How will the IRS catch me?
Sticking your head in the sand and wishing your troubles away is never a sound tax strategy. You may be surprised, though, as to how many US persons (i.e. US citizens, green card holders or resident aliens) continue to follow this path even after years of media attention on US tax filing obligations and the potential penalties for not becoming or remaining US tax compliant.
“How will the IRS catch me?” is often the question posed by those who hope to remain underground. Today, more than ever, staying hidden is becoming more difficult as there are numerous information sources that can be accessed by the IRS to identify non-compliant taxpayers living in Canada.
In 2010, the US enacted the provisions known as the Foreign Account Tax Compliance Act (FATCA). FATCA requires non-US financial institutions to enter into an agreement with the Internal Revenue Service (IRS) to report to the IRS accounts held by US residents and US citizens (including US citizens that are residents or citizens of Canada). As FACTA raised a number of concerns in Canada, an intergovernmental agreement (IGA) was signed with the US that meets the US objective of enhanced information collection, while remaining consistent with Canadian privacy laws.
Under the IGA, Canadian financial institutions will not report any information directly to the IRS. Rather, account holder information on US residents and US citizens will be reported to the Canada Revenue Agency (CRA). The CRA will then transfer the information to the IRS under the authority of the existing provisions of the Canada-US tax treaty. Despite the confidentiality safeguards under the treaty, certain taxpayer information will end up in the hands of the IRS.
US Immigration Records
In 2011, Canada and the US committed to establishing a coordinated entry and exit information system. This system permits sharing information so that the record of a land entry into one country can be used to establish an exit record from the other.
In 2016, the two countries reaffirmed the commitment to a coordinated entry and exit information system and pledged to build upon the process already in place.
While the current initiative limits who is covered by this exchange of information, the intention is to include the exchange of entry data on all travelers with the US at land ports of entry. The information that is currently shared can help the IRS determine the number of days certain individuals spend in the US.
For a non-US citizen, US tax residency is generally based on days of physical presence in the US. Travelers need to be aware that entering the US for business or pleasure will count towards US tax residency status which may alert the IRS as to a potential tax filing obligation.
Taxpayers filing US returns may be required to disclose information about ownership in foreign corporations (Form 5471), interests in foreign partnerships (Form 8865), interests as settlors or beneficiaries of foreign trusts (Form 3520 and 3520-A), and ownership of foreign financial accounts (Form 8938 and FinCEN Report 114, formerly the FBAR). If a taxpayer’s spouse, family member or business associate is compliant with their US filing obligations and is disclosing information through various information returns, the IRS may use that information to identify non-compliant taxpayers.
Given the significant wealth transfer that the Boomer generation is expected to receive over the next decade, non-compliant US taxpayers living in Canada who are beneficiaries of a US estate (established on the death of a US resident parent) may have an increased risk of IRS scrutiny. The issuance of a US Schedule K-1 to a beneficiary of the estate reporting that person’s share of the estate’s income, deductions and credits etc. can shine a light on a long hidden non-compliant US taxpayer living in Canada.
Information from Other Sources
Information obtained through the US Justice Department’s Swiss Bank Program provided detailed information on accounts held (either directly or indirectly) by US taxpayers. While the US scrutiny of Swiss Banks has now come to a close, the fight against offshore tax evasion is far from over. The Justice Department is now looking to financial institutions in other countries that may be havens for offshore accounts or undisclosed assets. Investigators are pursuing leads generated through the Swiss Bank Program, or via the occasional whistleblower, and following those leads to accounts held in countries such as the British Virgin Islands, the Cayman Islands, and Panama, among others.
As staying under the radar is not a viable long-term solution, now may be the best time to come forward and catch-up with your US filing obligations. Currently, the IRS provides various disclosure programs for non-compliant US taxpayers to come into tax compliance. As eligible taxpayers residing in Canada may qualify to have all penalties waived, there is no reason why one wouldn’t file over-due US tax returns.
If you would like to talk about your US filing obligations, please contact your DMCL advisor.