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Saturday, January 21, 2012

US Citizens Living Abroad: IRS Filing Guidance

US Citizens Living Abroad: IRS Filing Guidance

A recently released IRS fact sheet (FS-2011-13, December 2011) provides guidance to US citizens who reside outside the United States and who have failed to file US tax returns and form TD F 90-22.1 ("Report of Foreign Bank and Financial Accounts (FBAR)"). A US citizen is generally required to file a US federal tax return to report his worldwide income, regardless of where he resides. In addition, a US citizen must generally file an FBAR if he has a financial interest in, or signature authority over, certain types of non-US financial accounts (bank accounts, securities accounts, mutual funds, and RRSPs) whose aggregate value exceeds $10,000.

Tax returns. The fact sheet confirms that a US citizen who is resident abroad and owes no US tax for the prior six tax years (currently, 2005-2010) may file US tax returns for those years without penalties for failure to file or to pay tax. Many US citizens resident in Canada fall into this category due to the availability of US foreign tax credits for taxes paid in Canada.

For a US citizen who owes US tax, the fact sheet indicates that the IRS will consider whether, on the facts, the failure to file or pay tax was due to reasonable cause. The IRS will consider whether the taxpayer exercised ordinary business care and prudence in meeting his tax obligations and other factors such as (1) the specific reasons given by the taxpayer; (2) his compliance history; (3) the length of time between his failure to meet his tax obligations and his subsequent compliance; and (4) circumstances beyond his control.

On the basis of the following factors, the IRS may conclude that the taxpayer has established reasonable cause for not being aware of specific obligations to file returns or pay taxes: (1) the taxpayer's education; (2) whether he was previously subject to the tax; (3) whether he was previously penalized; (4) whether there were recent changes in the tax forms or law that he could not reasonably be expected to know about; and (5) the level of complexity of a tax or compliance issue. Reasonable cause for non-compliance may also be established due to ignorance of the law if a reasonable and good faith effort was made to comply with the law or the taxpayer was not aware of, and could not reasonably be expected to be aware of, the requirement.

FBARs. The fact sheet also provides guidance for a taxpayer who failed to file an FBAR. In the absence of reasonable cause, a US citizen residing abroad who failed to file an FBAR may suffer penalties. The total penalties can be harsh, because a penalty is imposed per violation--that is, per account per year. The maximum penalty is $10,000 per non-wilful violation and more per wilful violation.

To establish reasonable cause, a US citizen who resides outside the United States should file a delinquent FBAR for each of the prior six years (2005-2010) and attach a statement indicating the reasons why he is filing late. Although no single factor is determinative, the IRS lists some factors that may weigh in favour of a finding that reasonable cause exists, including the following: (1) the individual relied on the advice of a professional tax adviser who was informed of the existence of the foreign financial account; (2) the unreported account was established for a legitimate purpose and no efforts were made to intentionally conceal the reporting of income or assets; and (3) there is no or only a de minimis tax deficiency related to the unreported foreign account. The IRS also considers factors that weigh against a finding of reasonable cause, including the following: (1) the taxpayer's background and education indicates that he should have known of the FBAR reporting requirements; (2) a tax deficiency relates to the unreported foreign account; and (3) the taxpayer failed to disclose the existence of the account to his tax preparer.

The fact sheet also reminds US taxpayers that, starting in 2012 and in addition to a taxpayer's FBAR reporting obligations, he must report in his US tax return on form 8938 any interest in certain foreign financial assets with an aggregate value exceeding $50,000.

The fact sheet is particularly welcome guidance for many US citizens resident in Canada: the 2009 and 2011 offshore voluntary disclosure programs (VDPs) frequently resulted in harsh penalties for US citizens resident abroad who were unaware of the need to file US income tax returns and FBARs, and the VDPs' parameters did not give IRS examiners any discretion to consider reasonable cause. However, many unanswered questions persist for non-filers. For instance, it is not clear whether the IRS will entertain reasonable-cause arguments for failure to file certain information returns (such as forms 5471 and 3520). In addition, the US tax treatment of RRSPs and other Canadian plans remains uncertain if no timely election was made to defer tax on the plan's income. The fact sheet notes that the IRS is continuing to review these issues and may provide additional guidance.

On January 9, 2012, an IRS news release (IR-2012-5) announced the reopening of the offshore voluntary disclosure program (VDP). The new VDP will be discussed in the February 2012 issue of Canadian Tax Highlights.

Marla Waiss
Hodgson Russ LLP, Buffalo

Canadian Tax Highlights
Volume 20, Number 1, January 2012
©2012, Canadian Tax Foundation
via ctf.ca