This topic is such a source of anger and high anxiety that I wanted to comment on this in a separate post.
I don’t believe it is possible (without the individual facts) as to whether the RRSP (although in terms of fairness no retirement plan should be included) to treat this as a “one size fits all question”. I expressed my thoughts on this before in a post called “Canadian RRSPs and the OVDI Penalty Base“.
Here is how I think the arguments about RRSPs should be made:
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.”
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!!!
One of the comments that I received on this post was:
I’m an Enrolled Agent in the U.S. and I must warn you that in the heirarchy of reliable evidence the FAQ has to rank below the form instructions. That is, you can use the advice when preparing the relevant forms but you can’t rely on them for appeals purposes. For that you must rely on the Tax Code, Treasury Regs, and IRS Revenue Procedures, also relevant court cases. The IRS can ignore the FAQ, even if it is the best or only advice they offer.
Thank you for your comment. I certainly accept that as a general principle that the code, regs, procedures (and at the top of the hierarchy court cases) are more important.
In this particular case though this is a voluntary program created by the IRS. Hence, (at least in so far as I am aware) none of these things would apply.
Are you saying that the IRS would not be bound by their answers to these FAQs?
Looking forward to your insight into this hugely important issue.
For the IRS to include the RRSPs of Canadian residents who have filed the required election seems to contradict their own FAQs. I don’t see how they can do that.
The Canadian goes down to the United States to work, eventually becomes a citizen. He still has his RRSP. Enters the 2011 OVDI program, because he was unaware of his filing requirements and the necessity of making his election according to the US Canada treaty. This is mere oversight, an error of omission. His account is not theft from taxes of the United States because it was earned in Canada while a Canadian citizen and while he was not a US person at all.
As you say, if the FAQ is not in the hierarchy, then they are just making up their own rules as they go. Why would anyone want to enter a program where the rules are not clear going into it?
Your post makes it clear that under no circumstances should a person who wants to keep their property in Canada should ever enter the make-believe world called the OVDI. No way in hell am I giving the IRS 27.5% of my RRSP and 27.5% of my house, art and other property.
f8891 tax deferral election problem is very common among Canadian US residents. All my Canadian friends except one who used to work at Royal Bank and hired his own corss-boarder account do not know anything about f8891. They all thought RRSP is like US IRA.
By common sense, people who own RRSP and still want to keep them — must want to have tax deferral as they thought it would be by default. However, this f8891 would require taxpayers to make an election. So that is the all problem for US residents who own RRSP but have never made such an election.
IRS does have so called 9100 relief that a taxpayer can ask for extension — so back file election. In general, IRS grants such a request — but this is all outside OVDI.
I think for those US residents have only RRSP problem (nothing else), it is better to do it outside OVDI — so IRS will fully respect the treaty as well the so called 9100 relief.
Inside OVDI, it is a different story — it is like a slaughter grand.
I don’t know if its true heard from someone today at lunch that Flaherty’s intervention is NOT being welcomed by the in particular by the top civil servants at the Treasury Department, DOJ, and the Joint Taxation Committee. Flaherty is seen as a politician and the in the US at least after Watergate politicians don’t get involved in legal, law enforcement, and tax matters. US supposedly is willing to talk to top public officials at the Department of Finance and CRA but not Flaherty. Also at least from a communications perspective Flaherty is working with staff from Langevin Block(aka the Prime Ministers Office/Privy Council Office). In addition during the preliminary negotiations with the European “five” there was little political involvement just the public service negotiated. In the case of Canada Flaherty wants to be deeply involved. Again don’t whether its true but just something I have heard.
I bet they don’t like Flaherty’s intervention because he’s out maneuvering them. He’s probably talking to other countries behind their backs and forming a coalition to stop the Americans from overreaching. If this rumor is true I take it as good news.
Keep up the good work Mr. Flaherty!
Again I don’t if its true. What I was told is Flaherty attempted to come to some type of agreement back in December and the US refused what he was offering him. I also get the sense that Geithner feels unable politically in the US to neogotiate on the issue directly with Flaherty. I do have to suggest keep up the letters and emails to all your MPs though.
The political pressure in Canada is working. Flaherty has some senior citizens occupying his office today (on another matter separate from FATCA). The seniors are also occupying the offices of about 20 other Conservative MPs. In Canada seniors have their own Occupy Movement!
Don’t mess with Canada’s seniors. They may be sweet and laid back but if you mess with their money former Prime Ministers have learned they’ll teach you a lesson you won’t forget.
My personal sense is that Geithner seems to have all but given up. If he’s living in an apartment in his old hometown already before his term is up he must be pretty worn out from all this.
First, I plead ignorance on exactly how the RRSPs work and what is/is not included in the Canada-US tax agreement. But looking at this retirement/pension issue from the swiss side of things it is indeed a minefield. The swiss-US tax treaty basically does not cover it, so even if contributions to a retirement account were made before a becoming a US citizen, to the extent they were still earning tax deferred income abroad after becoming a US citizen, the earnings would be taxable and if the vehicle would be deemed a trust it also would need reporting (signifcant penalties for non reporting I believe). So for non filers it would seem to be tax non-compliance, and even for filers due to the complexity it could also easily be tax non-compliance quite easily I am afraid.
OMG: Who are you calling sweet and laid back?!? That doesn’t describe any seniors I know. Boomers now call themselves Zoomers. We’ve never been known to be sweet or easy going.
Tim: I love your inside info. That rumour makes sense. US would definitely not like elected officials interfering in something as important as making sure fundamental rights of their citizens are protected.
You Go JF! Aren’t you a Zoomer?
I believe the real devil in all of this is Congressional Joint Committee on Taxation which to tell you the truth is an entity I was not familiar with until quite recently and I suspect most of the American public has never heard of. It is essentially a creation of the 1920s prohibitionist era that prides itself on its “non partisan” nature with apparently little democratic control over its activities.
I filed my 8891s with all of my back returns. Although the 9100 relief letter probably should have been filed… but it was not.
In conversation with a number of tax and Accountant pro’s…it seems the the IRS has been ‘accepting’ 8891s without this relief letter, however i am sure they could always exercise there authority on this matter.
If the time comes that they deny my 8891 election filing, that is the day I will go to the TAs.
More Estates Forced to File With IRS Under Estate Portability Proposal
IRS’s procedure for claiming the unused estate tax exemption of a spouse, known as portability, on the Form 706 will force many more estates to file. In Notice 2011-82, IRS told executors of estates of people who died after 2010 that to claim the unused portion of a spouse’s estate and gift tax exemption for 2011, they must file a complete and timely Form 706. Practitioners had been expecting a check-the-box election on the form, but IRS said it did not want estate executors to have to affirmatively elect portability.
It should be fine. A lot people have done that without any problem.
However, it is totally a different story inside OVDI. A taxpayer (Canadian US resident) who filed f8891 for the last 8 years with 9100 relief for tax deferral election.
Now, it came from Washington (top level of OVDI) that the taxpayer must include all the RRSP interests/dividends income (even it has never been cashed out) . So IRS rejected 9100 relief — basically the taxpayer was forced into tax non-compliance while IRS could show good faith to let the taxpayer to use the treaty.