Note: There is an updated version of this crossposted to the Isaac Brock Society.
A Reaction …
*”…Generally, amended returns will not be accepted in this program. Where they are, the amended returns will be considered “high risk” and subject to increased scrutiny…’;
All I can say is that I’m so glad I went ahead and amended and resubmitted my several years’ returns LAST year instead of waiting…had i waited, there’s a much higher chance the accountant would have considered it too risky for me to file quietly, given that these announcements are seemingly limiting what’s considered a simple return. I would thus probably have had to enter into the draconian OVDP and would have wound up losing well 75% ofmy assets because of the now 27.5% penalty plus all the related taxes, interest, accounting and obvious attorney fees… I have lived in the UK for the past 24 years, married to an Englishman so am bewildered how we’re becoming collateral damage. I’d thus done my financial planning like a Brit because I had assumed that the tax treaties would protect me from double taxation.
It’s always been my intention to be tax compliant but had had no idea of how extensive all the rules and anomalies are. I’m just so relieved that I managed to find an expert tax preparer who felt that my situation was innocent enough for a ‘loud’ quiet disclosure but without having to ‘ring the bell’ so to speak…I still have my 2011 tax return to file which is very complicated and will probably be around 250-300 pages long, in contrast to my UK tax return which will be more like 15-20 pages long. I’m going to have to pay her another four-figure sum for this year and probably next, plus will want to stick with this specialized firm at least till the statutes of limitations have run in mid-2016.
After that, I will see how things are going in terms of hope of reform; if it’s not looking any better than I will definitely then consider renouncing because I don’t want to be burdened with annual professional costs of $2000-3000 with the risks of draconian penalties for foot faults. It’s an industry; we’re forced by the artificially complex rules to rely on professional tax preparers so we can be defended if the IRS comes back to me. It’s almost like protection money; it’s essentially a further tax on tax even though by the 2013 tax year, I should no longer owe any more US tax itself…I agree with everyone here that it’s ludicrous, this whole situation.
I feel like my hands are tied till the statutes of limitations have run for my amended returns. I’m scared that if I renounced, say, next year, that it would raise red flags and I might then face a horrible audit for my returns and FBARs. It’s awful feeling stuck like this but at least I’m ploughing through it bit by bit.
It seems to me that this new system will only work for those with very simple situations…I’d imagine that there will be a larger grey area where the IRS will still accept more ‘high risk’ returns but that it could be risky for the filer because going forward there will no doubt be even more scrutiny for expats.
On August 31, 2012, the IRS issued guidelines for how certain U.S. persons living outside the U.S., can come into compliance. Interestingly the guidelines apply to U.S. persons who:
– were living outside the U.S. on January 1, 2009
– have not lived in the U.S. since January 1, 2009
– have NEVER filed tax or information returns
– and meet additional criteria ..
As the above comment demonstrates, the “Compliance Question” is frightening, exhausting, expensive, and uncertain for U.S. persons abroad. This is a “quick and dirty post” to share my thoughts on the “New Filing Compliance Procedures for Non-Resident U.S. Taxpayers – Effective September 1, 2012.” I will improve this post over the next few days.
Readers should remember three things:
1. I am writing this from the perspective of a Canadian resident. Obviously, the analysis would apply (by analogy) to residents of all other countries.
2. When I refer to “U.S. citizens”, I mean “U.S. persons”. This means that the new procedure would be available to non-resident Green Card holders.
3. This is not legal advice. You do need legal advice – obviously from a lawyer and NOT from blogs and discussion boards. At most this post may alert you to the right questions to ask.
The “Compliance Context” of U.S. Person Abroad:
On January 9, 2012 the IRS announced the reactivation of the Offshore Voluntary Disclosure Program – “OVDP 2012”. This is the third version of the program. The first was “OVDP 2009”, the second was “OVDI 2011”. At least initially, these programs (certainly “OVDP 2009”) were designed to encourage U.S. residents, who used “offshore accounts” to evade tax, to come into compliance. For many “OVDP 2009” was a good deal. Imagine the following situation:
You were a U.S. resident with lots of untaxed income that was hidden offshore – AKA a “Whale”. First, you had never paid tax on the money at the time of acquisition. Second, you were not paying tax on the income generated from the money. The IRS then came along and offered you a deal. They asked only that you pay the tax on the income generated from that money and pay a 20% (it is now 27.5%) penalty on the money that was never taxed in the first place. Many of these people could come into tax compliance by paying far less than they ever would have paid if they had paid taxes along. It was a great deal for them! They got away with it! In addition, they escaped criminal prosecution. That’s how OVDP worked for the criminals. Who did it work for “middle class” U.S. citizens abroad? It was completely unworkable. The legal and accounting fees alone can exceed six figures and are usually grossly disproportionate to taxes owed and the level of culpability. Furthermore, at least with respect to most non-compliant U.S. citizens abroad:
1. They are completely tax compliant in their country of residence (translation no attempt to evade tax and their assets after “after tax”);
2. Many have not been aware that they had to file U.S. tax returns (How could they know? Only “American Exceptionalism mandates citizenship-based taxation);
3. Even if they were filing U.S. tax returns, they had no knowledge of information returns (FBAR, 5471, 3520, 8891, etc.)
4. Even if they were filing U.S. tax returns, and knew of FBAR (very unlikely), they had no reason to even imagine that they would have to make a special election, on a special form (8891) for their Canadian RRSP to be U.S. tax compliant. (The U.S. is not called “Form Nation” for nothing.)
4. They want to come into compliance but have received lots of confusing information from their accountants and lawyers and from the IRS
5. They are good people who have been caught in the worst nightmare of their lives.
This is the reality for many U.S. citizens abroad – certainly in Canada.
Flashback to August 2011
In the summer of 2011, the mainstream media (unknowingly) entered into a partnership with the IRS (the newspapers “carried IRS water”), to spread the story that:
1. Anybody born in the U.S. was – whether they believed it or not, whether they were a dual citizen or not, whether they were a U.S. citizen or not, whether they had previously renounced their U.S. citizenship or not – required to file U.S. tax returns; and
2. Failure to have filed those returns, would subject them to life altering penalties that would confiscate your retirement savings.
Panic, fear and rage ensued. On October 18, 2011, the U.S. Ambassador David Jacobson, made a speech in Ottawa where he promised that a reasonable clarification would come from the IRS and that the U.S. was not going after “70 year old Grandmas”. Presumably, the Ambassador didn’t know that at least one “70 year old Grandma” in Saskatchewan had actually exhausted a good part of her life savings by entering “OVDI 2011”. In early December, Barrie McKenna of the Globe and Mail, broke the news that the IRS was ready to announce relief for U.S. taxpayers in Canada. The initial article suggested that OVDI penalties would be refunded. When the official announcement came (a few days later) there was no offer to refund OVDI penalties. The “cross border professional Priests” – those who we need to communicate with the IRS – were quick to point out that the IRS was not offering any concessions and was simply restating the existing law. What the IRS did do was clarify that it was NOT mandatory to enter OVDI (of course “OVDI 2011” had ended by then and “OVDP 2012” had not yet been announced). The December 2011 FS was the first communication from the IRS that said that the imposition of penalties was not automatic and that the IRS would entertain “reasonable cause” arguments. I wrote three posts about the December FS.
December 2, 2011 – Possible Waiver of Tax and FBAR Penalties for U.S. citizens living abroad
December 9, 2011 – IRS Issues Fact Sheet for Dual Citizens and U.S. Citizens Abroad
December 18, 2011 – Update on the IRS December 2011 FS – No new relief for Canadians
The bottom line is that: I interpreted the December 2011 FS as an opportunity to get tax compliant.
On January 9, 2012 the IRS introduced “OVDP 2012” which, without backtracking from anything in the December 2011 FS, specifically promised new procedures for U.S. and dual citizens outside of the U.S., to come into compliance. It also promised updated guidelines for “OVDP 2012”. To add more context, in early January of 2012 TaxPayer Advocate issued a report that was highly critical of the way in which the IRS dealt with U.S. citizens abroad. The report said that it was basically impossible for U.S. citizens abroad to be compliant with U.S. tax laws and that the IRS should stop terrorizing them. (Although this is a paraphrase, it does capture the gist of the message). At this point LAW ABIDING U.S citizens abroad were:
1. Emotionally exhausted
2. Physically exhausted and experiencing health problems
3. Completely unable to trust the IRS
4. Completely unable to trust the U.S. government
5. Completely unable to trust the “cross border professionals” (many who were certainly pressuring people to enter OVDP)
6. Experiencing (in some cases) a breakdown of their marriages
7. Wanting desperately to renounce their U.S. citizenship at almost any price (and for many the Exit Tax makes renunciation pricey)
8. Worried about the impending FATCA nightmare
Those U.S. citizens abroad who were NOT LAW ABIDING obviously didn’t care.
OVDP Is Not The Only Way To Come Into Compliance
I want to reinforce a simple FACT. The FACT is that there has never been a requirement for people to enter OVDP. In FACT, the IRS even has/had a page on its site that outlines various compliance options (note the use of plural) for compliance. Here it is:
The page has recently been moved (and somewhat updated in content), but you will note that the IRS says:
The IRS reminds taxpayers that recently learned of these tax requirements that many options are available outside of the normal filing process to help them get current with their tax obligations.
Furthermore, the information in the December 2011 FS is still applicable. (The December 2011 FS seems to operate in more general terms) Indeed the new “Streamlined Procedure” references the December 2011 FS.
The IRS is confirming that there are options beyond OVDP. I hope that certain lawyers who advocate OVDP for everybody – “The One Size Fits All Approach To The Practice Of Law” – are reading this. The value of a lawyer is directly proportionate to his/her ability to understand your specific situation and help you decide what option works best for you. As far as I am aware (lawyers reading this post can chime in on this), traditional voluntary disclosure is still an option. In any event, my point is that it is wrong and has always been wrong to presume that OVDP is the only game in town.
On June 26, 2012, the IRS issued new FAQs for OVDP 2012. In addition, it promised “Streamlined Procedures” for U.S. citizens abroad who had never filed tax returns to come into compliance. The IRS announced that the new procedures would come into effect on September 1, 2012. Further guidance would be coming.
New Filing Compliance Procedures for Non-Resident U.S. Taxpayers – Effective September 1, 2012 – A Preliminary Analysis
Here is what the IRS says about about how to use the new “streamline filing compliance procedures”:
On August 31, 2012 the IRS released some additional guidance for “some non-resident U.S. taxpayers”. The guidance needs to be understood in the context of the previous history. Here is how I interpret the guidelines. I will update this post over the next few days as the dust continues to settle. Here goes – and remember that none of this is legal advice. For legal advice, you must go to a lawyer.
Q. To Whom Does This Program Apply and What are the guidelines intended to accomplish for the IRS?
A. It appears that the purpose is to encourage U.S. taxpayers living outside the U.S., who have never filed a return during their time living outside the U.S., to enter the U.S. tax system. In order to qualify one must have been living outside the U.S. on January 1, 2009 and not have lived in the U.S. after January 1, 2009. Interestingly the program is available only to those who have never filed. (The one exception is if you wish to make the RRSP election on the 8891 form. Those who have previously filed are permitted to do that.) It is not open to a non-resident just because he is non-compliant. If you have filed, and not included income that you didn’t know was taxable in the U.S. (and it is very easy to do this), you cannot enter this program. What if you made a mistake on a previous return? The IRS makes it clear that one cannot use this program to file amended returns. This strikes me as incredibly unjust. Let’s reward those of who have never filed and punish those who have made an effort to comply but have made mistakes. When it comes to the IRS:
“No good deed goes unpunished.”
Therefore, I infer that the real purpose of this program is to seduce people into entering the U.S. tax system. Welcome to a lifetime of forms!
Q. Assuming I am eligible to enter the program, what am I required to do?
A. You are required to file three years of tax returns and six years of FBARs. Any required information returns must accompany the three years of tax returns.
Q. Okay, what happens if I file the three years of tax returns and the six years of FBARs?
A. It depends. If you are deemed to be “low compliance risk”, they will likely just accept your returns, and welcome you to the U.S. tax system. You will then either file forms forever or renounce your U.S. citizenship. If you are not of “low compliance risk” then you may be subjected to a detailed audit and may be required to file more years of tax returns.
Q. What does it mean to be of ” low compliance risk”?
A. Ultimately this will be determined by the IRS. But, here are some of the things that the IRS says it will consider:
– if you owe less than $1500 of tax for each of the three years and you have a “simple return” you will probably be “low compliance risk”. Note that this does NOT say that if you owe more than $1500 each year that you are NOT low compliance risk. In addition. owing less than $1500 of tax is NOT a guarantee of being low compliance risk.
– whether you are claiming a refund (although this seems absurd)
– whether you are tax compliant in Canada
– whether you have bank accounts outside of Canada
– whether you own an “entity” outside of Canada (although this would clearly include a business, would it include mutual funds based outside of Canada?)
– whether you have an economic connection to the United States – Note that although this clearly includes having business or employment income from the U.S., it doesn’t speak to the question of investment income. What if you own a portfolio of dividend paying U.S. stocks? What if you own a rental condo in Arizona? What if you own U.S.mutual funds?
– whether there is evidence of sophisticated tax planning (whatever that means). Would a Canadian TFSA account constitute tax planning? (There are many kinds of investments that U.S. citizens should not own under any circumstances.)
Evidence of one or more of these factors could mean that THE IRS WILL DETERMINE THAT YOU DO NOT meet the requirements of “low compliance risk”. See a comment from Roy Berg on what might disqualify you . In other words, tell us who you are, and we will decide the status of your “compliance risk”.
Q. What if you are NOT “low compliance risk”?
A. The IRS says that you will be treated in a manner that is analagous to an “opt out” under OVDP. At a minimum this means “heightened scrutiny” and a possible audit for more than the three years. Yes, this does sound risky. Interestingly, the IRS says that they may, at this point, ask for “reasonable cause” submissions. This suggests that, even with “heightened scrutiny”, that penalties are NOT inevitable.
Q. What if all I want to do is fix my RRSP problem with the election on form 8891 but I have been filing my tax returns?
A. In this case, even though you have filed tax returns, you ARE allowed to fix your 8891 problem.
Q. What if I fear criminal prosecution?
A. First, you need to make sure that it is a “rational fear” of criminal prosecution. Obviously you need a consultation with a criminal lawyer on this issue. If there is a “material risk” of criminal prosecution, then OVDP is the only rational way to go. Note the guidelines which appear to say that you can’t enter OVDP after trying to use these streamlined procedures.
Evaluating or Re-Evaluating The Compliance In Light of the Compliance Procedures for Non-U.S. Residents – September 1, 2012
Some thoughts on how to proceed:
Preliminary: Your job is to determine the best way to come into compliance. This new program may or may not make sense for you. You just don’t know. Although I hate lawyers as much as the next person, by using a lawyer you will get the benefits of “lawyer client privilege”. The accountant can then work for the lawyer, rather than for you.
Step 1 – Determine Your Citizenship Status: The first step is to make sure that you are a U.S. citizen or Green Card holder. There are many people in Canada who became Canadians before 1986 (this is the magic year). By becoming Canadian they may have lost their U.S. citizenship. Therefore, the first step is to confirm your citizenship status.
Step 2 – Make sure that you are completely tax compliant in Canada. All returns filed. All taxes paid. Collect your notices of assessment.
Step 3 – Sit down and begin to complete your FBARs for the last six years. This will help you organize your information. It will also help you to see how the the IRS might see you. The IRS is clearly obsessed with “offshore” bank accounts. Yes, from the perspective of the IRS, there are only banks located in the U.S. and banks that are “offshore”. Note that participants in this program are required to send their FBARs to the IRS and NOT to Detroit. Do you have any bank or financial accounts outside of Canada? Do you have any bank accounts in the U.S.? (Although bank accounts in the U.S. could not go on the FBAR, their existence matters for other reasons).
Step 4 – Determine Your U.S. Tax Liability: If you are satisfied that you are a U.S. person for tax purposes, then you need to get an accurate assessment of your tax liability. Bearing in mind that you may not be “low compliance risk”, I suggest that that you determine your tax liability for more than the three years. If you are NOT “low compliance risk”, you need to anticipate the possibility of more than three years of filing. This implies the use of another compliance option. Although it should only be a last resort, participation in OVDP would require eight years of returns. Hence, if you have reason to believe that you may not be “low compliance risk”, it might be worth investing in up to eight years of tax returns. Do NOT make any assumptions about your U.S. tax liability based on your Canadian tax liability. Your U.S. tax liability will be determined as though you were a U.S. resident (subject to the earned income exclusion and foreign tax credits). There are many things that are taxed differently in the U.S. For example, pay special attention to the sale of a principal residence or the sales and distributions from Canadian mutual funds. PFICs anyone? Do you own a CCPC? There may be Subpart F income issues. In other words, it is not as simple as you might imagine. Make sure that you disclose all relevant information to your adviser. On this point, I suggest that if you have either sold a principal residence or have sold a Canadian mutual fund, you are unlikely to meet the $1500 guideline!
It is very hard to make an intelligent decision without seeing the “big picture” may involve more than three years.
Unless your life is very very simple you will require the assistance of an accountant with experience in U.S. tax. This is likely to be expensive. In addition, I hate to say it, but: the more years of tax returns the more expensive it will be.
Step 5 – Complete the IRS Questionnaire: You are now in a position to complete the IRS questionnaire (see below). This will be used to determine your compliance risk. I strongly recommend the use of a competent lawyer with experience in compliance issues. You should also be asking the question:
If I were required to submit a “reasonable cause” letter, what would that letter say?
Step 6 – Decide Whether To Enter The Streamlined Program or Not: This is a question of deciding the degree of your “compliance risk”. If your “compliance risk” is high, then you might consider other options for coming into compliance.
Step 7 – Use this as an opportunity to decide whether you want to renounce U.S. citizenship or remain a U.S. citizen. It is very difficult for U.S. citizens to live outside the United States. If you don’t renounce you will need very specialized financial planning. Certainly, any young people in your life, should be educated about the opportunities, obligations and liabilities of U.S. citizenship. A great benefit to dealing with the “compliance issue” is that by becoming compliant, you have created conditions to renounce U.S. citizenship!
The devil is always in the details. Here is what the IRS says about this program.
Some Concluding Musings …
The Problem of finding a U.S. tax preparer – It’s Getting Harder
New IRS regulations require that preparers of U.S. tax returns be registered/licensed with the IRS. This means that the number of U.S. tax preparers is far lower than in past years. Yes, the accounting costs will be significant. U.S. citizenship has simply been priced out of the market.
Will People Be Enticed To Enter The U.S. Tax System?
Who knows. It appears that a very small percentage of U.S. person abroad are even eligible for this program. Here are the thoughts of one person:
I agree that it will be interesting to see if the new announcement results in substantial increases in expats (and accidental Americans) (and Greencard holders, etc.) deciding to start filing and getting compliant…or if it will be interpreted as more fear tactics. Since I learned of my issues, I’ve told every American and US person I can think of but none of them share my fears or concerns…they’re taking the ostrich approach and still seem to think that even with FATCA coming that it isn’t going to directly affect them. They think I’m being hysterical. . It’s a decision that each person will have to make for himself/herself.
I feel I did the prudent thing to become compliant but others seem to think I’m a sucker. Perhaps it’s one of those things that we won’t know for at least a few more years as things become finalized and implemented. I suppose I felt that the wisest thing to do in my situation was to hedge my bets by losing out now with the extra taxes and professional costs rather than risking losing all my assets to various fines for not reporting and complying. Others who haven’t been filing at all may be more inclined to stay below the radar but as I’d already been filing, I was already in the system so saw no way around it really. Classic case of being frozen in the headlights!
Will The Renunciation Stampede Accelerate?
The new guidelines reinforce the impossibility of living as a U.S. citizen abroad. Thoughts echoed in the following comment:
Useless procedures. Only more fodder pushing US persons resident abroad in the direction of renouncing.
Three points not previously mentioned:
- OVDP/OVDI participants are purposely excluded. OVDP 2009 and OVDI 2011 participants have likely filed US tax returns in 2010 and 2011. This means the new procedures do not apply to them even if they had “simple” returns. The IRS obviously wants to keep these hapless souls in the OVD programs.
- Not all countries have the same tax filing schedule as the US, thus necessitating an amended return. For example, in Sweden, if you do not file an electronic return, you will receive the final decision as to how much tax you have paid, how much refund will be received or if tax is owed, on 15 December. As IRS Form 4898 only allows you to extend to 15 October, you may have to file an amended return to show the IRS that you owe 0 tax.
- It is quite common in Europe for a person to work in a “third” country (from the US point of view) for a year. Not all countries use the Euro, e.g., UK, Sweden, Denmark. In order to avoid ATM charges of around USD 5 per transaction each time cash is desired and/or to receive local salary, an account may be opened in this “third” country. As the person fully intends to return to the country he or she previously resided in, it would be foolish to close out his or her entire financial life in that country.
The IRS has done has communicated that:
– Coming into compliance carries with it a huge risk of IRS inflicted penalties
– The IRS doesn’t understand how it has made it impossible for honest hard working U.S. citizens to live outside the U.S.
– The IRS is not likely to ever be able to see how much damage it has and is continuing to inflict on U.S. citizens abroad.
Sooner or later, every sane person leaves an abusive relationship.
Not that it matters to the U.S., but …
If tax compliance is really the goal then you should make it possible for people to come into compliance without the threat of penalties. That’s how voluntary disclosures work in many other countries. My guess (for what its worth) is that the new program will attract very few people. The perception (whether true or not) will be:
It’s not worth the risk!
I just understand why the IRS is so obsessed with forms and penalties.
Of course, life for all would me much easier if the U.S. would: