Five options for Americans not filing tax returns (or filing incorrectly) with the IRS
So what if you are one of the thousands of American citizens, derivative citizens, or green card holders living in Canada that haven’t filed U.S. tax returns with the IRS? Or suspect that your returns have not been filed correctly? Here are 5 options for Americans not filing with the IRS:
- Do Nothing
Many non-compliant taxpayers are taking a “wait and see” approach to what the IRS is going to do under the other programs listed below. They are also watching the media for stories on others coming forth to see how the IRS treats them and so far, that waiting has paid off. We do not recommend waiting anymore as recent changes to the Offshore Voluntary Disclosure Program (OVDP) outlined below simply don’t warrant waiting anymore. Further, as Canadian financial institutions begin disclosing your account info to the IRS under the intergovernmental agreement starting July 1, 2014 as a part of the Foreign Account Tax Compliance Act (FATCA), your days are numbered. Consider these additional situations which often lead to a notice from the IRS asking you to file a return:
* simply crossing the border into the United States;
* becoming a beneficiary of a U.S. estate or trust;
* receiving American-source investment income;
* selling U.S. real estate that you own;
* choosing to return temporarily to the United States as a snowbird, to retire there, or to care for an ailing family member there;
* receiving a U.S. employment opportunity requiring a move from Canada;
* becoming eligible for an American-source pension such as Social Security; or
* sponsoring a family member for a green card.
- Offshore Voluntary Disclosure Program
After a couple of trial programs, starting in January 2012 the IRS began an open-ended Offshore Voluntary Disclosure Program (OVDP) that allowed folks with foreign accounts to come forward and disclose them, pay any taxes, interest and penalties owing, and get right with the world rather than risk detection by the IRS through FATCA, under which criminal prosecution is possible. Through OVDP, the IRS has reduced (but still substantive), standardized penalties that give non-compliant taxpayers the opportunity to calculate, with some certainty, the total cost of getting into compliance with the IRS. So far, 45,000 taxpayers have taken advantage of the program with $6.5B in taxes, penalties and interest collected.
On June 18, 2014, IRS Commissioner John Koskinen announced new “streamlined offshore procedures” for U.S. tax filers living both outside and inside the U.S. who have not been filing or properly reporting their foreign accounts and the income from them. We believe these are very positive changes that will give many “U.S. persons” a better way to come into compliance because of the substantial reduction in penalties. Here is how to get into compliance with the IRS and begin sleeping at night.
Non-Filers Living Outside the U.S. (The American in Canada)
For those living outside the U.S., if your non-filing was due to “non-willful conduct” and you meet the “non-residency” requirement, no “failure-to-file,” “failure-to-pay,” “accuracy-related,” “information return” or “FBAR” penalties will apply. This is good news, but it is important to define terms:
Non-Willful Conduct – “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”
Non-Residency Requirement – “in any one or more of the most recent three years for which the U.S. tax return due date (or extension) has passed, the individual did not have a U.S. abode AND the individual was physically outside the United States for at least 330 full days.”
Abode – “The location of your abode often will depend on where you maintain your economic, family, and personal ties.” – see IRS Publication 54 for more details and examples
If you meet the definitions above, you are eligible to file under the new streamlined OVDP procedures which require:
- File Returns/Amendments – For each of the three most recent tax years that have passed (with extensions), file delinquent Form 1040 or amended Form 1040X tax returns along with all required disclosures (Forms 3520, 3520A, 5471, 8891, 8938). You must pay all taxes due and all applicable statutory interest for each return at the time you file your returns!
- File FBARs – You will need to file the most recent six years delinquent FBARs (FinCEN Form 114 – previously Form TD F 90-22.1) electronically at FinCEN.
- Certification – Complete and sign “Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures” which is a new form the IRS is providing
- Failure to Make a Timely Treaty Election – If you have an RRSP in Canada and have not filed Form 8891 to elect to defer the income inside the RRSP each year, you are required to submit: 1) a statement requesting an extension of time to make the election along with the applicable treaty provision; 2) sign a statement under penalties of perjury describing what led to the failure to make the election, how you discovered the failure and if you relied on a professional advisor, the engagement with the advisor and his/her responsibilities; 3) a completed Form 8891 for each RRSP/RRIF account for each of the past three years.
If you don’t have a Social Security Number or an Individual Taxpayer Identification Number, you can submit an application along with your tax returns to get one issued. Mail everything to:
Internal Revenue Service
3651 South I-H 35
Stop 6063 AUSC
Attn: Streamlined Foreign Offshore
Austin, TX 78741
Non-Filers Living Inside the U.S. (The Canadian in America)
For those living inside the U.S., you have likely been filing U.S. returns but you are out of compliance because you have not filed any FBARs, Treaty elections or other disclosure forms as outlined above. Again, if your non-filing was due to “non-willful conduct” as described above, no “failure-to-file,” “failure-to-pay,” “accuracy-related,” “information return” or “FBAR” penalties will apply! However,” the Title 26 miscellaneous offshore penalty is applied in your situation and is equal to 5% of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.”
If you meet the definitions outlined above, you are eligible to file under the new streamlined OVDP procedures which the same as those living outside of the U.S. The only difference is you have to pay all applicable taxes, statutory interest and the miscellaneous offshore penalty at the time you file your returns.
- “Quiet Disclosure”
Another alternative called “quiet disclosure” means you simply amend your previously filed U.S. tax returns and/or add the requisite disclosure forms for the previous six to eight years. Another approach some have used is filing late returns or simply ignoring past filing requirements and just filing their current tax returns along with the required disclosures for the current tax year hoping to get into compliance prospectively. In theory, quiet disclosure allows you to avoid the penalties if you did not underreport any income and there is no change to taxable income or tax liability in the prior years. However, most do not qualify for quiet disclosure because either they are non-filers or their taxable income changes (even though their tax liability doesn’t change). A far better alternative is to enter the formal OVDP and pay the tax, interest and penalties (for U.S. residents) to get into compliance. The problem with “quiet disclosure” is that you are now on the IRS radar screen, and the likelihood of an IRS examination has increased significantly. The U.S. Government Accountability Office has encouraged the IRS, and it has agreed, to actively seek out those avoiding OVDP through quiet disclosure because it undermines the overall integrity of the OVDP.
- “Normal” Voluntary Disclosure
Besides OVDP and quiet disclosure, the regular voluntary disclosure practice of the IRS can be used. Set forth in IRS manual 22.214.171.124, Section 4.01 of the Criminal Tax Manual for the U.S. Department of Justice, procedures have been in place for a long time providing direction for any taxpayer who wants to get into compliance with the IRS. They don’t have the “discounted” penalties and forgiveness like OVDP, but they may be worth investigating.
- Renounce Your U.S. Citizenship
When confronted with the administrative, financial, tax, and estate planning challenges of being a dual tax resident or dual citizen, many U.S. citizens and green card holders ask us for a way out. One answer we find many quick to suggest is to simply renounce your U.S. citizenship or relinquish your green card — and the problem goes away. Unfortunately, it is not as easy to renounce your citizenship because of the U.S. Expatriation Tax. Congress got tired of American citizens building their net worth in the United States, renouncing their citizenship, and then retiring to a tax haven to live a tax-free lifestyle for the rest of their lives. In 1996, new laws were passed, amended again in June 2008, that impose serious consequences on American citizens who renounce their U.S. citizenship or green card holders who relinquish their permanent resident status.
With the amendments in June 2008, an alternative tax regime applies to a U.S. citizen or green card holder (held for 8 of the past 15 years) who satisfies any one of three criteria:
(1) your net worth is U$2 million or more on the date of your expatriation;
(2) your average annual net income tax liability over the previous five years before expatriating was U$157,000 or more (after foreign tax credits) in 2014 (adjusted for inflation); or
(3) you fail to certify, under the penalty of perjury on Form 8854 — Initial and Annual Expatriation Information Statement, that you have complied with all U.S. tax filing obligations for each of the previous five years before expatriation.
If any of these rules applies, you are considered a “covered expatriate” because you are renouncing citizenship to avoid taxes and therefore fall under the alternative tax regime. As a result, you are required to file Form 8854 — Initial and Annual Expatriation Information Statement on an annual basis (U$10,000 penalty for failure to file) along with Form 1040NR — U.S. Nonresident Alien Income Tax Return for a period of 10 years after expatriation, no matter where you live in the world. Form 8854 is onerous and invasive as it requires disclosure of the following information:
* your U.S. Individual Taxpayer Identification Number or Social Security Number;
* your country of residence and address after expatriating;
* your U.S. federal income tax liability for the five taxable years ending before the date of expatriation;
* your net worth on the date of expatriation;
* a statement under the penalty of perjury that all U.S. federal tax obligations have been complied with; and,
* if subject to the alternative tax regime based on net worth and income, the number of days present in the United States during the year of expatriation, a balance sheet of worldwide assets and liabilities, and a detailed statement of worldwide income.
As a reminder, if you expatriated between June 4, 2004 and June 15, 2008, you are not permitted to spend more than 30 days in the U.S. (60 days if working for an unrelated employer) for the 10 years following your expatriation . . . it is like you never left. This means if you want to attend a funeral, help an ailing friend, accompany your children or grandchildren to Disney World, or just stay in your 2nd home in Florida and end up spending more than 30 days in the U.S. in any calendar year for the 10 years following your expatriation, you have to file 1040 tax returns here in the U.S. and declare your worldwide income. Congress sent a rather clear message that if you want to expatriate, don’t come back! We are unsure if they will bring a similar provision back into the expatriation rules in the future but it is possible. Currently, there is a little known, little used provision in the Immigration Act that bars expatriates from entering the U.S. This could easily be enforced in the future with no additional laws needing to be passed so it is something to factor into your decision-making.
We have presented 5 options for Americans not filing with the IRS. So what should you do? We recommend taking advantage of the new streamlined procedures under the OVDP and get into compliance. As a Canadian taxpayer, it is likely you won’t have much tax owing to the IRS because Canada is not considered a tax haven, which means any statutory interest owing should be minimal as well. We believe it is a small price to get a good night’s sleep!
If you have any questions or need help with your filing, please contact us at 480/722-9414 or email us at firstname.lastname@example.org
Written by Brian Wruk of Transition Financial Advisors Group, Inc.
Brian Wruk, MBA, CFP®(US), CFP®(Canada), TEP, CIM, is the author of The Canadian in America and The American in Canada and a Canadian now living in the U.S. as a dual citizen. His firm, Transition Financial Advisors Group, Inc. specializes in high net worth families migrating between Canada and the U.S.