US Tax Confusion for US Persons in Canada

July 31, 2014

Many U.S. persons living in Canada are angry, scared or confused about their US tax obligations and the new Foreign Account Tax Compliance Act (“FATCA”). The internet is buzzing with stories of massive penalties, crippling professional fees and denied entry into the U.S., some of which may be partly true.

Contrary to the internet, most U.S. persons resident in Canada who have not filed U.S. tax returns will not owe any penalties at all for failure to timely file U.S. tax returns and the related disclosures. Most delinquent filers will also owe no US tax.

Nothing prevents an individual from preparing their own U.S. tax return. Our firm and others do prepare U.S. tax returns. We will also review self-prepared U.S. tax returns for a fee. The more complex an individual’s financial affairs, the more significant the professional costs.

U.S. citizens have a right to enter the US regardless of whether or not they have filed U.S. tax returns. Personal tax information is confidential in the U.S. and is not available to other government agencies, including at border crossings.

Under US tax law U.S. persons are obligated to file U.S. tax returns reporting their worldwide income and to disclose their financial accounts outside the U.S. They also may be required to disclose investments and transactions outside the U.S. The disclosure of financial accounts outside the US does not result in a U.S. tax liability.

People can debate the US’s right to tax U.S. persons outside the U.S., but it has a very long history that goes back to the US Civil War.

US persons include both U.S. citizens and U.S. residents as defined under US tax law, including “green cards” that have not formally been abandoned. The fact that they have never lived in the U.S. or only briefly lived there does not alter their status or their U.S. tax filing obligation.

If you are a U.S. person, what should you do? Regardless of whether you prepare your own U.S. tax return or engage a competent professional, you should comply with US tax law. Failing to do so will unnecessarily expose you to even greater risks.

No penalties will apply to U.S. persons who file under the IRS’s Streamlined filing program. It requires U.S. persons resident outside the US to file their last three years of delinquent U.S. tax returns and disclose their financial accounts outside the US for the last six years.

Lots of U.S. persons resident outside the U.S. have ignored their U.S. tax filing obligations and have suffered no ill consequences to date. The landscape has changed starting in 2008 when the IRS discovered that UBS, a Swiss bank was helping its US clients evade U.S. tax. The bank settled for a $780 million fine and divulged the names of 4,500 of its US clients. FATCA’s enactment in 2010 is a testament to the US Congress’ determination to get U.S. persons compliant with US tax law. It became effective worldwide July 1, 2014.

FATCA will give the IRS another tool to locate U.S. persons who are delinquent in filing their U.S. tax returns. Those that the IRS does locate will be denied benefits otherwise available to them and will not be eligible to have penalties waived under the Streamlined filing program.

Despite beliefs to the contrary, the IRS has been very accommodating with delinquent U.S. persons who file voluntarily. In the very few cases where penalties have been assessed they have proportionate to the actual tax due.

Individuals who revoke their U.S. citizenship or abandon green cards and have failed to file the last five years of U.S. tax returns may be subject to even more significant US tax consequences. Revocation or abandonment may be desirable strategies, but make sure you’re not putting yourself in a worse position.

There has been a lot of noise from a variety of sources about the U.S. tax filing obligations of U.S. persons resident in Canada and elsewhere. Doing nothing, whether on principle or from apathy, unnecessarily puts you at risk and does nothing to minimize or eliminate your US tax exposure now or in future years.