There are, by one estimate, 825,630 US citizens in Canada. Even if they owe no tax, nearly all are still supposed to file US federal income tax returns. Despite the penalty risk, many US citizens outside the US do not file US tax returns.
To date, the consequences of ignoring these obligations have been fairly marginal. While there have been some high-profile cases of US tax enforcement against US citizens in Canada, those have been generally few and far between. Most non-filing US citizens in Canada have stayed comfortably below the radar. This despite 900,000 names being transferred to the IRS under FATCA. FATCA requires Canadian financial institutions to report accounts held by US taxpayers or suspected US taxpayers to the CRA, who turns them over to the IRS.
There are some signs on the horizon that the perfect storm approaches and this may be about to change.
The first warning sign is a recent, little noticed, change to FATCA. Under both the treaty between Canada and the US relating to FATCA (the “IGA”) and Canadian income tax rules, Canadian financial institutions are obliged to have a US social security number associated with an account that gets reported under FATCA. That rule has always been in place, but for 2017, 2018 and 2019 there was a grace period in place. That grace period expired January 1, 2020 and now Canadian financial institutions are required to make sure that there is a US social security number associated with the account.
The problem is that many US citizens in Canada, especially those who are “accidental Americans” don’t have a US Social Security Number. A Social Security Number is essential to filing a US tax return as a citizen and the IRS will not accept a return without it. That means that every US citizen who does not have a Social Security Number is not filing a US tax return.
Consider the following example to illustrate the problem. Beth was born in the US when her mother was pursuing graduate studies. She returned to Canada at age 1. Under US law, she is a US citizen by virtue of her birth in the United States. Because she has a US place of birth, she is easily identifiable as a US taxpayer. But since she left at a young age, she doesn’t have a Social Security Number. Since she doesn’t have a social security number, she has never filed a US tax return.
Canadian financial institutions are now strongly motivated to ensure that they have a Social Security Number on file for people like Beth. If they do not, they might ultimately face a 30% penalty on every dollar they earn from the U.S. Under Canadian law, financial institutions are even allowed to threaten that failure to provide the US social security number may lead to a fine from CRA (the amount of the fine ($100) is often omitted).
Assuming they do not receive a US Social Security Number, the financial institutions may resort to closing the account to stave off the penalty from the IRS. Recently, the European Union asked the IRS to provide an assurance that the failure to have a Social Security Number on file would not require the financial institution to close the account. The IRS declined to provide that assurance in a March 2020 letter.
In short, there will be a lot of pressure from financial institutions on Americans abroad to provide a Social Security Number – a number many of them do not have. Since they do not have the SSN, they cannot be filings US tax returns.
The IRS will thus soon have at its fingertips a list of Americans abroad who have never filed a US tax return. Thanks to the COVID stimulus, the 2020 budget deficit is projected to be in the trillions of dollars. At some point, the bill will come due. It doesn’t strain the imagination that with this information at its fingertips, the IRS will try and fill the budget hole on the backs of non-compliant US citizens abroad – many of whom have horrendous penalty and tax exposure. The March 2020 letter to the European Union hints at this.
Catching up on those returns with a view to stave off future enforcement may prove more difficult in the future than it is currently. Since 2012, non-compliant US citizens abroad have been able to catchup without penalties through the Streamlined Procedures. Oddly, the IRS recently introduced another program for those who have renounced US citizenship but did not file US tax returns. On their face, the renunciation procedures overlap with the streamlined procedure quite a bit but with four key differences – a) they require five years of tax returns instead of 3 years; b) you have to renounce US citizenship to take advantage of them; and c) the renunciation procedure is not available if you have ever filed a US tax return.
The enactment of a new program may indicate that the IRS is looking to close the Streamlined Procedure in favor of the new, narrower, relief program. In fact, the IRS commissioner announced at a conference at the end of 2019 that the end of the Streamlined Procedure may be sooner rather than later.
There are storm clouds on the horizon for US citizens in Canada who do not file US tax returns. To avoid crippling penalties from the IRS, financial institutions will now start chasing American taxpayers for a Social Security Number. At best, that provides the IRS with a list of those who have never filed. At worst, it may lead to account closures. The budgetary pressures in the US may prompt more aggressive IRS action. Those who want to get caught up ahead of that may be wise to do so sooner than later as the window to do so smoothly may be closing.