U.S. tax compliance: The costs of compliance, the costs of non-compliance, and how to choose a lawyer

The costs of coming into U.S. tax compliance and how to choose a lawyer

Introduction

U.S. citizenship-based taxation is bad for the U.S., bad for U.S. citizens and bad for the world. Tax compliance for U.S. citizens living outside the U.S. is very difficult. For most, U.S. citizenship has been priced out of the market. The differences between the Canadian and U.S. tax systems is such that  investments being prohibited to U.S. citizens. U.S. citizens living outside the United States find themselves in a very difficult situation. Regardless of their final decision, many of them are faced with the crippling fear and anxiety of dealing with the Obama/IRS assault on their lives, their wealth and their health. Many of us remember the moment when our lives changed. The great tragedy is that those of us who are the most negatively affected are the ones who spent a lifetime behaving in a financially responsible manner. We saved for our retirements. We put our children through school. We have paid out taxes in Canada. We have been employed taxpayers who have contributed to our communities. We are now faced with the fear and reality of having to deal with deal with this Obama/IRS led assault on our lives, wealth and health. Some people are actively trying to avoid making money. It is no surprise that renunciations of U.S. citizenship have soared under the Obama administration. And this is only the early days …

On a positive note (if there is one):

1.      I suspect that the imposition of significant FBAR penalties on dual citizens living in Canada is remote.

2.      I suspect that most dual citizens living in Canada  do NOT owe much (if any) U.S. tax on income.

On a negative note (and there are plenty):

1.      The very fact that you have RRSPs, TFSAs, RESPs, mutual funds and (possibly) Canadian Corporations leaves you open to all kinds of potential tax problems.

2.      Those who have NOT filed U.S. tax returns in the past (presumably) have not made the required RRSP elections. (Note the December 2011 FS which directs that you file for the last six years.)

3.      MOST SIGNIFICANTLY: There is no way to determine your situation and make a rational decision on how to proceed without “professional help”.

 Is all “professional” help really professional?

Since all of this started (Fall of 2011) there have been hundreds of comments, blog posts, advertisements from “Cross Border” professionals, etc. There have been a number of comments and experiences of those who have engaged “Cross border” professionals (mostly in the context of OVDI). Now, before going further, I wish to make it clear, that this post is not directed to the “whale”. It is directed to the “minnow”. By “minnow”, I mean somebody who has truly been subjected to “collateral damage”. OVDI was not intended for “minnows”. A “minnow” should have no reasonable expectation of criminal prosecution.

But, that does not mean that the “minnow” does not have compliance issues. The very fact that you have been a hard working, honest, tax compliant Canadian, who has saved for your retirement, is exactly the reason why you now have problems with the IRS. If you had lived your life as an irresponsible person, no bank accounts, no savings, no financial planning, etc. you would have  no problems. You would have nothing to report and therefore nothing for them to take. Also, responsible people have a certain emotional characteristics. Those emotional characteristics make this whole process particularly difficult for them. In a very real sense this recent IRS initiative is a project to steal the fruits of your life’s work. The problem is that if the taxes don’t get you, the compliance costs will. Some of you will, or are, taking steps to come into compliance. Some will not. The real question is:

Is the cost of not coming into compliance (particularly in a FATCA environment) greater than the cost of coming into compliance?

“Cost” includes more than financial cost. It includes: stress, continued focus on this problem, etc.

Logical Options For Coming Into Compliance

I emphasize that these are logical or theoretical options. Some of them don’t make practical sense for most people. Nevertheless, here are some logical options:

1.      OVDI – Offshore Voluntary Disclosure Initiative –  If you want to interact with the IRS on the assumption that you are a criminal, this is for you. The reason is that “reasonable cause” arguments will be entertained only with an “opt out”. On the other hand, Canadians may be able to take advantage of the 5% penalty. It is therefore conceivable that this could be a rational option for those who find the payment of 5% of your assets an inexpensive way to go. For most people entering into the OVDI makes little sense and OVDI should be approached with caution.

2.      VDP – Good “old fashioned” voluntary disclosure. Voluntary disclosure implies that you are notifying the IRS that you are filing back tax returns, etc. Obviously this would include the making of “reasonable cause” arguments. It is not a “quiet disclosure”.

3.      Reliance on the IRS 2011 FS for dual citizens of Canada and the U.K. This probably assumes simple facts and a relatively unsophisticated taxpayer.

4.      Compliance on a “going forward” basis – probably appropriate for only  people with simple situations

That said, you should take steps to resolve any past compliance issues only with the assistance of a competent adviser.

What follows is an interesting exchange between a concerned person and a tax lawyer, about various compliance options,  which took place on the Isaac Brock Society blog.

desi
February 25, 2012 at 10:20 pm

Hi Michael,
What if Tom happens to be a dual Citizen Canadian who had been in Canada since 1995 had inherited $1000000 and had the funds in a Canadian Bank. He has never filed US tax returns. In your opinion, what should he do?

Michael J. Miller
February 26, 2012 at 6:34 am

@Desi — I don’t think I can responsibly give a bottom line conclusion without all the pertinent facts. Having said that, it would take some further, negative facts before I’d be likely to advise paying 27.5% under the OVDI in this situation. OVDI might nevertheless be a“desirable” option, however, since it may be possible to reduce the 27.5% to 5%, assuming that Tom has been fully compliant in Canada. Depending upon an individual’s financial situation and temperament, it certainly might be desirable to make the whole issue go away if the 5% is possible.

One thing I sometimes like to do in this type of situation is have a qualified US tax return preparer prepare, for example, the last six federal tax returns to see what they look like. The less tax that would be owed (and, indeed, it may be zero), the less likely it would seem (everything else being equal) that Tom’s noncompliance was intentional. Let’s assume, for the sake of discussion, that Tom would literally owe zero US tax (though I would urge caution, since this need not be the case), and that he has no non-US corporations, trusts, or other entities that should have been reported, so that his only “problems” are not filing 1040 (with worldwide income), and failing to disclose a single non-US account on the FBAR. In that case, his failure to report the one account on an FBAR seems, quite evidently,
to be nonwillful (absent other, bad facts). As a result, the maximum penalty would be $60,000 ($10,000 for each of the six years open under the applicable statute of limitations, i.e., 2005-2010). If Tom complies with all of the rules for 2011 (including 1040 (with new Form 8938) and FBAR), then once July 1, 2012 rolls around, that potential FBAR penalty of $60,000 becomes $50,000 (max) because it would now be too late for the IRS to assess any penalty for 2005 (even though no 2005 return or FBAR was ever filed). On these facts, I might consider all of the following (in no particular order): (1) going into the program, but opting out and making an argument for zero FBAR penalty by reason of reasonable cause; (2) going into the program, but arguing for the 5% penalty (and, failing that, opting out); (3) filing late returns (showing zero tax due) for some number of years and possibly FBARs with a note explaining the situation and asserting reasonable cause (as the IRS suggested recently in a release directed at US citizens living abroad); and (4) complying prospectively, with no other action. Note that (1) and (2) involve significant attorneys’ fees, as well as the assurance (as opposed to merely the risk) of IRS attention, so I’d be more inclined to recommend for a client that has a lot of anxiety about the situation, doesn’t want it hanging over his or her head, and can afford some extra fees/potential penalties to make that happen

How To Select The Right Lawyer

I wrote an earlier post that discussed how to select the right tax preparer to do your U.S. tax returns on a going forward basis. Most people feel that the IRS cannot be trusted. But, can we trust the cross border professionals? The purpose of this post is to share some thoughts on how to get the “professional help” required to clean up past compliance issues. This should  be considered in terms of:

A.     How to decide who to retain for professional help

B.     How much will it cost?

Re A: How to decide who to retain for professional help

First – You have a compliance problem. This is different from a tax problem. The tax problem may have caused the compliance problem, but now your problem is to bring yourself into compliance. Hence, you need a professional who is experienced with U.S. tax compliance issues. You do NOT go to your local tax preparation firm. You do go to a lawyer experienced in compliance issues. Remember that only a lawyer will give you the benefit of “lawyer client” privilege.

Second – Your specific facts must be understood. The most important principle is to find somebody who will really take the time to understand  your situation. There are infinite permutations of facts – some helpful and some not so helpful. Your route to compliance must be based on an analysis and understanding of your specific situation. Any adviser who recommends a specific course of action (for example OVDI or compliance going forward) without a lengthy discussion of your history should NOT be retained. Your decision must be the result of an analysis of you. Your lawyer will need to write “reasonable cause” letters. The effectiveness of the letter is a function of an understanding of your facts.

Third – You need to be able to speak freely, honestly and openly. Because the decision is the result of an analysis of your specific factual situation, you should consult with a lawyer. You need to be able to share all relevant facts with the professional. Consultations with lawyers are subject to “lawyer client privilege”. Consultations with accountants are not. Lawyers cost more, but that’s life.

Fourth – the lawyer who advises you on what to do, doesn’t have to be the same as one who helps you actually come into compliance. Seeking professional advice in the compliance area is similar to obtaining the services of a financial planner. There are “fee based planners” and planners who survive off commissions from the sale of products. There are planners who charge for their advice on an hourly basis. There is an analogy here. The reality is that it is in the financial interest of the lawyer for you to be in OVDI (or something elaborate). For this reason, you might consider:

Using one lawyer to help you decide how to come into compliance;

And use a different lawyer to bring yourself into compliance.

To put it another way, you might consider simply paying for a “compliance consultation” where it is clear that you will NOT be retaining that lawyer to bring you into compliance. This could be the best money you will spend. Then, move onto the decision of what lawyer to use to bring you into compliance. In other words, the decision to undergo surgery is different from the decision of who will be the surgeon.

Re B: How Much Will It Cost?

First – This will cost money. No matter what you do, this problem will cost you part of your hard earned money. And yes, this is grossly, grossly unfair.

Some people are of the view that: it will cost less to deal with the problem now, than to deal with it later.

Some people are of the view that: they will deal with the problem when the IRS is at the door. That is likely to be more expensive (unless you have only a few days left to live) and even then it would become a problem for your estate.

Second – The fees for “cross border professionals” are high. The more responsible you have been in your financial life, the more this is likely to cost you. Consider the following comment:

AnotherVictim

March 6, 2012 at 9:38 pm

Having been a victim myself, USD 40k in lawyers fees for an overseas resident in OVDP or OVDI is easy to understand. I also agree that Pamela has been ripped off and is just another victim of the practices in place in the current OVD industry.

Think of it like this:

1) Accounting Fees – most overseas accountants who can do US taxes charge between USD 1000 and USD 2000 for doing a simple US tax return. They are considered specialized and not very prevalent in most foreign countries so they can charge these rates. Even taking an accountant in the States will only put you at the lower end of these charges due to the “specialized” nature of the returns.

An accountant is likely needed if you have any mutual funds which are considered to be PFICs. This is more common than you would think as many foreign retirement plans are mutual funds which need to be declared according to the bizarre and complicated PFIC way of calculation.

Also if you take a Foreign Tax Credit, this automatically triggers the Alternative Minimum Tax, both of which have their own peculiarities as to how they are calculated, which may increase the price of the return.

So assuming an average of USD 1500 per return, for the 8 years of OVDI that amounts to USD 12k in accounting fees.

2) Where costs really add up are with the lawyers. Here are tricks that they often use that one should watch out for:

a. Partners will bring you in. They will tell what the retainer is and that may seem reasonable. They will say it covers everything, but often times it does not and once you are locked in, it is difficult to change lawyers. You would have to re-pay the same initial hours to get the new lawyer familiar with your case.

b. Many Partners in tax law firms have rates around USD 600-700 per hour. They will tell you that to save you money they will let an associate lawyer do the work. They assign work to associates that could have been done by an accountant. This way they keep the work-in house at much higher billing rates. What one will find is that an associate has checked all your bank statements and FBARs and billed you for this at rates of USD 300-400 per hour. Associates will also do what is pretty much secretarial work like writing the OVDI letters and filling in the forms and charge you full rates for this. They will charge you for any time they spend consulting with the partner at the associate’s rate and the partner’s rate.

c. They will cite the Kovel agreement that is in place with the accountant as protecting your rights even and refuse to let you talk to the accountant without being present. So you get involved in a game of telephone that costs lots of money if the accountant has any questions about your statements and foreign tax returns that are in a foreign language even if you have already translated them.

Given the above, at an average associate rate of USD 350 per hour, you only need two weeks worth of work to run up a tab of USD 28,000.

So legal and accounting fees of USD 40k are easy to understand. A lot of the work is done and you only get your bill at the end of the month and are shocked at what has happened. At that point it is too late. Your only remedy is to set limits on future work.

As Calgary 411 has said, all of us have our own reasons for initially wanting to rely on a lawyer. It could be fear, illness, work and family requirements, whatever. Most expats who are in OVDI have probably had little to do with lawyers in their lives and therefore they can easily be taken advantage of by lawyers and associates who are eager to bill them for their time.

I am not saying that the lawyer’s work is not good and thorough, but unless you set limits, which due to lack of experience you may not know to do, the fees can mount up.

I hope this will help anyone reading this who is contemplating using a lawyer for anything related to tax compliance in the current environment.

An interesting response to this comment and perspective on the effective use of lawyers (in a relatively simple situation) comes from JustMe.

@AnotherVictim

Excellent comments, and right on point! Thanks for providing them for those here who struggle with the cost of doing what they feel is right. As another victim I heard say, when he got his attorney fees, he had to put on adult diapers! $40K is nothing compared to how much it can run, if you turn over the entire process to an attorney!

This confirms why I have said, one needs to do their own drudgery related to the OVDI. I quickly figured that using an attorney, for all the reasons you have sited would be as expensive as the penalties themselves. I figured, that most of the work was really just clerical crap, and anyone could do it, if they would just apply themselves, rather than pay some attorney, their associate or CPA to do it.

So, I would only use an attorney for advice as to helping you assess your facts (after you have done your own education drudgery). That is warranted at the beginning of the process or at some critical decision point like should you Opt Out, but other than that, DIY for the OVDI is very possible, in fact the only logical way for a Minnow to approach the problem. At max, pay for a few hours of legal assessment time, vs having them do everything for you and giving them or a CPA Power of Attorney (POA).

I would NEVER pay an attorney to do for you, what you can do for yourself. Their fees are structured for those rich enough that money is of no consequence, or for folks who feel they can not spare the time, as theirs is too valuable, or for folks that are fearful and don’t know what to do. And so they pay through the nose for it.

When it comes to attorney and their fees, Caveat emptor!

However, if you don’t have monopoly money and the above does not describe you, then by all means, if you have decided to join the OVDI after doing your drudgery, then DO THE ACTUAL PROCESS YOURSELF. You can write the letters. You can calculate your highest aggregate. You can figure exchange rates. You don’t need an attorney for any of this. Your examiner may want an POA to deal with as it is easier for them. They like someone who talks the lingo, but I told mine, “tough… you are getting me… period. So if you want something I don’t understand, you are just going to have to explain it to me, as I am not paying someone to deal with you!!!”

Now, I have to say, that having some meager Excel spread sheet skills did help, especially when it came to creating a flow sheet to show fund flows between accounts and to be sure you were not double counting money. Also, there is a year by year reconciliation process that required me to produce spreadsheets to verify the examiners numbers and to link them all up so that there was a summary sheet which the IRS did not provide.

If a person wasn’t comfortable working with Excel, then they might have been tempted to have someone do it for them, However, in this day and age, there are many inexpensive help sources in learning how to add up numbers in a column within a spread sheet, and you don’t need to be paying a CPA or attorney $100s of dollars an hour to accomplish that. If that is an issue for you, then it is FAR cheaper just to take an Excel class yourself for a few hours to get proficient enough rather than pay for the simple clerical help. At the end of it, you have something for your money, a new skill!

So my advice is to steer clear of the attorneys for mundane processing, and use them only for critical legal assessment. It is there that they are worth the money, but for anything else, pay yourself the $400 to $700 and hour these guys want to charge. Frankly for most of what you have to do in the OVDI, $50 an hour is too much to pay.

I know that all of this sounds horrible. But, once heard it said that:

The good thing about bad things is that come to an end. The same person also told me that the bad thing about good things is that come to an end. Hang in! This will come to an end.