1. IRS streamlined voluntary disclosue procedures

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1 8. Alternatives for a U.S. citizen living in Canada to make a voluntary IRS disclosure in the event of failure to file past U.S. income tax or FBAR returns By Simon Sturm All Canadians who are U.S citizens, regardless of where they reside, are required to annually file U.S. federal income tax returns as well as various U.S. information disclosure returns. (See Tag #1) Until recently when a new Form 8938 return was instituted (see Tag #3), the principal annual information return most U.S. citizens abroad had to file with respect to their foreign asset holdings was the Foreign Bank and Financial Account Report ( the Form 114 FBAR return, see Tag # 4.) This return compels all U.S. taxpayers wherever they live to disclose to the IRS all foreign financial accounts which they either own, or over which they had some form of signature authority. The filing of an FBAR return is only required if at any time during a tax year the aggregate value of various foreign financial accounts owned or controlled by the U.S. taxpayer collectively exceeds a total of $10,000. For those who never previously filed an FBAR return or who filed past the June 30 th deadline in any year, a statement must be attached to the form explaining the reason for the delayed filing. The penalty for an FBAR form that is not timely filed depends on whether the late filing is "willful" or non-willful". The civil penalty for willfully failing to file an FBAR return is the greater of $100,000 or 50% of the total balance of the foreign account in each year the form was not filed. There is also the potential for a criminal penalty being imposed. Where a failure to file is deemed by the IRS to be non-willful, the penalty is up to $10,000 per violation in each year. (See Tag #6) In general these penalties (where they apply) can easily result in the taxpayer ending up owing penalties far in excess of the original unreported amounts that were not reported. At the same time if the IRS determines failure to file was due to "reasonable cause", the IRS has discretionary authority not to impose any penalty at all. (As to what factors are considered by the IRS in determining whether failure to file was for "reasonable cause", see Tag #19). In general the IRS has long had a policy of encouraging and trying to show extra leniency towards U.S. taxpayers abroad who voluntarily came forward on their own initiative to become U.S. tax compliant. However, in the past any such voluntary disclosure to the IRS has rightfully been eyed with great suspicion and fear by such taxpayers. Disclosure outside of any formal program involved filing both U.S. income tax and FBAR returns going back a minimum of 6 years. Aside from the time and professional fees involved in making the submission, there has always been great concern about the possible civil as well as possible criminal, penalties that could easily be meted out by the IRS when a non-compliant U.S. taxpayer abroad suddenly came forward. Furthermore by coming forward, the taxpayer would be making themselves easily vulnerable to an IRS examination and possible audit going back many years into the past. Even if no tax would end up being owed by virtue of the U.S foreign tax credit for Canadian taxes paid in previous years (see Tag # 14,) no U.S. taxpayers could be assured in advance of what to expect if and when they would voluntarily come forward. The following represent three alternative methods presently being used by U.S. taxpayers seeking to become U.S. tax compliant by voluntarily coming forward and filing U.S. returns due for previous years.

2 1. IRS streamlined voluntary disclosue procedures This policy has been further clarified and considerably modified by the fast track IRS streamlined voluntary disclosure procedures which first came into effect on September 1,2012 ( IRS Streamlined procedures, see also Tag #7.) It applies only to U.S. taxpayers who first certify to the IRS that their past failures to report all income, pay all taxes and submit all required U.S. income tax and information returns (including FBAR returns) in past years was the result of non-willful conduct. Under the IRS Streamlined procedures U.S. taxpayers abroad (including their estates) would have to file delinquent U.S. income tax returns with appropriate related information schedules and returns only for the preceding 3 years. (Previously the IRS had required returns going back 6 years.) Such return would be required to include a valid U.S. tax identification number, which in the case of U.S. citizens would be their U.S. social security number. As before, such taxpayers would also be required to submit delinquent FBAR returns for the previous 6 years. Payment of any tax and interest due would be required to be made at the time all the required returns and forms were submitted. All submissions would be reviewed by the IRS, but the level of scrutiny would vary based on the IRS perceived compliance risk of the particular U.S. taxpayer abroad coming forward as determined by the IRS using designated guidelines. Under the IRS Streamlined procedures a taxpayers who make a voluntary submission open themselves up to being subjected to a more thorough review and possibly a full IRS examination. Such examination, in some cases, could go back much further than 3 years. In addition tax, interest and penalties may be imposed with respect to any, or all, of these years. Where a U.S taxpayer elected to utilize the IRS Streamlined procedures, in any single year, the IRS would retain discretion to impose any additional penalty for past failures to file returns. However, the taxpayer would still have the right to claim a reasonable cause defense by submitting a statement under penalties of perjury explaining the grounds for why they believe their failure to file previously was for reasonable cause. (See Tag #19) The taxpayer would have to await the subjective determination of the IRS based on all the facts and circumstances as to whether their excuse was held to be acceptable. U.S. taxpayers who are concerned that on making a voluntary disclosure under the IRS Streamlined procedures they risk possible criminal prosecution should not being using this route for coming forward to the IRS. It does not provide any element of immunity from such possible prosecution. Instead a submission under the Offshore Voluntary Disclosure Procedures (the OVDP ) discussed in Section 2 below should be considered. Where the non-tax compliant U.S. taxpayer is concerned about the possibility of some level of criminal prosecution in connection with their past failures to file, extreme caution is warranted before getting involved with the IRS Streamlined procedure process. The IRS has announced that once a U.S. taxpayer has elected to come into compliance under the IRS Streamlined procedures, they are no longer eligible to participate in the OVDP. This would cause a taxpayer to lose their right to possible amnesty from criminal prosecution. Where a U.S taxpayer seeks to make a voluntary disclosure under the IRS Streamlined procedures there are still a strict set of IRS rules that must be followed. All voluntary disclosures require that funds come from a legal source since such programs don't apply to funds from illegal sources. Furthermore, under the IRS Streamlined procedures (as well as under the rules governing the OVDP,) a

3 disclosure would be considered to be untimely and ineligible for pre-clearance if submitted after the IRS had initiated an examination of a U.S. taxpayer or related entity. Similarly such voluntary disclosure would not have to be accepted by the IRS under either program where it had already received information from a third party alerting it to the possible non-tax compliance of a U.S. taxpayer living abroad even where the IRS has not had an opportunity to follow up on the lead. In order to participate in any IRS voluntary disclosure program (including the OVDP,) previously non-u.s. tax compliant taxpayers would have to file complete accurate U.S. income tax returns as well as all other U.S. asset disclosure returns due for past years covered by such disclosure. (See Tag #4, Tag #5 and Tag #6.) All returns and information submitted with such forms would be required to be truthful, accurate and complete in all respects. Such taxpayers would also have to provide some explanation for their failure to file in previous years. Furthermore, they would be required to show their willingness to cooperate with the IRS in all possible ways including informing the IRS about who their advisors and consultants were. What may be the most difficult challenge for many taxpayers is that, regardless of their personal feelings about whether they owe any tax or penalty amounts, at the very outset, all taxes, penalties and interest due would have to calculated and paid to the IRS up front (or satisfactory arrangements would have to made with the IRS for such payments.) For those who have not filed timely FBAR returns in past years they may proceed to do so without resort to the IRS Streamlined procedures and no penalty would be imposed provided (a) income from financial accounts reported on the delinquent FBAR form is now properly reported and taxes are paid and (b) the taxpayer had not previousy been contacted by the IRS relating to a possible income tax examination or a request for delinquent FBAR returns covering past years. U.S. taxpayers filing under the IRS Streamlined procedures would always have to accept the fact that by doing so they are always subjecting themselves to possible further IRS scrutiny. The results cannot be known with any certainty in advance since by making a voluntary disclosure outside the OVDP an IRS agent reviewing the file of a U.S. taxpayer abroad has much greater discretion in how to handle the file and impose possible penalties. 2. Offshore Voluntary Disclosure Program (the OVDP ) For those who believe, for a variety of reasons, that the IRS Streamlined procedures are not suitable to their purposes, they would be advised to consider coming forward under the partial penalty amnesty offered by the IRS through the OVDP (See Tag # 9) The U.S. penalties for a dual Canadian-U.S. taxpayer who failed to file either annual U.S. income tax returns and/or FBAR returns in preceding years can be considerably reduced by voluntarily participating in the OVDP. In addition, protection from possible criminal prosecution may also be provided.since the OVDP first began more than 45,000 taxpayers have come into compliance under the program and approximately $6.5 billion in back taxes and penalties have been collected by the IRS. In order to qualify under the OVDP, a Canadian who is a U.S. citizen would have to file U.S. tax returns as well as FBAR returns for the preceding eight years, paying any taxes due as well as interest and penalties. They would also be required to pay a penalty equal to 27.5 % of the highest aggregate value of foreign financial accounts and other assets located abroad in any single year during these 8

4 years. The penalty would be reduced to 12.5% of such balance if the aggregate amount in such foreign accounts in any single year during this 8 year period never exceeded $75,000. The OVDP does not provide a tax cure for U.S. filing non-compliance, but is simply just a different kind of medicine. The cumulative total amount of these penalties for those electing to participate in the OVDP could still end up being exceedingly steep where a Canadian-U.S. taxpayer had significant undeclared accounts and assets in Canada or in other countries abroad. Furthermore, once a taxpayer elects to participate in the program, the amount of these penalties is fixed and is not subject to appeal. The waiver of the right to appeal is one of the conditions a U.S. taxpayer must accept in order to be eligible for the OVDP. In the past many U.S. taxpayers felt that under the OVDP, the lump sum penalty of 25%-27½% of the highest foreign balance during the preceding eight years represented an unacceptable draconian punishment for simply failing to file what ultimately is really only an information form. Often U.S. taxpayers seeking to come into U.S. tax compliance had never even heard of the FBAR form. However, once they elect to participate in the OVDP, there is no further chance for leniency since the terms of the program are firm. Under the OVDP where a U.S. taxpayer, for example, had a foreign account of $1,000,000 abroad for even a brief point in time during the preceding eight year period, they would automatically be subject to a $275,000 penalty. Furthermore under the terms of the program, such penalty is not vulnerable to appeal. For this reason many Canadians, who feel they will not end up owing any taxes anyway even if they would file U.S. tax returns for preceding years, have given serious consideration to making a voluntary disclosure outside the OVDP. They have also often elected to opt out of the program even after they had entered it. (See Tag #9) 3. Quiet Disclosures In order to hopefully avoid payment of penalties imposed under the FBAR rules, many U.S. taxpayers in the past had attempted to make a kind of voluntary disclosure in a soft and quiet way. Such taxpayers were advised either, to start filing prospectively and ignore non-compliance in past years, or simply to quietly mail in delinquent income tax and/or FBAR returns for the past three years (and sometimes for the preceding six years.) They did so without attaching any statements and without coming forward to the IRS, all in anticipation that by being inconspicuous the returns might just quietly slip through. These amended returns often included information with respect to their offshore accounts and income derived from such accounts. In practice while the IRS did in fact pick out some of these returns for review, for the most part the IRS took few active steps to challenge these disclosures. The IRS often just allowed them through despite the fact that by doing so it sharply undermined its official position that quiet disclosures were not a legitimate way of becoming tax compliant. The IRS official position had long been that it would view a quiet disclosure made outside an officially sanctioned voluntary disclosure program as no disclosure at all. Submissions in this manner enabled U.S. taxpayers to avoid back taxes, interest and penalties that would otherwise rightfully be owing. Accepting quiet disclosures clearly undermined any incentive for U.S. taxpayers abroad from participating in any of the formal IRS voluntary disclosure programs. The IRS has repeatedly indicated that those taxpayers who had in fact submitted quiet disclosures could elect to participate in the OVDP. However, if they failed to do so and were later identified by the IRS, they would have lost their right to participate in the OVDP. In addition they would face not only the prospect of paying back-taxes, cumulative interest and penalties, but possible criminal prosecution, notwithstanding the volunteerism expressed by their previous submission. The possible mitigation of criminal penalties offered under the OVDP would no longer be available to them.

5 The IRS policy of not accepting quiet returns is clearly underscored by its acceptance in October 2013 of the findings of the Government Accountability Office that the IRS was letting easy money slip out of its hands. As a result of this chastisement and the generally more aggressive collection procedures recently initiated by the IRS, it is likely that those living abroad and seeking to fly under the IRS radar by engaging in a quiet disclosure to try to become U.S. tax compliant, will have considerably less success in doing so in the future than was the case in the past. The alternatives facing a Canadian-U.S taxpayer as to whether they should elect to make a disclosure under either the IRS Streamlined procedures or under the OVDP is a difficult one. It involves weighing risks as to the level of back taxes and penalties imposed under these programs against the possible U.S. back taxes and penalties a non-compliant U.S. taxpayer abroad might have to face if the IRS discovers their identity on its own initiative. Guidance from a cross-border tax adviser is always a good idea to help weigh these alternatives, but plain vanilla answers are unlikely to be present. Judgment calls just have to be made, like it or not. Ultimately it is the U.S. taxpayer in Canada seeking guidance who must assume the risks, the costs, and both the short as well as long term consequences of coming forward and filing returns. It is they who would have to review their alternatives and decide what level of risk they are willing to assume that they will continue to remain undiscovered by U.S tax authorities. Nevertheless, it seems that under all circumstances a Canadian who is a U.S. citizen would be ill advised in continuing to try to hide from the IRS by simply persisting in not filing tax returns and assuming that they will never be discovered. The IRS is relentlessly seeking information on offshore assets, income and accounts of U.S. taxpayers living abroad. There is presently an extensive international information network (including whistleblowers) which the IRS can access at any time, as well as expanded information being provided by Canadian banks under the new FATCA regulation to the IRS since September 30,2015 ( with Canada Revenue serving as a conduit, see Tag #11.) As a result, chances are extremely high that inevitably at some point, if not now than later, those U.S. citizens in Canada and abroad who have not filed all their required returns will eventually be caught within the U.S. tax web. It is for this reason that Canadians who are U.S. citizens, or who otherwise qualify as U.S. residents, would be strongly encouraged to come forward now and voluntarily meet their U.S. filing obligations. DISCLAIMER: Any U.S. federal tax advice included in this article or in any articles on this web site is not intended to be used and may not be used by you or any other person for the purpose of avoiding penalties that may be imposed by the Internal Revenue Code or marketing or recommending to another party any tax related matter addressed in this article or on this web site. The information provided here is intended as a general guide for Canadians with no direct U.S. ties as well as those who may be U.S. citizens or residents. However, it should not be relied on as a basis for making decisions or taking action affecting possible U.S. tax obligations including annual U.S. income tax and/or financial disclosure returns. No representation is made with regard to the correctness or timeliness of the information presented. Canadians concerned with the possibility of U.S. tax obligations should consult directly with a lawyer or international tax professional with U.S./Canada cross-border tax expertise. This article is for general information purposes only and is not intended to represent legal or tax advice

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