Low Risk U.S. Tax Compliance

January 4, 2013

On June 26, 2012 the Internal Revenue Service (“IRS”) announced new streamlined filing procedures (“SFP”) for non-resident U.S. taxpayers to go into effect September 1, 2012. SFP is available to U.S. persons and dual citizens living outside the US who have failed to timely file U.S. federal income tax returns or disclose their non-U.S. bank and financial account information and now wish to become compliant with their US income tax filing obligations.

SFP differs from the Offshore Voluntary Disclosure Program (“OVDP”) announced January 9, 2012, in that it is designed for taxpayers that are “low risk” filers. The IRS will review submissions filed under SFP and determine which filers present a low compliance risk and are eligible for the streamlined procedure. For taxpayers that qualify, the IRS will expedite the review process and waive any late filing penalties. The IRS will provide additional relief to taxpayers by recognizing an election to defer US tax on income accrued within certain retirement plans including Registered Retirement Savings Plans (“RRSP”) on a retroactive basis, if there is a treaty provision between the two countries that allows it.

Low compliance risk filers will be predicated on simple returns with little or no US tax due. If the submitted returns and application show less than $1,500 in tax due in each of the years, they will be treated as low risk and processed in a streamlined manner.

Determining a taxpayer’s risk level however is not entirely objective. The following factors may disqualify a taxpayer from low risk status despite having met the criteria above.

  • Filing under SFP results in a refund claim;
  • The taxpayer has “Material” economic activity in the US;
  • The taxpayer has not reported all of their income in their country of residence;
  • The taxpayer is under audit or investigation by the IRS;
  • The taxpayer has previously been assessed penalties for failure to disclose their non-U.S. bank and financial information;
  • The taxpayer has a financial interest in accounts or entities including non-U.S. corporations and trusts outside of their country of residence;
  • The taxpayer has income from US sources;
  • There is evidence suggesting intentional tax avoidance using sophisticated tax planning techniques.

Taxpayers wishing to file under SFP must:

  • Submit complete and accurate delinquent tax and information returns for the last three years from which a U.S. tax return is due;
  • Submit payment of all tax due and owing as reflected on the returns and statutory interest due and owing;
  • Submit complete and accurate delinquent Reports of Foreign Bank and Financial Accounts (“FBAR”) for the last six years for which an FBAR is due.

Taxpayers who file under SFP who are later determined to be high risk filers ineligible for the streamlined procedure may be subject to failure to file and failure to pay penalties in accordance with U.S. federal tax laws and FBAR penalties may be imposed in accordance with US law.

In early December, the IRS confirmed that not having met the criteria for filing under SFP is not a valid reason to avoid applying to the program. The IRS recommended that taxpayers should still submit under SFP and have their application reviewed by an IRS agent who will determine whether any further examination or enquiry from the IRS is required. The IRS has stressed that SFP is a small window of opportunity for taxpayers to become willingly compliant before the IRS intensifies its investigations on non-U.S. filers and tax evaders living outside the U.S.

High risk filers who want absolute certainty in the processing of their application will want to opt toward OVDP which provides another means for taxpayers to become fully compliant. It is worth mentioning that once a taxpayer submits under SFP, they are no longer eligible for OVDP.