“Can the IRS ever catch me?” That’s not a quote from Al Capone, just before the IRS nabbed him. It’s a question I get asked so often by US citizens resident in Canada that it’s worthwhile to focus on it in this week’s post. Not surprisingly, the question usually comes from those who have not complied with their US tax responsibilities and are wondering just how long the arm of the IRS really is.
First of all, there’s a lot more to that question than whether or not US citizens resident in Canada have an obligation to pay taxes in the US (they do) or whether or not they should make payments to the IRS (they should). As the only western country in the world that imposes tax on the basis of citizenship rather than residency, US citizens have US tax obligations regardless of where they live or where the income is earned. So, at its core, that question is primarily about enforcement – granted, the IRS can assess taxes, penalties and interest on US citizens resident in Canada, but can it really collect if they fail to pay? Surely the IRS would be on a hiding to nothing if it attempted to collect payment? Well, not really. As the recent court case of Donald Dewees v. United States of America* has made perfectly clear, living in Canada offers limited protection to US citizens as far as the IRS is concerned, unless they are also Canadian citizens. Here’s why:
Mutual collection assistance
A very important, but little-known fact about the Canada US Tax Convention is that under Article XXVI A, Canada and the US agree to extend mutual collection assistance to each other in respect of “revenue claims” – i.e taxes, Social Security and Employment Insurance premiums, civil penalties and interest. Which means that if the IRS assesses taxes, penalties and interest against a US citizen resident in Canada, once that citizen has exhausted his administrative and judicial rights to restrain collection, the IRS can apply to the CRA to have the amount collected as if it were a Canadian liability. The CRA, as we all know, has very broad powers to collect amounts owing under the Income Tax Act, and so there’s little doubt that the IRS will eventually get its money, thanks to the CRA.
Which brings me to the court case I referred to above. The plaintiff in that case, Mr. Dewees, was a US citizen living in Canada. He operated a business which was incorporated in Canada, and from 1997 to 2008, he failed to file Form 5471 to disclose his interest in the corporation, as required under US law. As a result, the IRS assessed a penalty of $10,000 per year for failure to file, leading to a total penalty of $120,000 against him. In May 2015, the CRA notified Mr. Dewees that it was withholding his Canadian tax refund due to his outstanding $120,000 debt to the IRS. Mr. Dewees promptly brought a court action in the US, challenging the constitutionality of the collection assistance provisions of the CanadaUS Tax Convention. On August 8, 2017, the court ruled against Mr. Dewees. The answer to that opening question, therefore, is “Yes, the IRS can catch you!”
To every rule, an exception…
Interestingly enough, there’s an important exception to Article XXVI A that could have resulted in a different outcome for Mr. Dewees. According to paragraph 8(a) of Article XXVI A, the CRA is not allowed to collect on behalf of the IRS in respect of Canadian citizens. If Mr. Dewees had acquired Canadian citizenship instead of remaining simply a landed immigrant of Canada, that exemption would have protected him from collection action by the CRA.
To be clear, the moral of the story is not that you should become a Canadian citizen in order to avoid your US tax obligations – we are, after all, a firm that assists people in complying with their US tax obligations and we always encourage people to do so. Rather, the moral is that in today’s highly interconnected world, it would be foolhardy to ignore your tax obligations as a US citizen, or to believe that you can get away with doing so. Government agencies like the IRS and CRA, Customs and Border protection agencies as well as passport processing, are all linked up like never before, ensuring that they are constantly sharing information. The trend towards information sharing between tax authorities of various countries is increasing, meaning that the IRS is getting and will continue to get information on income and assets of US citizens resident in Canada. The right thing therefore, is to comply, in order to avoid an unpalatable outcome like the one Mr. Dewees experienced.
*U.S. District Court, D. District of Columbia, 2017-2 U.S.T.C. 50,321, (Aug. 8, 2017).