Americans in Canada: The End of the Amnesty
Many US citizens living in Canada are unaware of their US tax-filing responsibilities. The 2011 Offshore Voluntary Disclosure Initiative (OVDI), an amnesty program for missed filings, ended on September 9. Because of recent political developments, the current situation is in flux.
In Canada, personal filing requirements are based on residence and income source. The United States, in contrast, taxes individuals primarily on the basis of citizenship (although taxation can also be based on residence and immigration status, among other criteria). With a few narrow exceptions, US citizens must file returns and pay the related taxes and penalties regardless of where they reside and without regard to the country in which their income originates. In addition to income tax returns, US citizens must file information returns, and different filing requirements apply for each type of form. One of the most common forms is the FBAR (TD F 90-22.1, “Report of Foreign Bank and Financial Accounts”), which must be filed by persons who have a financial interest or signing authority in banking and/or investment accounts outside the United States if the cumulative balances in those accounts exceed $10,000 at any one point in the year.
Penalties for failure to file a personal income tax return (form 1040) are based on a percentage of the tax outstanding. The maximum charge is 25 percent of the outstanding amount plus interest. In the case of most information forms, such as the FBAR, the maximum penalty is US$100,000 or 50 percent of the amount in the foreign bank account at the time of the violation, whichever is greater. In addition, criminal charges may be filed.
Penalties for failure to file tax returns and information forms may be reduced at the IRS’s discretion. For tax returns, the determining factor is reasonable cause; for information forms, it is wilful versus non-wilful failure to comply. The penalty may be eliminated completely for tax returns. However, the penalty for errors or omissions in respect of information forms may still apply at a rate of up to US$10,000 per infraction, even if the failure is considered non-wilful.
At the time of writing, it is unclear what position the IRS and the Department of the Treasury will take on each category of infraction. The Canadian minister of finance, Jim Flaherty, has said that most people affected by these rules are not tax evaders and deserve to be treated with leniency. In a speech delivered on October 18, 2011, David Jacobson, the US ambassador to Canada, said that both he and the commissioner of the IRS are sympathetic to the plight of the many Canadians unwittingly caught by the rules, but “we have to figure out a way to do it without letting the person who is trying to evade taxes in the Cayman Islands off the hook.”
Two things are clear. First, consequences will be more severe in cases where the IRS identifies the non-compliance than in cases where a taxpayer makes a voluntary disclosure. Second, proving that non-compliance was due to reasonable cause or non-wilful error is expected to become more difficult as the media coverage of the issues becomes more prevalent. Thus, taxpayers should not delay becoming compliant.
The probability of US citizens being caught is likely to increase over time. US customs agents at border crossings are noting travellers’ birthplaces as shown on their passports and are asking questions about whether they have filed their tax returns. Also, the Canada-US tax treaty contains an information-sharing provision (article XXVII). As computers and databases become more comprehensive and cross-referencing becomes more efficient, the tax authorities’ ability to identify non-compliance improves.
Finally, in 2014 Canadian banks will be required under FATCA (the US Foreign Account Tax Compliance Act) to report US citizens’ ownership of accounts to the IRS.
Many US citizens who live in Canada believe that they would not owe any tax even if they were to file US returns. This is not always the case. In general, Canadian-source income tax paid qualifies as a foreign tax credit to offset a taxpayer’s US tax liability. Because Canadian personal tax rates are generally higher than US rates, the US tax liability is often completely eliminated by the foreign tax credit. A foreign earned income exemption (FEIE) is also available to exempt the first US$92,000 in earned income for 2011 (less in previous years). Some types of income, however, are either not eligible for the FEIE or are taxed at higher rates in the United States; in those cases, a taxpayer can incur a significant unexpected tax liability. Some common items that may create a US tax liability are lottery winnings and windfalls, RRSP contributions that are disproportionately large relative to income, ownership of companies with passive earnings, large capital gains on assets held less than a year, receipt of certain types of dividend income, and use of the lifetime capital gains exemption or, on sales of high-value homes, the principal-residence exemption.
Another source of confusion is determining who is a US citizen. Birth in the United States guarantees US citizenship. A child of two US citizens is generally a US citizen even if the child was born abroad. If one parent is a US citizen and the other is not, their child may be a US citizen if the US-citizen parent lived in the United States prior to the child’s birth. Renunciation of US citizenship requires specific acts and the issuance of a certificate of loss of nationality by the US State Department; one’s US citizenship does not simply lapse. Consultation with a US immigration lawyer may be appropriate for a US citizen living in Canada who finds himself or herself in any of these situations.
Robert E. Ward