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Tax penalty relief for American citizens residing in Canada? One new concession however other relief is already available

On December 2, 2011 Canada’s Globe and Mail reported, after an interview with US Ambassador to Canada Jacobsen, that US citizens living in Canada will be able to avoid the punitive penalties that result from the failure to file US income tax returns and other forms.  The Globe article states that the IRS will issue written guidance by the end of December 2011 that makes clear the following three points:

  1. Individuals who took part in the 2009 IRS amnesty program (the Offshore Voluntary Disclosure Program or OVDP) or the 2011 IRS amnesty program (the Offshore Voluntary Disclosure Initiative or OVDI) can get a refund of the penalties paid.
  2. If a US citizen files late tax returns and owes no taxes, there will be no penalties for failure to file.
  3. US citizens who were unaware of their obligation to file the foreign bank account report (form TD F 90-22.1 or FBAR) there will be no penalty provided they can prove “reasonable cause” for failure to file this form.|

If there proves to be substance behind the article, this is promising news. It shows that the Obama administration is sympathetic to the millions of US citizens residing in Canada that have been unaware of the filing obligations appurtenant to their citizenship.

A close reading of the three points mentioned in the article, however, indicates that very little relief is actually being offered that is not already available.

  1. Refund of penalties paid under previous IRS amnesty programs.  This is the only point that actually offers new relief and is welcome mitigation to the thousands of individuals who have suffered through the indignities of this laborious, expensive, program.
  2. No penalties for late returns provided there are no taxes owed.  This point is not new and is simply a restatement of existing law. Section 6651(a)(1) of the Internal Revenue Code provides that the penalty for failure to file an income tax return is 5% of the taxes owed on the return for each month the return is late. The penalty is capped at 25%. Therefore, if no taxes are owed, there is no statutory basis to impose penalties.1
  3. Relief from FBAR penalties.  Likewise, this point is not new and is simply a restatement of existing law.  The draconian penalties imposed for failure to file the FBAR simply do not apply if the taxpayer’s failure to file is due to “reasonable cause.” Click here to see the actual statute (31 U.S.C. 5321(a)(5))

When the guidance is issued it will presumably address the multitude of additional questions that arise such as: what is the procedure for coming forward with unfiled returns? How many delinquent returns need to be filed? What certainty will the taxpayer have that penalties will not be applied? Will there be relief of the criminal sanctions imposed by the willful failure to file FBARs?

What the article does not address is relief, if any, for penalties imposed for the failure to file a multitude of other forms.  Each of the failure to file penalties for the following may be reduced to $0.00 provided the taxpayer proves “reasonable cause.”

  1. New individual income tax returns.  As mentioned above, beginning in 2012 there is a new schedule (form 8938) required to be included in the individual income tax returns for individuals who own non-us accounts. There is a $10,000 penalty for failure to file this form.
  2. Ownership of Registered Retirement Savings Plans.  US citizens who own an RRSP are required to file the form 8891 with their income tax return in order to defer the appreciation on these accounts.  The Treasury Regulations set forth the procedure for filing this form late. Will the there be a new protocol for making a late filing?
  3. Certain ownership interests in non-US trusts or estates.  If an individual is a trustee, settlor, or beneficiary of a non-US trust that person is required to file a form 3520 or 3520-A. The penalties for failure to file these forms can be $10,000 and higher. Tax Free Savings Accounts (TFSAs) are considered foreign trusts and require the filing of these forms.
  4. Ownership in non-US corporations and partnerships.  If an individual owns certain interests in non-US corporations or partnerships the individual is required to file form 5471 or 8865. The penalty for failure to file is $10,000.
  5. Transfer of property to a non-US corporation or partnership. If an individual transfers property to a non-US corporation or partnership the individual may be required to file form 926 or 8865. The penalty for failure to file can be 10% of the value of the property transferred.
  6. Receipt of a gift from a non-US person. If an individual receives a gift from a non-US person the individual is obligated to file a form 3520. The penalty for failure to file is 5% of the value of the gift for each month the form is not filed. The penalty is capped at 25%.

Since the only new relief mentioned in the article involves penalties paid by participants in the 2009 and 2011 amnesty programs, it is unlikely that the guidance, when released, will address the foregoing issues.

1. It is important to note that beginning in 2012 the individual income tax return (form 1040) will include a new schedule (form 8939) that requires the disclosure of foreign bank accounts much like the FBAR. There is a $10,000 penalty for the simple failure to file this schedule.