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It Seems that everything Montana Senator Max Baucus touches seems to create work for lawyers and accountants.The Democratic chairman of the powerful U.S. Senate finance committee was the driving force behind several rounds of bitter Canada-U.S. lumber wars in the 1980s and 1990s,that where nasty in nature.
At that time there where armies of lawyers built their careers on that dispute.Mr. Baucus is also the author of a bill that’s about to make life very unsettling for Americans living in Canada and their financial institutions – the Foreign Account Tax Compliance Act (FATCA). The law, which takes effect in 2014, is the hammer behind a U.S. crackdown on offshore tax cheats.
When he unveiled the legislation three years ago, Mr. Baucus said squeezing tax evaders would bring in “tens of billions of dollars a year,” money that would help reduce the massive U.S. deficit.Canadians are already paying a steep price for Mr. Baucus’s law – in bureaucracy, aggravation and compliance. Canadian banks, brokers, insurers and mutual funds have begun alerting customers to the impending law, which will require financial institutions to keep tabs on all their American account holders and to remit that information to the U.S. Internal Revenue Service.
Is Uncle Sam Going too far?
Today live from studios of Radio Shalom in Montreal ...........is Nathan Farkas
He is the owner and founder of a cross-border tax and accounting consulting firm. He is a CPA, licensed in Quebec, Ontario & New York. You can check him out further on his website ustaxesincanada.com. he will ....... discuss how this new law will impact Americans in Canada, what you should do if you are an American who has never filed a tax return. We will also discuss how Americans in Canada can avoid having to pay taxes to Uncle Sam, what types of investment products or businesses to avoid. We will also talk about how Canadians can do business in the US while minimizing tax exposure and finally, we will also discuss a means for Americans in Canada to collect large refunds from the US while not paying them a penny.
How US tax rules impact Americans in Canada and what Americans and Canadians need to do to avoid the punishing tentacles of Uncle Sam
Nathan Farkas is a CPA, licensed in New York, Quebec & Ontario. I manage my own accounting firm specializing in US tax planning for Canadians and Americans in Canada. The firm assists small Canadian accounting firms with limited exposure to US tax by preparing US returns for them in addition to maintaining a core group of my own clients. The firm has clients all throughout Canada, from the maritimes, to Ottawa, to Edmonton and some others in upstate New York as well. I have over 10 years of experience in the field and has worked in Montreal & New York. In addition, I am also the President-Elect for the Adirondack chapter of the New York State Society of CPA's, a trade group for CPA's in northern New York State.
Based on your intro, I think the first couple of questions once we get onto the topic should discuss FATCA to an extent. Your intro talks about it from the bank perspective so question 1 could be one of the following:
1) What exactly does FATCA mean for the average person? Or
2) I understand why the US is trying to cut down on tax evasion, but why would banks in Canada or other countries comply with these rules. The IRS still doesn’t have power in Canada to enforce these rules?
1) For the average person, FATCA means more reporting requirements. The requirement to file an FBAR or disclose your bank accounts to the IRS has been in the news a lot. With FATCA, it’s simply another form where an American in Canada is required to disclose most non-US properties they own. However, for those who have been holding out on starting to file, the incentive that the IRS might get you first might be the incentive to start filing your returns. Also, while not necessarily a FATCA issue, the US state department has begun requiring all passport applicants to provide a social security number. The state department will then run that number by the IRS and if someone is found to have not been filing, they will not get their passport renewed.
2) Canadian banks and banks in most of the world have a lot at stake here. One thing that hasn’t been widely reported is the penalties all banks will face if they don’t comply. As most of you know, banks around the world have significant business assets and investments in the US economy. IF the individual banks don’t reach an agreement with the IRS on disclosing the required information about US account holders, they will face a 30% withholding on US business activity. As most banks in the world have some dealings with the US economy, they will not want to risk losing that business or income. A bank that has absolutely no activity in the US in theory has nothing to fear, but those banks are probably hard to find. Now some banks in Europe especially are taking a different approach. They are simply contacting American account holders and telling them to take their business elsewhere, that US accounts are simply to difficult to maintain.
Lately, the US economy has gotten a lot of media attention in Canada. With the whole fiscal cliff conversation at the end of 2012 and now we are hearing about a sequester. What does all this mean?
The sequester goes back to the whole debate in 2011 regarding increasing the debt ceiling. The republicans insisted that too raise the debt ceiling, spending cuts would be needed. It was agreed to defer the problem until after the 2012 election when the Bush tax cuts were set to expire. This led to the fiscal cliff conversation that was taking place at the end of 2012. This was supposed to result in across the board tax increases on all Americans from the expiration of the Bush tax cuts and along with these tax increases, was supposed to be across the board spending cuts as well as was negotiated back in 2011. The idea was that the situation would be so bad if congress would do nothing, surely the 2 parties would figure out a way to come to an agreement. Early in 2013, congress reached a deal on the tax increase side of the table, and decided to defer the spending cuts until March. Now we are in March and the spending cuts are kicking in.
These cuts are supposed to be 50% domestic spending and 50% defense spending. This was set up in this manner as traditionally, Democrats don’t like cutting domestic spending and republicans don’t like cutting defense spending so it was thought that linking this all with tax increases would increase the likelihood of a deal. Well we haven’t seen it yet.
Now keep in mind that the US is coming up to the debt ceiling again and the country will be unable to increase its debt without a deal.
How will these recent events impact us up here in Canada?
These cuts are supposed to be 50% social programs and 50% defense spending. This was set up in this manner as traditionally, Democrats don’t like cutting domestic spending and republicans don’t like cutting defense spending so it was thought that linking this all with tax increases would increase the likelihood of a deal. Well we haven’t seen it yet.
Now these spending cuts are supposed to be across the board. For those who have been travelling this week, reports say that the US immigration lines at Dorval airport have been longer this week so that is just one way in which we can feel the sequester here in Montreal.
Stats show there are approximately 1 Million Americans living in Canada. Less than half filed tax returns in prior years. What can those who have never filed do?
Will they be at risk of losing their life savings or going to jail. What can they do?
There are multiple options for people in this situation. Back in December 2011, the IRS acknowledged that there was a problem with many Americans abroad being delinquent on their taxes. There are 2 full scale programs ongoing that deal with this scenario.
The first option is the OVDP program from 2012. It is aimed at those who knowingly violated the US laws, deliberately hid income and didn’t file necessary reports. For people in that situation, this program will require filing 8 years of tax returns & FBARS, and you will pay a penalty of 27.5% of your highest asset balance during that period. However, for those who make it through the program, you will not go to jail, you’ll just spend a lot of money.
The second option is the streamlined program for low risk taxpayers. This program is available only to those who have not filed anything after 2009 and don’t owe more than $1500/year. This program requires 3 years of tax returns, 6 years of FBARS and upon concluding the program, your prior failure to file tax returns will be forgiven. One thing to understand about this program is that there are no guarantees. The IRS can reject your application, and request criminal charges against the person trying to come clean. This program is risky and people should be aware of these risks before going ahead and doing the work.
The 3rd option is basically, just quietly file prior period returns and hope for the best. This isn’t advisable as there are no guarantees, but if you genuinely don’t believe you have criminal liability, then filing this way can be accepted. Please talk to your accountant or make an appointment to see me before just blindly sending in returns to the IRS.
The only certain thing here is that not filing is not a good option. Many people will bury their heads in the sand and if they are found, the penalties can be severe.
What can happen to someone if they don’t file?
It’s possible nothing will happen, but the odds of being able to stay under the radar are continually decreasing. In 2014 a new law goes into effect in the US. It will require all foreign banks to pass on information on its US account holders to the IRS. International agreements have been reached by the IRS and most foreign countries already. Canada is no different. It’s likely that soon your bank will be asking you if you are American. If you say yes, they will pass on your info to the IRS. IF you say no, but really are American, have you just committed fraud? So whatever the means, it is likely you will be found out eventually and when you are, none of the disclosure type programs or reduced penalties will be available to you.
There’s lots of talk about penalties for not properly filing American taxes here, but for some people, there are refunds available. What is that about?
Most benefits offered by the US government are exclusively for residents of the USA. However, the child tax credit is available for Americans anywhere. For anyone that has American citizen children, there is a $1000/child refundable credit available. What this means is that this refund is available EVEN IF YOU Didn’t pay any tax in the US prior to this.
So how can people get this refund and who is eligible.
To be eligible for the credit, you must have US citizen children. If the child is not a US citizen or resident, no credit is available. Well the first thing to do is to file your US tax return for the year. The credit is 15% of all earned income above $3000 for the year up to $1000/child. One thing to consider first though, is that in order to claim the credit, you need earned income. Therefore, the easiest way to prepare your return is not open to you. As all Americans living abroad can exclude up to approximately 95,000 of income it makes it easy to avoid most taxes payable. However, to claim this credit, you cannot exclude the earnings from your income.
It’s commonly known that Americans usually don’t pay taxes as tax rates are so much higher in Canada than in the US?
What are some scenarios where this isn’t true?
In general this is true, but there are many situations where this might not be the case. For example, if dividends make up a large part of a person’s income. The dividend tax credit in Canada cannot be applied against US tax and therefore, the tax in the US on certain dividends will be higher than the Canadian tax. The same thing exists on capital gains, which are 50% taxable here, and in the US, short term capital gains are taxed at the individuals’ marginal tax rate.
Other cases, could be, single parent families in Canada, can get almost the first $30,000 of income tax free, while in the US, it would only be the first $15,000 approximately. Individuals with large RRSP deductions can be impacted. There is a new scenario that will be in place for 2013 and that is, the new Obamacare tax or the healthcare tax.
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the whole thing
What is the Obamacare tax.
This is a new 3.8% tax on investment income above certain levels. For most people, this will not make a large difference but those who will likely suffer most from this will be seniors who have done a good job saving their whole lives. Those most affected will be seniors who are married to non-Americans. This is because their exemption level is only $125,000. Furthermore, no foreign tax credits can be claimed to offset this tax. So for those who celebrated Obamacare passing, you may be called upon to help pay for it, even though you don’t live in or use the medical facilities in the USA.
What are some common scenarios where An American living here can owe tax in the US?
One common scenario is the sale of a home. The US allows an exemption of up to $250,000 every 5 years, while Canada will exempt from tax, all gains on the sale of a principle residence.
Another scenario is if someone wins a prize, some money at a casino or a lottery. As gambling earnings are taxable in the US but not in Canada, there will not be Canadian tax to offset this.
The bulk of one’s income is dividends that are from a private business or a trust. This will mean unqualified dividends in the US and will be taxed at marginal rates, while they will be taxed at the lower rates in Canada.
How does Obama care fit into this scenario.
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What Canadian products can expose Americans to US tax?
There are a variety of products that are great for Canadians to have, but can have a negative impact on Americans. The first one would be an RESP, to save money for your kids college educations. The problems with the RESP are twofold. First, the RESP’s are taxed differently in Canada and the US. In Canada, the earnings are taxed in the hands of the student when the money is withdrawn from the account. In the US, the earnings, including the Canadian government grant, are taxable to the contributor as they are earned. This results in taxation in both countries on the income as they are to be reported at different times. The second problem with the RESP is that it is structured as a trust, which to the US makes it a foreign trust. A foreign trust has significant reporting requirements that are time consuming and costly if ignored.
But an RESP is a good thing, it allows me to save for my children’s college education without worrying about the taxes involved.
That is true and there are ways around the problem. For example, if a grandparent of the child is not American, they can take out an RESP for the child. A non-American parent can take one out if they desire as well. The key is, not having Americans contributing or owning assets in an RESP, there is no problem with using them. However, if both parents are American, and there are no non-American relatives available to take out the RESP on behalf of the child, then you are out of luck.
What other products are out there that Americans in Canada should avoid?
This is one product that should be avoided at all costs if possible by Americans up here. It is a mutual fund sold by a Canadian institution. The tax on these ranges from unfairly punitive, to astronomical. The history of this problem is, back in the 80’s wealthy Americans started investing in foreign mutual funds or other similar products in tax haven countries because they were taxed more favorably than the American mutual funds. As a result, the US mutual fund industry bribed/lobbied congress to change the rules making them unfavorable to own. Historically, Canadian mutual funds always considered themselves immune from these rules because they are structured as trusts, not businesses, but in 2010, the IRS in a ruling stated that Canadian mutual funds are really businesses and should always have been treated that way. Now the Canadian mutual funds are treated as follows, if you make one of 2 elections, the tax would be punitive but might be avoidable in some cases. One election is not easily available as it would require the fund to report itself on US standards, not Canadian. The second election is to mark to market, which means that every year, you report as income, the gain in value of the mutual fund, even though you haven’t sold it yet. This can result in tax in both countries as the income is reported in different years in both countries. Now failure to make any election, can leave you losing your entire investment. This is called the excess distribution system and is taxed as follows. You take an average of the total distributions for the past 3 years, and then gross it up by 25%. IF a distribution received is greater than that, the excess amount is considered an excess distribution. The excess distributions are allocated to each day where the fund was owned and are taxed in that prior year at the highest rate in effect during that year. Also, since we now are allocating income into those prior years, we have unreported income in those years, and interest and penalties apply as well. Also, gains on the sale of mutual funds are treated as excess distributions unless the proper elections are made. I have a client, who bought a fund back in the 80’s, it tripled in value since then so making a mark to market election would have resulted in a lot of tax payable. What we did was we chose to report an excess distribution of $8/year. The following year, we planned to make the elections properly and sell the fund, which will result in the capital gain being reported both in Canada and the US at the same time.
Another situation that can cause tax to be payable is the case of the investment company. Anytime a company reports interest, dividends, capital gains, rental income or other forms of investment income, that income is deemed to not be corporate income but individual income. Therefore, the Canadian company will be paying tax on that income, the individual will be paying tax in the US on the income and when the income is eventually paid out to the business owner, tax will be payable in Canada as well.
Another product to consider avoiding are tax free savings accounts. These have 2 reasons to avoid them, like the RESP. One, they earnings are not tax free in the US, so there can easily be taxes payable since it can’t be known if there will be enough other Canadian taxes to offset. Another problem is that TFSA’s are generally considered to be a foreign trust, requiring the same reporting requirements as the RESP. For these reasons, TFSA’s are not good for Americans to own.
Many of the people discussed earlier who have never filed, obviously did not file any of the many forms required. What penalties are involved for those who have never filed? Talk about all the reporting requirements and penalties for failure to file.
Start with a schmooze on language laws and rights of English business in Qc.
There have been lots of reports in the media regarding the need to file lots of reports and draconian penalties for failure to file. Can you elaborate on this.
Well all Americans are obligated to disclose annually, lots of information to the IRS. This includes Americans living abroad. Also, those living abroad, by virtue of that fact, will have bank accounts, investments, businesses in the countries they live in.
The first form to discuss is the much noted in the media FBAR form. This form requires all Americans to disclose to the IRS annually, all there financial interests outside the US if the total is above $10,000. This could include bank accounts, investment accounts, life insurance policies. This also includes financial holdings not owned by you, but if you have signing authority on a company account.
The second form would be the FATCA form, it’s a new form from 2011, form 8938. Once again it requires you to disclose mostly the same information as the FBAR above. The main difference is the thresholds for filing, and the ability to file this form jointly.
Another form would be for those owning businesses outside the US. There are separate forms for partnerships and corporations and they each require information about the businesses and the dealings with the shareholders.
Another important form is for those owning foreign trusts. This would include Tax Free Savings Accounts & RESP’s.
There are other forms, for those who receive gifts from a foreigner, give money or other assets to a foreign business along with estate and gift tax returns to prepare.
What penalties are involved for failure to file these forms.
The standard penalty for failure to file a form is $10,000 for each occurrence. This penalty applies to the failure to file the forms pertaining to businesses, FATCA, or the non-willful failure to file an FBAR.
For failure to file the forms pertaining to a trust, the penalty can be up to 35% of the trust value.
For the FBAR, the penalties are much worse, it depends on whether the failure to file is willful or non-willful. For a non-willful violation, the penalty is simply $10,000 per occurrence. For a willful violation, the penalty will be the greater of 50% of the value of the undisclosed accounts or $100,000. In addition, if the failure to file can be proven to be willful, criminal charges and up to 5 years in jail can be imposed.
Now before you start worrying about losing everything you own and going to jail, the IRS says all the time that if there was reasonable cause for the failure to file one of these forms, none of the penalties will be imposed. Reasonable cause generally means that you were relying on advice from the IRS, from a tax advisor and in some cases, not knowing of the requirement can be considered reasonable cause if you could not be expected to know about the requirement and you were not trying to stay in the dark either. In addition, if you didn’t know about a requirement for a prior tax return and all income was properly declared, but you didn’t file an information form as we discussed above, then all that’s needed is to file the missing information returns with an explanation as to why it’s being filed late.
One other thing to consider right now is that the current IRS position on these forms is, they are not looking to penalize people. An agent at a conference in upstate New York back in December said that if the form is filed, even if it is filed late, before they catch you, they will not impose penalties. Of course, this can be changed at any time and there is no guarantee that this policy is even still in force today.
So far, we have discussed what is required of the million Americans in Canada. But there are some Canadians who are not Americans who have to file in the US as well. Snowbirds, Canadians in the US.
Many Canadian seniors spend a large amount of time each year in Florida, Arizona or other warm places. What do Canadians who spend the winter in the US need to be aware of?
The first thing to be concerned with is whether you spent enough time in the US to qualify as a tax resident under the US rules. Now most people know that if they spend more than 6 months a year outside of Canada, they can lose their provincial health benefits. In addition, US tourist visas limit foreigners from being in the US more than 180 days.
However, for tax purposes, residency is treated differently. Under the rules of the substantial presence test, if someone spends more than 122 days a year in the USA, they are considered a resident for tax purposes. Once you qualify as a resident, you are obligated to file a US tax return, with the same annoying and punitive rules as above.
What can Canadians do to avoid these rules?
The first and obvious thing to do is to avoid spending more than 122 days per year in the USA. IF that is not possible, then there are still ways around the requirements. On my website (ustaxesincanada.com) we have a page that allows you to enter your total days spent in the US in each of the past 3 years, and how to properly deal with the results. The options are, first if you spent less than 183 days in the US in the year in question, then simply file a form called the closer connection exemption. This will result in your showing Uncle Sam that in reality, you are a Canadian and that Canada is your primary residence. This is shown through simple things like where your vehicles are registered, who issues your license to drive.
If you spent more than 183 days in the current year in the US, it is still possible to avoid filing as a US resident, by filing a treaty return explaining why you are genuinely a resident of Canada, and not the US. This explanation should cover the tiebreaker criteria listed in the Canada US tax treaty. Under the treaty, if it is genuinely impossible to determine where the actual country of residence is, tiebreaking provisions are available so only 1 country will be considered the country of residence. I’ve been told about a case where someone was deemed to be a Canadian resident, solely because he had paid for a burial spot in Canada but not in the US and that was his tiebreaking criteria.
What are the rules for investing in the US, either for a rental property of other investments?
Investing in US securities is fairly straightforward. The treaty spells out the rates of withholding on the investment and whether it can be recovered. For most Canadians, it’s worth it to just take the Credit on the Canadian return for these amounts rather than preparing and filing a US return. Also, these investments must be considered part of his US asset base for estate taxes.
However, for real estate there is an additional issue. Canadians cannot actively manage property in the US as they are not allowed to earn income in the US without a visa. Therefore, they are obligated to hire a managing agent to run the property. This managing agent should know what he is doing in terms of withholdings rules. So ownership of real property has issues as well.
Furthermore, for real estate, there is a requirement to withhold 10% of the gross sales price of any real property in the US. So for anyone selling a property, they will have 10% withheld unless they can get a clearance certificate. The amounts withheld can be refunded by filing a tax return the subsequent year, but this will result in the seller needing to wait months to get it back.
Can Canadians who won money at American casinos get their taxes back?
Under the treaty, Canadians can choose to report gambling losses to offset gambling wins. If a Canadian wins on a trip to vegas, they will have a large amount of the winnings witheld to cover the tax obligation. However, Canadians specifically are permitted to file a return to report gambling losses in order to claim losses against the winnings. For certain games though, losses don’t need to be proven and no amounts should be withheld. These games include, BlackJack, craps, roulette and a few others. If you won from those games, then no return is needed and the player can reclaim his losses..
How does the US estate tax affect Canadians?
There are 2 criteria, for those who have 60Kin total US assets, there will be a requirement to file.
For those with assets between 60- 5M, there is a form to fill out to claim a treaty exemption for the assets
For those with assets over 5M you are subject to US estate taxes. There are means to reduce them, but that may be for another time and place.
Nathan Farkas, CPA, CA
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