Date: September 2012
FROM OBSCURITY TO CENTER STAGE – THE DUAL CITIZEN/RESIDENT CLIENT
For almost half a century, advisors in Canada of all sorts (be they lawyers, accountants, stockbrokers, financial and insurance planners, or bankers) have largely been unmindful of the historical roots of their American clients living in this country. By and large, this “phenomenon” can trace its origins to a number of different causes. There is a much greater emphasis in the post-secondary educational system today on international aspects of any sort of professional planning than there was decades ago.
Advisors today are more apt to be considering international aspects of their clients facts such as nationalities, location of children and foreign assets. International trade and commerce and migration of families and business people is also far more prevalent and common than in the past. In short, advisors are more likely today to serve clients with a multijurisdictional mindset than with the single “Ontario” rules only approach to tax and financial planning.
Another significant reason for a lack of consideration of U.S. tax rules in tax and financial planning can be attributed to the lack of awareness of the potentially huge extraterritorial impact the U.S. tax and reporting system can play on numerous aspects of Canadian tax, business, financial, and estate planning for dual-citizens or U.S. citizens resident in Canada. But like it or not, this has all changed in the past couple of years with new reporting and enforcement initiatives by the U.S. government aimed at making as much money as possible from Americans with foreign assets abroad (e.g., through the unjust use of the FBAR penalty) and in particular, Americans residing abroad who have not ever filed or kept current with their U.S. tax and reporting obligations.
What this means in short is that advisors and their firms, be they solo practices or mid-large size firms, financial institutions in all areas relating to accounting, legal, banking, and financial services need to identify what are their professional and legal obligations towards clients with U.S. nationality and reporting obligations, especially non-compliant clients, and what are their strategies to deal with these clients both on a retrospective and prospective basis? This article is by no means an attempt to address such important and complex issues, but rather, aims to provoke a discussion between advisors in their firms with their professional practice departments, general counsel, professional organizations, and malpractice carriers.
PASSING THE DELINQUENCY PROBLEM TO THE CHILDREN – EXECUTORS AND TRANSFEREE LIABILITY
One of the all time favorite tax strategies of US families living in Canada is to ignore the U.S. tax and federal reporting system alltogether. Let’s say your client is the son or daughter of a U.S. citizen (Johnny) who dies in 2013 while a resident of Canada. Johnny has over $1.5 million in Canadian and U.S. securities and has never filed any U.S. returns. Now, even if the $5 million estate tax exemption (set to expire in 2012) continues into 2013, the executor must report any income on the decedent’s Canadian/foreign accounts on the decedent’s final Form 1040 and file a Form TD F 90-22.1 (FBAR). Depending on the facts, an executor may also be required to file a Form 706 estate tax return and report such foreign accounts thereon.
The IRS has stated emphatically that it will seek to impose both income tax and FBAR penalties arising from the delinquencies of the decedent on the executor as U.S. federal law imposes personal liability on fiduciaries who make distributions to beneficiaries and certain creditors all the while knowing of the existence of US tax liabilities. As you can imagine, this creates any number of quandaries for the executor, the family, and the advisors to the executor, and potentially the custodian of the executor’s assets.
Moreover, for some time now, large institutional banks and financial advisors in both North America and Europe have refused under a variety of fact patterns (from being a mere custodian of assets of a client with U.S. tax filing and reporting obligations to being a fiduciary) to make any distribution to the estate without proper closing agreements and releases from the IRS. Even if Johnny were not a Yankee, his ownership of U.S. securities would impose certain non-resident estate tax reporting and potentially subject his assets to U.S. estate tax (and foreign institutions know this and may freeze those assets!)
Furthermore, we don’t know what legislation congress might enact in the future to further impose burdens on financial institutions to enlist them to indirectly help enforce U.S. tax and reporting rules. The best way to prevent these issues from manifesting themselves is to deal with the problems of the delinquent U.S. filer while he or she is alive. In the course of not living in denial, it astounds me how many Canadian estate planners continue to create wills and trusts for clients with U.S. nationality without teaming up with U.S. tax counsel to craft a best practices cross border estate plan. There just isn’t time here to list the numerous horrors that flow from the “one country” thinking two a two country family, yet alone the many significant tax saving measures that could have been put in place.
IRS NEW PROGRAM FOR NON-RESIDENT, NON-FILER U.S. TAX PAYERS
In June 2012 the IRS announced a new “streamlined” procedure to bring U.S. citizens resident in Canada who are non-filers back into the system. In September, the IRS elaborated on that procedure. Great caution is advised for any advisor or their client considering this program as without a proper legal evaluation of the taxpayer’s facts and history, well meaning advisors and their clients can unnecessarily place themselves in greater harm (for example, being subject to a huge FBAR penalty). The best strategy is for a non-filer to be carefully advised of their U.S. tax reporting obligations and rights given their unique facts, and to be evaluated for relief measures, including this new program.
Although there are many potential traps for the unwary, for those eligible taxpayers who are “low risk”, coming into good standing may only require filing of 3 years of delinquent returns and FBARS. “Low risk” may include taxpayers who do not have any “high risk” factors, and who owe less than $1500 in tax due for each of the three years. The “high risk” factors are rather broad and may include: claiming a refund, material economic activity in the U.S., failure to declare offshore income/income to CRA; having an account outside of Canada. This new program is nothing short of a mine field with potentially enormous downsides and the most careful of scrutiny needs to be undertaken before put-ting a client into the jaws of the IRS. Obvious a full scene size up and evaluation of the taxpayer’s tax situation with draft returns are strongly recommended, also is the search for reasonable cause under the complex legal regime that has evolved over many decades.
SPECIAL CONCERNS FOR ADVISORS IN FINANCIAL INSTITUTIONS AND FINANCIAL PLANNERS
When I served in the U.S. Chaplain’s Corp I was confronted with helping to provide support to Marines and their families in times of great trial. I do not want to underestimate the emotional distress that many of my clients have had to face because the financial planning advice they have received in relation to various Canadian investments (while making excellent sense for residents of Canada) had very burdensome U.S. compliance and tax costs (please see my article in this Journal for May 2012 – “Saving Your Clients from US Tax Cancer”).
The dark side of the voluntary disclosure process is that clients receiving a “360 degrees” check up on their cross border tax situation almost always discover the costly asymmetries between the Act in Canada and the Code. The bright side is that for most of them, the clean up can lead to an end to their personal and family misery by severing the umbilical cord to the U.S. tax system through a well planned expatriation.
There is potentially a huge risk (and downside) for dual citizen/resident Canadian clients who receive financial planning advice that does not embrace, include, or integrate U.S. (and international) tax and reporting laws. Financial advisors and their organizations should very carefully evaluate this risk as it relates to their services and develop appropriate and best practices strategies.
Copyright © David S. Kerzner