Liberty and justice for all United States persons abroad

The Isaac Brock Society

Posted on by Posted in Issues regarding US persons abroad 11 Comments

This post has been cross posted from renounceuscitizenship.

See also:
OVDI Switcheroo: Canadian RRSP back in the penalty base
Re: OVDI Switcheroo: Canadian RRSP back in the penalty base

Those who entered OVDI understood (hopefully) that they were paying a fine based on a percentage of a base of assets. Obviously the lower the base, the lower the amount of the penalties. An interesting thread on this appeared on the Jack Townsend blog.

For Canadians who entered OVDI (for whatever reason) there has much been much concern over whether RRSPs would be part of the base for which the OVDI penalty was calculated. People have been asking: will RRSPs be included or not? Why won’t the IRS take a position? Now, what follows is just my thinking and interpretation. It is not legal advice (or any other kind of advice). But, here is how I think you should view this and the arguments you should make.

The obvious question is: how is the penalty base determined under OVDI?

Let’s begin by looking at the FAQs for the OVDI program. You are dealing with the IRS, so you begin by looking at their FAQs.

FAQ 35 is relevant:

35. What kinds of assets does the 25 percent offshore penalty apply to?

“The offshore penalty is intended to apply to all of the taxpayer’s offshore holdings that are related in any way to tax non-compliance, regardless of the form of the taxpayer’s ownership or the character of the asset.  The penalty applies to all assets directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets; tangible assets such as real estate or art; and intangible assets such as patents or stock or other interests in a U.S. or foreign business.  If such assets are indirectly held or controlled by the taxpayer through an entity, the penalty may be applied to the taxpayer’s interest in the entity or, if the Service determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying assets. Tax noncompliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.  See FAQ 52, category 3, for a limited exception to this rule.”

Three points:

1. The penalty applies to ALL assets (this is more than what is required to be reported on an FBAR) related to “tax noncompliance”.

2. “Tax noncompliance” is defined as the failure to report income from and/or a failure to report the funds that were used to acquire the asset.

3. “Tax noncompliance” is not defined to include “Reporting (FBAR) noncompliance”.

FAQ 36 provides an example that is  helpful in understanding FAQ  35. As you read FAQ 36 you will see again that the emphasis is on “tax noncompliance”.

36. A taxpayer owns valuable land and artwork located in a foreign jurisdiction. This property produces no income and there were no reporting requirements regarding this property. Must the taxpayer report the land and artwork and pay a 25 percent penalty? What if the property produced income that the taxpayer did not report?

“The answer to the first question depends on whether the non-income producing assets were acquired with funds improperly non-taxed. The offshore penalty is intended to apply to offshore assets that are related to tax non-compliance. Thus, if offshore assets were acquired with funds that were subject to U.S. tax but on which no such tax was paid, the offshore penalty would apply regardless of whether the assets are producing current income. Assuming that the assets were acquired with after tax funds or from funds that were not subject to U.S. taxation, if the assets have not yet produced any income, there has been no U.S. taxable event and no reporting obligation to disclose. The taxpayer will be required to report any current income from the property or gain from its sale or other disposition at such time in the future as the income is realized. Because there has not been tax noncompliance, the 25 percent offshore penalty would not apply to those assets.

In answer to the second question, if the assets produced income subject to U.S. tax during 2003-2010 which was not reported, the assets will be included in the penalty computation regardless of the source of the funds used to acquire the assets. If the foreign assets were held in the name of an entity such as a trust or corporation, there would also have been an information return filing obligation that may need to be disclosed. See FAQ 5.”

Now, let’s apply this reasoning to an RRSP. Obviously an RRSP is bought with funds that are easily traceable from income. But remember that the U.S. is viewing your behavior from the perspective of U.S. laws.

Case 1: A U.S. citizen in Canada has been filing U.S. tax returns but enters OVDI for some other reason. The money used to buy the RRSP has been properly reported on the U.S. return. Furthermore, the appropriate election is made under the Canada U.S. tax treaty, then I see no way on earth that the RRSP can be part of the penalty base.  There is simply no “tax noncompliance”.

In addition, this reasoning should apply to checking accounts that do not pay interest and any other kind of account that did not pay interest.

Case 2: A U.S. citizen has not been filing U.S. tax returns and enters OVDI. The question is now whether there has been “tax noncompliance.” You file your returns as part of the OVDI program and there is no tax owing. Is there “tax noncompliance”? I believe that the IRS would take the position that there was “tax noncompliance”. The income from RRSPs is taxable in the U.S. unless the appropriate elections are made. But, now you rely on the Canada-U.S. tax treaty. You would need to get advice from a “trusted professional” on this point.

1. The issue of whether an RRSP is part of the penalty base depends on whether there was “tax noncompliance” in relation to it. Some people may have a problem here (non filers) and some will probably not. Those who have filed U.S. tax returns but did not know about FBARs (almost everybody who filed U.S. tax  returns) should not have a problem if they have made the appropriate election.

For these reasons I don’t think it is possible (in terms of the FAQs) to say in advance whether an RRSP is part of the OVDI penalty base. It depends …

The IRS has announced the reactivation of OVDI. Those who are considering entering this program should be very careful.

THIS POST IS NEITHER LEGAL ADVICE OR ANY OTHER KIND OF ADVICE. IT IS SIMPLY MY ATTEMPT TO APPLY THE FAQS TO A PARTICULAR SITUATION. COMPETENT LEGAL ADVICE IS ESSENTIAL!!!

I would be grateful for your comments.

11 thoughts on “Canadian RRSPs and the OVDI penalty base”

  1. I know this sounds like a really simple question coming from such as myself but do people who enter OVDI have to “prepay” sometype of estimated penalty amount when they enter they the program or are they later assessed an amount. It would seem as though if the amount is assessed later that some will simply refuse to if it is seen as totally outrageous and thus at that point the IRS will have to attempt to seek the cooperation of CRA or else be seen as a paper tiger.

  2. At least in the 2011 not only do have to prepay but you have to calculate yourself. This is like:

    – in China where if they kill you they charge your family for the bullet; or

    – Jesus being forced to carry his own cross …………..

    The OVDI programs are great deals for criminals. Probably a professional courtesy extended by the IRS.

    For law abiding people who just didn’t know how to be in compliance,they are devastating.

  3. Thanks for taking time to write this up, and I appreciate especially your expertise in taking so many different factors into consideration as to why the IRS just does waive RRSPs from both taxes and from FBARs.

    I wish to indicate my anger and protest over this whole ludicrous scenario of having my retirement savings become the target of United States’ greed. Everything that the US government offends my sense of justice and fairness. Frankly, raiding people’s livelihood, and not being willing to back off when told to do so, is a sign of desperation and corruption. I will not cooperate with such a system.

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  5. I read on his blog that Phil Hodgen will be going to Washington DC to meet with people from the IRS. The magic date is May 7, 2012, 10:00 a.m. Along with his co-author, Steven Walker, he will be presenting a position paper suggesting that the IRS change the rules regarding RRSPs.
    For more information, take a look at his web site:
    http://hodgen.com/how-the-irs-can-make-rrsp-cleanups-painless/
    They’re likely to talk about OVDP and how RRSPs they should not be included in the base for penalty calculations.
    I hope they will tell them what they think about the program as a whole, and not just address the RRSP issue, but from the article, it looks like RRSPs are the main topic of this meeting.
    Hopefully, something positive will come out of it.
    I hope he’ll update his blog next week to update his readers on the outcome of this meeting.

  6. Worth reading the TAS comments as reported here:

    http://oicattorney.blogspot.ca/2012/11/taxpayer-advocate-fbar-penalties.html

    Sunday, November 18, 2012

    “Taxpayer Advocate – FBAR penalties:

    National Taxpayer Advocate suggests changes to Offshore Voluntary Disclosure Initiative”
    “peaking at a recent international tax enforcement conference, National
    Taxpayer Advocate Nina Olson suggested that IRS implement an approach to
    its Offshore Voluntary Disclosure Initiative (OVDI) that would only
    penalize taxpayers based on their level of non-compliance…………………”

    …………….”If the Ratzlaf standard
    for willfulness isn’t satisfied, then Olson said that the taxpayer
    should be given a break and permitted to only pay the accuracy-related
    penalties. “Such an approach would increase voluntary compliance and
    would stop terrorizing the entire country of Canada    ,” Olson observed.”

  8. Canada: Three Important Changes To IRS Streamlined Filing Procedures For US Taxpayers Resident In Canada
    02 April 2013
    The IRS recently released answers to frequently asked questions (which you may find by clicking here) regarding its new Streamlined filing compliance procedures (“Streamlined”) for US persons who reside outside of the US and are not current on their tax and filing obligations. The FAQs address six questions, three of which resolve important issues:

    First, the FAQs examine the $1,500 tax liability threshold that is used to determine whether a taxpayer is eligible for Streamlined. Eligibility is determined by examining a taxpayer’s compliance risk, which is generally measured by the complexity of the returns. The FAQs state that if the taxpayer owes less than $1,500 in any of the three submitted years he will not necessarily qualify as “low risk” and, conversely, if the taxpayer owes more than $1,500 in any of those years he will not necessarily be considered “high risk.”

    Second, if the taxpayer is currently a participant in the 2011 offshore voluntary disclosure initiative (“OVDI”) or 2012 offshore voluntary disclosure procedure (“OVDP”) he may opt out of these programs and seek to enter the Streamlined.

    Third, taxpayers who have completed one of the IRS’s offshore voluntary disclosure programs, such as the 2011 OVDI or 2012 OVDP, may have their cases reexamined under Streamlined. Taxpayers who are eligible for Streamlined will receive a refund of the penalty imposed by those programs.

    The recently released FAQs indicate that the IRS will administer the program without strict adherence to the previously released instructions, but still leave a lot of discretion in the hands of the revenue agent assigned to the file. This discretion is a double edged sword: on one hand, the agent has the flexibility to arrive at the “right” (or “wrong” as the case may be) result for the taxpayer; however, on the other hand there is little certainty of the ultimate result. Streamlined is not a perfect program, but the recently released FAQs show that IRS is moving in the right direction.
    http://www.mondaq.com/canada/x/230064/tax+authorities/Three+Important+Changes+To+IRS+Streamlined+Filing+Procedures+For+US+Taxpayers+Resident+In+Canada&email_access=on

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  11. I seriously wonder how anyone could work for the IRS administering this stuff and not go home and hang their head in shame. I know the vast majority of Americans have no idea what evil is wrought in their name – heck, not ten Congressmen knew what they were voting for when FATCA was foisted on the world. However, the IRS folks implementing this garbage must know what jack-booted nonsense it is. I guess it would be too much to expect them to do more than follow orders but the difference is the orders are given by a Congress that has no idea what it is doing or what the consequences are. The bureaucrats are enthusiastic torch-bearers for this stuff and that I find harder to forgive.

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