It’s estimated that there are up to one million U.S. citizens living in Canada. And as most U.S. citizens know by now, the U.S. is effectively the only country in the world that currently imposes citizenship-based taxation in that it taxes all its citizens regardless of where their income is earned or where they live.
This leads to a substantive tax-compliance burden imposed on U.S. citizens who live outside the U.S., including those U.S. citizens living in Canada. These U.S. expats must not only file a Canadian tax return reporting and paying tax on their worldwide income, but they must also file a U.S. tax return reporting that same worldwide income, which is then subject to U.S. tax. While most U.S. citizens who are resident in Canada find that no U.S. income tax is actually owing due to offsetting foreign tax credits, the investment restrictions, compliance burden and costs of filing U.S. tax and information returns can be severe.
One such filing requirement that can cause particular hardship for U.S. citizens, whether they are living in the U.S. or abroad, is the requirement to annually disclose to the U.S. Department of Treasury all foreign (i.e., non-U.S.) financial accounts, including bank, brokerage, mutual fund, trust or other types of foreign financial accounts where the total, in aggregate, exceeds US$10,000.
While it’s true that Canada also requires the disclosure of foreign property, such as foreign bank and investment accounts, foreign investment real estate and even foreign stocks held in your Canadian non-registered account, our threshold for this reporting (on the Form T1135, Foreign Income Verification Statement) is much higher at $100,000, (based on the total cost of the foreign properties).
And while we often decry our severe penalties at $25 for each day beyond the deadline that the form is late (up to a maximum of $2,500 per tax year), our penalties pale in comparison to the U.S. penalties for not filing the “Report of Foreign Bank and Financial Accounts” (FinCEN Report 114) or the “FBAR,” as it’s affectionately known. The U.S. penalties range from a non-willful failure-to-file penalty of US$10,000 per account per year to a willful failure-to-file penalty equal to the greater of US$100,000 or 50 per cent of the value of the foreign accounts not reported.
In its continual crackdown on offshore investing, it’s perhaps not surprising that the IRS, like our Canada Revenue Agency, is assessing these penalties, even in cases of innocent non-filing.
Take, for example, the most recent U.S. FBAR case, decided just last week by the U.S. District Court for the Eastern District of Michigan. The case involved a Michigan woman, who along with her husband, run a special event rental equipment business. During the years under review, 2007, 2008 and 2009, she was hit with penalties for failure to disclose two foreign financial accounts that she held during those years. Surprisingly, these were not offshore Swiss or Cayman accounts, but rather brokerage accounts at now-defunct Octagon Capital in Toronto.
The taxpayer explained that she opened the accounts with a Canadian broker “because the broker showed interest in growing my assets. My previous experience with U.S. brokers was that they cared about growing their own assets.” She stated that she “had an interest in commodities such as gold and … (her Canadian broker) showed me how to buy gold producing companies instead of directly buying gold.”
During the years under review, the unreported balances in the two brokerage accounts ranged from just over US$917,000 to more than US$1.9 million dollars. In August 2016, the IRS assessed penalties against her of US$10,000 for each account and for each year she failed to report them. She thus was hit with a total of US$60,000 in penalties, and additionally, US$10,130 in late-payment penalties and nearly US$1,700 in interest.
The IRS went to court to collect on this debt.
Under the U.S. rules, the penalty can be waived if the failure to file the FBAR “was due to reasonable cause.” Prior jurisprudence has held that a taxpayer can establish “reasonable cause” by showing they exercised “ordinary business care and prudence.”
The taxpayer argued she was unaware of the FBAR filing requirements and had indeed exercised ordinary business care and prudence in light of all facts and circumstances. She argued that she only had a high-school education and sought the advice of an accountant to prepare her returns.
But reliance on the advice of a professional tax adviser does not necessarily demonstrate reasonable cause. As the judge wrote, “(S)he has not shown that she took any steps to learn whether she was required to report her foreign financial accounts. To the contrary, she notes that she hired an adviser to complete her tax returns, but fails to even suggest that she informed the adviser of these accounts.”
Upholding the penalties, the judge concluded that “this certainly does not constitute ordinary business care and prudence. (Her) limited education and experience does not excuse this misstep.”
While this case dealt with a U.S. citizen taxpayer living in the U.S., could the same fate befall a U.S. citizen, living full time in Canada, who fails to report the existence of her Canadian accounts?
Patrick J. McCormick, a principal and attorney at Drucker & Scaccetti in Philadelphia, who practices exclusively in international taxation and has written extensively on the FBAR penalties, thinks the situation would be very different for U.S. citizens living in Canada. He cautions non-filing U.S. citizens who are living abroad and who actually have good and valid reasons for maintaining their offshore accounts, “not to give in to the fear mongering that’s often out there in this area. Penalties can be scary and very honestly, the case law is not favourable to U.S. taxpayers. That being the case though, if you’re proactive about coming forward … using one of the retroactive disclosure programs, you can get things taken care of with fairly minimal headaches.”