IRS Streamlined Filing Procedure for U.S. Citizens Living Abroad

During the summer of 2011 there was a significant amount of media attention directed towards the IRS’ Offshore Voluntary Disclosure Initiative (OVDI). This brought to light the fact that there is a staggering number of U.S. citizens, living in Canada, that are not up to date with their U.S. filing obligations (all U.S. citizens must file annual returns to the U.S.). The media attention focused on the potential penalties for failure to become compliant, with a focus on the “FBAR” (Form TD F 90-22.1 Report on Foreign Bank and Financial Accounts) penalties.

Many of these individuals chose to enter into the 2011 OVDI program by the September 7, 2011 deadline, which granted reduced penalties for late filed FBAR forms.

Another option that many others chose (where they had no U.S. tax liability) was to simply file past due U.S. individual income tax returns and FBAR forms (normally 3 to 6 years of overdue tax returns) and “hope for the best”.

The fact that most U.S. citizens living in Canada owe no U.S. tax, mainly due to the U.S. “foreign earned income exclusion” and Canadian foreign tax credits, meant that the second option was the preferred choice for many people. Most did not even know of the existence of the FBAR forms prior to 2011, so the IRS generally accepted late filed FBAR forms without assessing penalties, where the taxpayer did not owe any U.S. tax as a result of reporting the income from such accounts.

However, due to the significance of the FBAR late filing penalties and the lack of a guarantee from the IRS that penalties would not apply, many people chose not to file or to wait until a better deal came along to consider filing. So they remain delinquent.

It happened that, on June 26, 2012, the hoped-for “better deal” became a reality, when the IRS announced a new procedure for delinquents. The “Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers” took effect on September 1, 2012 and provided a simplified filing method for taxpayers who presented a “low compliance risk”.

What is low compliance risk, you ask? Well, that was not made abundantly clear in the guidelines, but it was generally left to the IRS to determine, based on the information provided on the returns and the questionnaire to be completed as part of the submission. Generally speaking, simple tax returns where the amount of U.S. tax owing is less than $1,500 in each year will be treated as low-risk, absent any “high-risk factors”. Evidently, high-risk factors include (but are not limited to) investments and financial accounts outside an individual’s country of residence, significant U.S. source income, claims for a refund, previous FBAR penalties, material economic activity in the U.S., or indications of sophisticated tax planning or avoidance. The instructions for the new streamlined filing procedures specify that individuals who qualify as a low compliance risk will have their review expedited, and the IRS will not assert penalties or pursue follow-up action.

Under the new streamlined filing compliance procedure, individuals who qualify will be required to file tax returns, with appropriate related information returns (i.e. Form 5471 or Form 3520) for the past three years and delinquent FBAR forms (Form TD F 90-22.1) for the past six years. In addition, a deferral election with respect to your Canadian RRSP and RRIF accounts can be made with the submission where deferral is permitted by the Canada-U.S. tax treaty.

The streamlined filing procedure is relatively new, so we have yet to see whether the IRS will request any additional information. However, it’s clearly an improvement over the OVDI program. At this point we encourage non-compliant U.S. citizens to take advantage of this, since it appears to be the best “deal” yet offered by the IRS, and might be the last.

The IRS is committing significant resources to the tracking down of non-compliant taxpayers, and with new laws aimed at foreign financial institutions requiring disclosure of U.S. depositors, it’s only a matter of time until the IRS can detect delinquents via third-party information. We have no idea how the IRS is going to handle delinquents that it finds through this channel, but leniency seems unlikely.

Here is a useful link to the IRS webpage containing detailed information with respect to the streamlined filing procedures. The webpage contains additional links other useful topics: