IRS targeting U.S. citizens living ‘offshore’

It seems the U.S. federal government is turning up the heat on offshore US citizens who aren’t part of the U.S. tax system – and they’re getting more focused on finding them.  This potentially has implications for U.S. citizens living in Canada.

In an announcement earlier this year, the U.S. federal government launched the 2011 Offshore Voluntary Disclosure Initiative (OVDI) to bring offshore money back into the U.S. tax system (and yes…for these purposes, Canada is considered “offshore”).

Some people may be surprised to find they are U.S. citizens.

If you were born in the United States you are a U.S. citizen (unless citizenship was revoked). In addition, a child born outside of the U.S. to a U.S. citizen parent may also be a U.S. citizen – citizenship may be transmitted if the parent was present in the U.S. after age 14. The rules have changed over time, so a U.S. immigration lawyer should be consulted.

Beth Webel is a partner at PWC Private Company Services and a specialist in the area. She recently paid us a visit to talk about this issue and explained that, “since U.S. taxation is based on citizenship, rather than residency as it is in Canada, U.S. citizens are required to file annual income tax returns with the Internal Revenue Service (IRS) regardless of where they live in the world. In addition, U.S. citizens must report their interests in foreign financial accounts, such as Canadian bank and investment accounts. If they don’t, they can be subject to penalties even if no U.S. income tax is due. These penalties are generally applied as a percentage of the balance in the foreign accounts.”

For U.S. citizens who have not made annual filings (either innocently or otherwise), the IRS is conducting this special OVDI to give them a “last chance” opportunity to voluntarily come forward to report assets and income from non-US financial holdings under a reduced penalty structure. This voluntary disclosure opportunity closes on August 31, 2011.

This U.S. initiative is designed to encourage taxpayers to respond, rather than risk exposure to the risk of higher penalties, as well as the possibility of criminal prosecution, if subsequently detected by the IRS after the voluntary disclosure program closes on August 31^{st 2011}. In a recent news release, the IRS Commissioner, Doug Shulman, described the 2011 OVDI as, “the last, best chance for people to get back into the system.”

Further, the risk of detection by the IRS will significantly increase over the next two years. The U.S. has announced that combating international tax evasion is a top priority and as part of these efforts they will require Canadian banks and financial institutions to begin determining which of their clients are U.S. citizens, and will then report the holdings of such clients to U.S. authorities starting in 2013.

U.S. citizens who have not previously filed with the IRS would be wise to obtain advice from cross-border tax and immigration specialists to determine whether or not they have an issue.