Last week, the Internal Revenue Service followed up on its promise to grant relief to the estimated one million U.S. citizens, including dual citizens, living in Canada, many of whom may not be up to date with their U.S. tax filing obligations, by posting a Fact Sheet on its website.
U.S. citizens are required to file a federal income-tax return as well as Reports of Foreign Bank and Financial Accounts (FBARs) annually no matter where they reside, as the United States imposes taxation based on citizenship. Most countries, including Canada, have a residency-based taxation system. For non-compliant U.S. citizens, the IRS is looking for six years' worth of tax returns and FBARs.
In most cases, since U.S. citizens won't end up owing any U.S. federal tax due to offsetting foreign tax credits for taxes paid in the foreign jurisdiction, such as Canada, no income-tax penalties would be assessed.
As for late-filed FBARs (Form TD F 90-22.1), the IRS is requesting a statement along with the overdue forms explaining why they are being filed late.
Generally, late filing FBARs can result in either a "willful" or "nonwillful" civil penalty. The penalty for willfully failing to file can be up to the greater of $100,000 or 50% of the total balance of the foreign account at the time of the violation. Non-willful violations are subject to a penalty of $10,000 per violation, unless the IRS determines the late filings were due to "reasonable cause," in which case no penalties would be assessed.
So, what exactly is reasonable cause? The IRS has stated that factors that will be taken into account include reliance upon the advice of a professional tax advisor who you told about the account, whether the unreported account was established for a legitimate purpose, whether there have been any signs of intentionally concealing the reporting of income or assets, and whether any tax was owing related to the unreported foreign account.
Jim Yager, a partner at KPMG LLP's international executive service, says that "although the IRS Fact Sheet can be seen as a softer approach by the IRS - an American coming forward - is at the mercy of the IRS. Reasonable cause is a subjective determination."
The IRS states that if it's determined that a taxpayer's background and education indicate he or she should have known of the FBAR reporting requirements or if the taxpayer never disclosed the existence of the account to her tax preparer, the reasonable-cause defence may not be accepted.
Since the Fact Sheet was released, Toronto cross-border lawyer Christine Perry of Keel Cottrelle LLP has been besieged with calls from clients wondering whether they are home free.
"People need to be aware that 'reasonable cause' - is a very narrow technical concept. Behaviour that you or I may consider 'reasonable' in an intuitive sense may not cut it for the purposes of penalty relief," Ms. Perry cautions.