If you have American connections, you may owe the IRS some tax money

Kim Moody: Welcome to a world of onerous tax filing requirements for U.S. tax purposes

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Were you born in the United States? Was one of your parents born there? If you answered “yes” to either question, then there’s a good chance you are a U.S. citizen and have been since the moment you took your first breath.

This, of course, is an overly simplified statement since the determination of one’s citizenship can entail a surprisingly difficult legal analysis of the relevant facts against applicable laws. But it’s important to know. Why? Well, the U.S. is one of only two countries that we know of that taxes its citizens based on citizenship. U.S. permanent residents — commonly known as “green card” holders — are also taxed like citizens of the U.S. And, if you spend a lot of time in the U.S., you can also be taxed by the U.S.

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If you’re one of the many in Canada who is both a U.S. citizen and a resident of Canada for tax purposes (there are varying estimates, but my guesstimate is there are somewhere near two million of them), welcome to a world of onerous tax filing requirements for U.S. tax purposes and, in some cases, extra taxes.

I had zero U.S. taxation training or awareness when I first started practising tax almost 30 years ago. I was blissfully naive of the filing and taxation requirements when I obtained clients who were U.S. citizens. It was about five years into my career when I became aware of the need for U.S. citizens to file and report their worldwide income for U.S. taxation purposes.

The U.S. taxation system is vastly different than Canada’s, so it took a while for me to become aware of the significant issues. But most people I came across — including many professionals — simply ignored the U.S. legal requirements. “Let them come and find me” was the common rebuttal. Ethically, I had to refuse to deal with such people.

The entire ball game changed with the introduction of the Foreign Account Tax Compliance Act (FATCA), which was passed into U.S. law in 2010, and effective from 2014 onward. Since that time, foreign financial institutions such as Canadian banks have been required to report their U.S. citizen account holders (after doing sufficient due diligence) to the Canada Revenue Agency, which in turn hands the information over to the U.S. Internal Revenue Service (IRS).

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In other words, the U.S. wants to know who their non-compliant U.S. expat taxpayers are. The fines and penalties for not filing are astronomical and potentially devastating.

Accordingly, the amount of information passed to the IRS by the CRA since being required to do so has been large. There have been a number of voluntary disclosure programs initiated by the IRS since 2010 to encourage non-compliant U.S. citizens to come forward. Some of those programs continue today, but there are open questions on how much longer they will continue.

While there are some academics, practitioners and advocacy groups that have — and continue to — loudly proclaim that citizenship taxation is an outdated form of taxation (it’s hard to disagree with some of the points made), the U.S. is not likely to change its taxation system to accommodate its expats anytime soon.

It would certainly be nice if that would happen since U.S. expats often face a daunting task to remain tax compliant in the U.S. and their home country. One can easily make the case that such people are not treated fairly. Unfortunately, life is not fair for many.

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What are the solutions for U.S. citizens who are residents of Canada and not tax compliant? The options are pretty simple, notwithstanding such options are not ideal. In all cases, it’s important to get proper U.S. legal advice. The first is to get compliant and remain compliant. This can be expensive. And if such a person is a high-net-worth individual, it can also come with some daunting and expensive consequences upon death if they are exposed to the U.S. estate tax.

The second option is to renounce their U.S. citizenship, but such a renunciation needs to be very carefully considered with proper legal advice to ensure the U.S. “exit tax” and other potential consequences won’t apply or can be managed. Another option is to continue to ignore the legal requirements to file, but that is not much of an option and certainly a dangerous one given FATCA.

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In the meantime, if you’re a U.S. citizen living in Canada, please ensure you’re tax compliant. The consequences for not complying can be costly.

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And if you’ve made it this far, any guesses as to what the second country is that taxes on a citizenship basis? If you guessed Eritrea — a small African country in the Horn of Africa — then you guessed right. But, and I’m just guessing here, it’s not likely Eritrea has a FATCA equivalent to enforce taxation of its expats … just saying.

Kim Moody, FCPA, FCA, TEP, is the founder of Moodys Tax/Moodys Private Client, a former chair of the Canadian Tax Foundation, former chair of the Society of Estate Practitioners (Canada) and has held many other leadership positions in the Canadian tax community. He can be reached at [email protected] and his LinkedIn profile is www.linkedin.com/in/kimmoody.

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