On June 26, 2012, the IRS announced a new compliance procedure for certain US taxpayers living abroad who have failed to timely file US federal income tax returns or reports of foreign bank and financial accounts (FBARs), form TD F 90-22.1. Effective September 1, 2012, the new procedure applies to current non-US residents, including those who are dual citizens. The IRS also released FAQs for its open-ended 2012 offshore voluntary disclosure program (OVDP).
New compliance procedures. To come forward under the new guidance, a taxpayer must file delinquent tax returns with appropriate related information returns for the past three years and delinquent FBARs for the past six years. Notably, the guidance allows a taxpayer to claim retroactive relief for failure to timely elect income tax deferral on certain retirement and savings plans, such as RRSPs and RRIFs, for which deferral is permitted by a tax treaty; the deferral elections for a taxpayer’s non-US retirement plans must be made with the submission. Any tax and related interest must also be paid with the submission. Further guidance on the application procedure is expected before September 1, 2012.
The IRS is expected to review all submissions, but the level of the review will vary according to the taxpayer’s compliance risk. For taxpayers who present a low compliance risk, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. For those who present a higher compliance risk, the IRS will conduct a more thorough review and possibly a full examination of the returns—in some cases, for more than three years—and on that basis will impose tax, interest, and any appropriate penalties in accordance with US federal income tax laws. The IRS refers taxpayers to its fact sheet FS-2011-13 (issued in December 2011) for more information on penalties that may be imposed.
The level of compliance risk is based on certain information provided in the returns filed and on certain other information required in the submission. A low-risk taxpayer has simple returns with little or no US tax due. Absent any other high-risk factors, a taxpayer is generally considered to be low-risk if he or she has less than $1,500 in tax due in each of the three years. The risk level rises (1) as the taxpayer’s income and assets increase, (2) if there are indications of sophisticated tax planning or avoidance, or (3) if the taxpayer has material economic activity in the United States. Additional risk factors include any additional history of non-compliance with US tax laws and the amount and type of US-source income. Before September 2012, the IRS is expected to release more information and guidance on how the level of compliance risk is determined.
In order to claim reasonable cause for failure to file a tax return, an information return, or an FBAR, the taxpayer must submit a dated statement, signed under penalties of perjury, explaining the reasonable-cause justification for the failure to file. (Taxpayers are referred to fact sheet FS-2011-13 for examples of reasonable cause.) In addition, a taxpayer who seeks to file a late election to defer income from certain retirement or savings plans pursuant to a relevant treaty must submit (1) a statement that requests an extension of time to make an election to defer income tax and identifies the treaty position, (2) for relevant Canadian plans, a form 8891 (“US Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans”) for each tax year and a description of the type of plan covered by the submission, and (3) a statement describing the event that led to the failure to elect; the events that led to the discovery of the failure; and, if the taxpayer relied on a professional adviser, the nature of the adviser’s engagement and responsibilities.
The IRS reminds taxpayers that this new procedure does not provide protection from criminal prosecution if the IRS and the Department of Justice determine that it is warranted in the taxpayer’s particular circumstances. Furthermore, once a taxpayer makes a submission under this new procedure, the IRS’s 2012 OVDP is no longer available. A taxpayer who is ineligible to participate in that OVDP is also ineligible to participate in this procedure.
OVDP FAQs. The IRS released long-awaited FAQ guidance for its open-ended 2012 OVDP. The lookback period is the most recent eight tax years for which the US income tax return filing date (with valid extensions) has passed either with no income tax returns filed or with returns filed from which income was omitted. Thus, for a Canadian who did not file a 2011 US income tax return—or a request for an extension to file by October 15—by the June 15, 2012 deadline, the lookback period is 2004 through 2011.
The OVDP requires payment of any US tax owing, interest, and mandatory penalties for late filing of US income tax returns and late payment of any US income tax due. The values of foreign accounts and other foreign incomeproducing assets are aggregated for each year, and the penalty is calculated at 27.5 percent of the highest year’s aggregate value during the period covered by the voluntary disclosure. The rate of penalty is reduced to 5 percent for a taxpayer who did not reside in the United States during the lookback period, made a good-faith showing of timely compliance with all tax reporting and payment requirements in his or her country of residence, and has $10,000 or less in US-source income each year.
The new FAQ guidance reaffirms that no penalties are imposed on a taxpayer who for the last eight years timely filed US income tax returns reporting all non-US income, and failed only to file FBARs and forms 3520 or forms 5471. In that case, a taxpayer may file the delinquent information returns with the appropriate processing centre (forms 5471 must be filed with amended income tax returns) and include a statement that explains why the information returns are being filed late. The IRS will not impose penalties for failure to file if the taxpayer was not previously contacted by the IRS regarding an income tax examination or a request for delinquent information returns.
The new compliance procedure is welcome guidance for many US citizens living in Canada, particularly its inclusion of deferral elections for RRSPs and RRIFs. Some questions remain unanswered, but the available penalty relief should encourage US citizens who may have just learned of their US tax-filing requirements to come forward. Canadians should consult a US tax adviser to determine the appropriate approach to come into compliance with their US income tax and information reporting obligations.