Americans living in Canada forewarned

Submitted by Darren Millard, CA, CPA, TEP
Partner, Facet Advisors LLP, Chartered Accountants

Many may not know it, but all U.S. citizens and green card holders living in Canada are required to file tax returns and report certain other financial assets to the IRS every year, regardless of whether or not they may be liable for taxes in the U.S.

All “U.S. persons,” which, under the IRS definition, includes U.S. citizens and green card holders, must file tax returns and report any foreign financial account they may hold, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account.

The IRS requires that you also report your worldwide income if you meet the minimum income filing requirements for your filing status and age.

If you live in Canada, you will also have Canadian tax filing and reporting requirements. You may be able to exclude some or all of your Canadian earned income for assessment for U.S. tax purposes if certain requirements are met, or you may be able to claim a foreign tax credit if Canadian income taxes are paid.

The penalties for not filing and reporting assets can be significant. For example, according to the IRS Tax Tip 2011-74 published on April 14, 2011, the IRS can assess a penalty if you fail to file, fail to pay, or both. If you do not file by the deadline, you might face a failure-to-file penalty.

If you do not pay by the due date, you could face a failure-to-pay penalty. The failure-to-file penalty is generally more than the failure-to-pay penalty. So if you cannot pay all the taxes you owe, you should still file your tax return on time and explore other payment options in the meantime.

The penalty for filing late is usually five per cent of the unpaid taxes for each month or part of a month that a return is late. This penalty will not exceed 25 per cent of your unpaid taxes.

If you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 per cent of the unpaid tax.

If you do not pay your taxes by the due date, you will generally have to pay a failure-to-pay penalty of half of one per cent of your unpaid taxes for each month or part of a month after the due date that the taxes are not paid. This penalty can be as much as 25 percent of your unpaid taxes.

So what can you do if you have just realized that you should have been filing U.S. returns and reporting your Canadian financial accounts, but have not done so?

While each case will be considered on its merits, IRS Tax Tip 2011-74 states that you will not have to pay a failure-to-file or failure-to-pay penalty if you can show that you failed to file or pay on time because of reasonable cause and not because of willful neglect. Of course, that may be difficult to prove, but getting your affairs in order with the IRS sooner rather than later is always the best course of action.

But now there may also be another way. In recent media reports, the U.S. Ambassador to Canada, David Jacobson, stated that the IRS will soon issue new rules that could allow U.S. citizens living in Canada to file tax returns without paying penalties for late filing.

Mr. Jacobson’s comments followed earlier reports that the IRS was getting ready to crack down on U.S. citizens living abroad who had not filed tax returns.

The news created anxiety among many of the one million U.S. citizens living in Canada. Although details of what the IRS may announce are not yet known, Mr. Jacobson was quoted in the Globe and Mail as saying: “What the IRS is saying here is that if... you don’t owe taxes to the U.S., and you file your return and they show you don’t owe taxes, there aren’t going to be any penalties for having filed late.”

That could be good for U.S. citizens living in Canada because it may give them a chance to put themselves onside with the IRS without having to pay penalties for failing to file returns in the past.

To avoid paying penalties, U.S. citizens and green card holders living in Canada should seek professional cross-border tax advice as soon as possible.

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