US expatriates in Canada and Canadians in the U.S. need to remember that the border, when it comes to tax obligations, may be closer than they think. The income tax treaty (the “Treaty”) between the US and Canada allows for Canada Revenue Agency (“CRA”) to collect tax, interest, and civil penalties from delinquent US taxpayers residing in Canada even if they never step on the US soil. As proven by the recent case in Donald Dewees vs. United States (No. 1:16-cv-01579, 8/8/2017), living in Canada does not negate your responsibilities to file accurate US income tax returns and tax disclosures.

In 2009, Mr. Dewees discovered his US citizenship came with some responsibilities and costs when he submitted eight years of US income tax returns and forms FinCEN 114, The Report of Foreign Bank and Financial Accounts (FBARs), under the Offshore Voluntary Disclosure Program (“OVDP” or the “Program”). His US income tax returns contained Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporation, for his controlling interest in a Canadian consulting corporation which he formed in 1997.

OVDP was developed by the IRS to encourage noncompliant taxpayers who were reluctant to come forward with foreign asset reporting delinquencies due to the uncertainty surrounding their potential liability. One of the stipulations of the participation in the Program is that the taxpayer must not be under investigation by the IRS for foreign or domestic disclosures or payment noncompliance. In exchange for voluntarily declaring the oversight, a taxpayer could avoid a myriad of penalties on outstanding returns and taxes due using the uniform penalty structure offered by the Program. In addition, there is the opportunity to avert a criminal prosecution by the Federal Department of Justice regarding the lapse.

Under the OVDP uniform penalty, Mr. Dewees was assessed US$185,862 related to his failure to file FBARs for tax years between 2003 and 2008. His failure to file Forms 5471 was not taken into account. Mr. Dewees refused to remit the penalty and withdrew from the OVDP.

The result of his decision was a different assessment and a prolonged and costly effort to challenge the IRS position. His non-filed 5471s now became the new subject of penalty.

The IRS has the power to impose $10,000 (and up to $50,000) penalty for each year a form 5471 is not filed. And that’s what they did with the help of the CRA when in May of 2015, Mr Dewees received a notification from the CRA that his Canadian tax refund was being withheld under Article XXVI(A) of the Treaty. Mr. Dewees immediately sent payment to the CRA for US$120,000 plus interest totaling US$134,116.34, which was promptly remitted to IRS.

Though legal action between Mr. Dewees and IRS ensued, nothing favored the plaintiff in his efforts to attain a refund for what he paid to the IRS. Mr. Dewees attempted to argue that the Treaty was unconstitutional as it defied the 8th Amendment’s Excessive Fines Clause. He also contended the Treaty ignored both the Due Process Clause and the Equal Protection Clause of the 5th Amendment. In the eyes of the Court, Mr. Dewees failed to supply an argument substantiating his due process and excessive fines claims, while his equal protection claim lacked subject matter jurisdiction.

There are lessons to be learned from this case by US expatriates, as well as foreign nationals residing in the U.S. The IRS is actively redirecting resources toward foreign and transnational transactions to locate tax evasion activities. Full compliance and total transparency are the sensible way to go. Using a cross-border tax specialist is recommended especially given the expanding network of the IRS.

Whistle Blower

“It’s really American to avoid paying taxes, legally” –  Lindsey Graham

Let’s face it, penalties can be painful.  However, they can serve a valuable purpose in motivating people to do the right thing.  Whether we’re discussing filing accurate returns, making the proper payments or simply watching the calendar for due dates, full compliance with tax laws is the best way to avoid pain.

Though penalties have been used to enforce tax collection for over a century, the last 60 years have seen more frequent use.  Since 1955, the number of penalties one can incur has grown by more than a multiple of 10.  Even now, new and expanded penalties seem to follow new legislation or redefined tax codes.  The IRS is anticipating $136 million in additional income from new and modified penalties that will be paid over the next decade.  To avoid these agonizing costs, let’s look at recent changes where we need to pay attention.

  • The Protecting Americans from Tax Hikes (PATH) Act of 2015

The PATH Act came into effect on December 18, 2015.  For the tax preparer, there is a bit more work to do and a lot more scrutiny.  PATH addresses 15 areas with new or revised penalties. Yes, the IRS is getting tougher on a few things so you might want to read the details.

A newly revised checklist (Form 8867) is a must for returns claiming the Earned Income Tax Credit (EITC), the Additional Child Tax Credit (ACTC) and/or the American Opportunity Tax Credit (AOTC).  Tax preparers are required to submit this list as a part of the due diligence process.  It is meant to substantiate a client’s eligibility for these claims to reduce fraud and erroneous refunds.  The fine is at least $500 for each credit on a return that does not satisfy the due diligence condition.  And, don’t forget the simple things like signing a return, furnishing and keeping copies, and accurate information or it will cost you from $50 to $25,500 for each year.  Ouch!

  • The Consolidated Appropriations Act of 2016 – updates to the PATH Act

The new deadline for filing a US Return of Partnership Income (Form 1065) is now a bit earlier, March 15.  Failure to file on time will cost each partner approximately $200/month.  In addition, as of 2016, all W-2, W-3 (SSA) and 1099-Misc forms must be filed with the IRS by January 31. This has been added to emphasize the importance of accurate reporting, giving the IRS a chance to verify more information.  The good news is the penalties are flexible.  How quickly returns are amended can save you some cash.  The base penalty is $100-$250/return with a maximum of $3million in aggregate. My advice, double check your information and update your calendars today.

  • The Trade Preference Extension Action of 2015

While this action was primarily an extension of the 1974 trade act between the US and the African Growth and Opportunity Act, leave it to legislators to slip a clause in at the bottom.  As of June 2015, failing to file accurate information on returns or to furnish the correct payee statements (under Section 6722) is cause for penalties, which on average have doubled.

  • The Trade Facilitation and Trade Enforcement Act of 2015

This act increased the penalties found In Sec 6651(a). The failure to file penalty is 5% of the tax due on the return per month past due, or part thereof, up to a maximum of 25% in aggregate.  Returns more than 60 days late deemed due to neglect will find an additional penalty of the lesser of $205 or 100% of the tax due.  Failure to pay will cost .5% of the tax due per month. We recommend you heartily suggest clients both file and pay promptly. If payment is not possible, file, file, file anyway.

  • The Tax Increase Prevention Act of 2014

Embedded in this act is another action called the Achieving a Better Life Experience (ABLE) Act. It allows the penalties under Sections 6651, 6652c, 6695, 6698, 6699, 6721 and 6722 to be adjusted for inflation for all returns due after 2014.  Some leniency may apply under certain circumstances.

DON’T FORGET there are very few exceptions to the Affordable Care Act’s penalties.  Information returns for the first year of Obamacare have also had penalties adjusted.  The IRS can offer some relief if they feel a diligent effort was made to comply and will consider waiving the penalties under Sec 6724’s definition of reasonable cause.

In summary, having additional knowledge is only beneficial if you use it.  Take the time to create organizational checklists to ensure all the correct information and forms are filed. Keep yourself, your employees and your clients up to date on new or modified tax regulations. If all else fails, reach out to the IRS for help.  Any effort toward honesty is usually well received by our friends at the IRS.