVDPs were designed primarily for the cheaters –​ people who had a legitimate fear of being incarcerated for their tax deficiencies. The OVDPs required filing of 8 years’ returns and FBARs, plus a great deal of supporting documentation. Then the IRS would carefully scrutinize each submission. Going this route was cumbersome, expensive and time-consuming.

The six-year approach was less onerous, but still expensive – particularly so for people who were compliant in the country in which they resided.

These approaches didn’t work for taxpayers, but they didn’t work for the IRS either. The IRS had to spend a great deal of manpower processing paper submitted by people with no meaningful tax liability. Instead of generating net revenue, the Service was losing money on these taxpayers.

New approach offered

For months, the IRS has been promising a new, less costly regime for non-compliant Americans living abroad. Today, it announced at least the skeleton of a new plan:

For individuals who want to come in from the cold:

  • Taxpayers will be required to file only 3 years’ tax return, but still 6 years’ FBARs.
  • If they have Canadian Registered Retirement Plans (RRSPs), Income Funds (RRIFs) or Life Income Funds (LIFs), they will be eligible for a simplified method of gaining treaty relief for income earned inside of the funds. Previously an expensive Private Letter Ruling was required.
  • Taxpayers will be divided into 2 categories – low and high risk. To be low risk, a person will have tax of US$1,500 or less for each year, and each return will be simple.

At this point, there is little guidance on what constitutes “simple” – that is to come. A high level of income or assets will make a return not simple, as will a significant amount of US-source income. My guess is that involvement with non-US corporations, partnerships and trusts will have the same effect.

The intensity of the IRS’ review for low-risk taxpayers will be low, and the IRS will not assert penalties or pursue follow-up actions. Higher-risk taxpayers will be subject to more intense scrutiny, and may be asked to file additional material. They will be subject to ordinary penalties, but will still be able to claim relief where they can show they had reasonable cause.

The phrase “reasonable cause” was addressed in a previous blog post;

In my view, this program 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 two old plans.

At this point, any American in Canada who has not yet come into the system, or filed an extension for 2011 with an expectation of doing so, should wait until more information becomes available under this new arrangement.

I’ll keep you posted.