Jul 19, 2017
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The Internal Revenue Service was handed a defeat with respect to its ability to assess some penalties with respect to late filed FinCEN Form 114, “Report of Foreign Bank and Financial Accounts.” In the case of United States v. Colliot (W.D. Texas, Austin Division, Case No.: AU-16-CA-01281-SS) the court ruled in favor of Ms. Colliot. The case revolved around the ability of the IRS to impose FBAR penalties in excess of US $100,000. The potential imposition of significant FBAR penalties has been one of big hammers the IRS has used in its ongoing efforts to combat tax evasion.
FBAR civil penalties are imposed under Title 31 of the United States Code of Federal Regulations (“C.F.R.”) Chapter X Subpart H §1010.820. The provision states:
(“g) For any willful violation committed after October 27, 1986, of any requirement of § 1010.350, § 1010.360 or § 1010.420, the Secretary may assess upon any person, a civil penalty: …
(2) In the case of a violation of § 1010.350 (Reports of foreign financial accounts) or § 1010.420 (Records to be made and maintained by persons having financial interests in foreign financial accounts) involving a failure to report the existence of an account or any identifying information required to be provided with respect to such account, a civil penalty not to exceed the greater of the amount (not to exceed $100,000) equal to the balance in the account at the time of the violation, or $25,000.”
The penalties, as outlined in the instructions to Form 114 state, “A person who willfully fails to report an account or account identifying information may be subject to a civil monetary penalty equal to the greater of $100,000 or 50 percent of the balance in the account at the time of the violation.”
At issue was whether the IRS had the ability to issue a willful violation penalty in excess of the $100,000 minimum. Given the current language of the regulations, the court ruled that it could not. On page 5 of the Order the Court states:
“In sum, § 1010.820 is a valid regulation, promulgated via notice-and-comment rulemaking, which caps penalties for willful FBAR violations at $100,000. 31 C.F.R. § 1010.820. Rules issued via notice-and-comment rulemaking must be repealed via notice-and-comment rulemaking. See Perez v. Mortgage Bankers Ass ‘n, 135 S. Ct. 1199, 1206 (2015) (requiring agencies to ‘use to the same procedures when they amend or repeal a rule as they used to issue the rule in the first instance’). Section 1010.820 has not been so repealed and therefore remained good law when the FBAR penalties in question were assessed against Colliot. Consequently, the IRS acted arbitrarily and capriciously when it failed to apply the regulation to cap the penalties assessed against Colliot. 5 U.S.C. § 706(2) (requiring agency action to be ‘in accordance with law’); see also Richardson v. Joslin, 501 F.3d 415, (5th Cir. 2007) (‘[A]n agency must abide by its own regulations.’) (citing United States ex rel. Accardi v. Shaughnessy, 347 U.S. 260 (1954)).
If FinCEN or the IRS wished to preserve their discretion to award the maximum possible penalty for willful FBAR violations under § 5321(a)(5), they might easily have written or revised § 1010.820 to do so. For example, § 1010.820 might have incorporated § 5321 (a)(5) ‘s maximum penalty thresholds by reference, or alternatively, the IRS might have revised § 1010.820 to reflect the increased penalty limits. Instead, FinCEN and the IRS enacted and then left in place the $100,000 penalty cap.”
While this is a win for the taxpayer, the IRS believes the judgement to be error. Further, what happens when a government loses a case? They change the law. In this case, they update the Regulations.
The moral of the story is that if you have not (yet) properly disclosed all of your foreign financial accounts to FinCEN you need to do so while the various IRS voluntary disclosure programs are still in effect. Even a US $100,000 penalty is too much.
We at Cadesky US Tax strive to keep our clients up to date on all relevant U.S. tax issues. If you have any questions or needs please do not hesitate to reach out to your Cadesky US tax team member.
U.S. citizens abroad are burdened with the same federal tax compliance obligations as U.S. residents. In fact, one can argue that U.S. citizens abroad have more compliance obligations, as they typically have foreign asset, foreign corporation and/or foreign trust filing obligations. Historically, however, the Internal Revenue Service (“IRS”) has not provided the same level of service to U.S. citizens abroad as they to do U.S. residents. As the IRS expands its online service offerings this uneven level of service seems destined to continue.
Many U.S. citizens abroad have had the frustrating experience of trying to reach the IRS by telephone, only to discover that the toll-free “800” telephone numbers, published for IRS service lines, do not work for telephone calls made from outside the United States. This means that U.S. citizens abroad can only reach the IRS at their own expense while it is a free call for U.S. residents. This gets even more frustrating when one discovers that certain departments and individuals only have “800” contact numbers and no published local number, leaving access to these telephone lines impossible for those outside of the United States. [Hint: try using Skype, Google Hangouts, or some other VOIP phone service in order to call these “800” numbers.]
The ability to provide original documentation to the IRS is also limited for those outside the country. When required to provide original documentation, taxpayers residing in the United States have the ability to visit a local IRS Service Center or Social Security office. Until recently, taxpayers abroad were able to visit a U.S. embassy or consulate to have their original documentation certified and then forwarded to the IRS or the Social Security Administration. Last October, these services were suspended. This means that taxpayers must now return to the United States and visit an office in person. For those of us in Toronto, our “local” Social Security office is in Niagara Falls, New York. For those in the Ottawa area, it is Ogdensburg, New York.
As the IRS expands its online service offerings, it appears that they have again neglected to consider the needs of U.S. citizens abroad. Last year the IRS launched “View Your Account” where taxpayers are able to view their basic tax information online. Basic information includes copies of the recent years’ tax return transcripts, account balance information, and payment plan information. Taxpayers can also pay their outstanding taxes with a debit or credit card through this site. While the information is not as robust or as sophisticated as the CRA’s “My Account”, at least it’s a start.
But, there’s a catch. This IRS is using a U.S. credit agency to verify the identity of those registering to use the “View Your Account” service. Taxpayers must provide a U.S. credit card, or information from a U.S. mortgage or auto loan in order to pass the online security and register. Those without a current U.S. credit history are not able to clear the security and thus cannot register for this service. There are currently no alternatives available. [For those who want to try and register, you can access the “View Your Account” web page at https://www.irs.gov/payments/view-your-tax-account].
Similarly, the U.S. Social Security Administration (“SSA”) has been encouraging U.S. citizens to sign up for “My Social Security” to manage Social Security benefits online. With “My Social Security”, a U.S. citizen can view projected Social Security benefits, register to begin receiving benefits, and can manage administrative tasks such as a change of address. In fact, SSA no longer mails out Social Security benefit statements to those paying in to the system — this information is now only available online.
However, registering for this service is even more difficult than “View Your Account.” In addition to requiring a U.S. credit history, the user must also have a current U.S. address in order to register. This precludes U.S. citizens abroad from registering for this service, and arguably this is the group of persons that would be best served by using online services. [For more information, visit https://www.ssa.gov].
At Cadesky U.S. Tax, we believe that part of our mission is to advocate for U.S. citizens abroad. We recently sent a member of our staff to the IRS Nationwide Tax Forum in Atlanta, GA, where we had the opportunity to raise some of the obstacles facing international taxpayers. We provided feedback directly to IRS and Social Security staff regarding the online registration limitations, and these staff are taking our feedback under advisement. We also participated in a focus group on the delivery of IRS services, sponsored by the Taxpayer Advocate Service, where we provided feedback about international taxpayers.
The IRS does not seem to recognize that there is the imbalance of service offerings between U.S. citizens abroad and U.S. resident taxpayers. Until these services offerings are better balances, we will continue to speak up. We encourage all U.S. citizens abroad to do the same.
In light of the United States Supreme Court South Dakota v. Wayfair et al decision, 585 U.S.__(2018) (see U.S. Tax Tip Volume No. US-18-14) many states are moving to enact legislation allowing them to impose sales tax collection requirements on out-of-state sellers. The Wayfair case dealt with the Commerce Clause and a state’s ability to require out-of-state sellers to collect and remit the state’s sales tax. The Streamlined Sales Tax Governing Board, Inc. (www.streamlinedsalestax.org) is moving forward on this issue.
In the prior Quill Corp. V. North Dakota, 504 U.S. case, the majority of the Supreme Court expressed concern that “a state tax might unduly burden interstate commerce, by subjecting retailers to tax collection obligations in thousands of different taxing jurisdictions.” 504 U.S., at 313, n.6.
In his Wayfair opinion, Justice Anthony Kennedy, stated:
“That said, South Dakota’s tax system includes several features that appear designed to prevent discrimination against or undue burdens against interstate commerce. First, the Act applies a safe harbor to those who transact only limited business in South Dakota. Second, the Act ensure that no obligation to remit the sales tax may be applied retroactively. Third, South Dakota is one of more than 20 States that have adopted the Streamlines Sales and Use Tax Agreement. (Italics added) This system standardizes taxes to reduce administrative and compliance costs: It requires a single, state level tax administration, uniform definitions of products and services, simplified tax rate structures, and other uniform rules. It also provides sellers access to sales tax administration software paid for by the State. Sellers who choose to use such software are immune from audit liability.”
The Streamlined Sales Tax Governing Board, Inc. has set an emergency meeting for July 19th and 20th in St. Paul, MN. Per their website “The focus of this meeting will be discussions related to implementation of remote sales tax collection authority in light of the United States Supreme Court’s decision in South Dakota v. Wayfair et al, to ensure smooth, efficient and transparent implementation.”
There are 24 SSUTA member states including: Arkansas, Georgia, Indiana, Iowa, Kansas, Kentucky, Michigan, Minnesota, Nebraska, Nevada, New Jersey, North Carolina, North Dakota, Ohio, Oklahoma, Rhode Island, South Dakota, Tennessee, Utah, Vermont, Washington, West Virginia, Wisconsin and Wyoming. 12 of the member states have already enacted economic nexus models that impose sales tax collection duties.
What is clear is that individual states are starting to move on this issue.
Cadesky U.S. Tax continues to be on top of the latest U.S. sales tax developments. We can assist in determining whether you have sales tax nexus with a state, registering with that state and the filing of any returns. Please reach out to your Cadesky U.S. Tax Ltd contact for more information.
On July 2nd, the IRS Large Business and International division (LB&I) announced five new additional compliance programs. This will bring the total to 40 new compliance programs since January 31, 2017. The five most recent programs additions are
Restoration of Sequestered AMT Credit Carryforward
The recently enacted Tax Cuts and Jobs Act eliminated the corporate alternative minimum tax (AMT). Before it was repealed, a corporate taxpayer that was subject to AMT could carry forward, indefinitely, the AMT taxes paid as a minimum tax credit (AMT credit). This credit could be utilized against the corporation’s regular tax liability in future years. For tax years beginning after 2017 and before 2022, 50 percent of the excess AMT credits are either claimable against corporate taxpayer’s federal tax liability or refundable. Any remaining AMT credits are fully refundable in tax years beginning in 2021.
Pursuant to the requirement of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended by the Budget Control Act of 2011, the Office of Management and Budget (OMB) had determined that corporations claiming refundable AMT credits were subject to sequestration (automatic spending cuts made to deal with the government’s budget deficit).
Refund payments and credit elect and refund offset transactions processed on or after October 31, 2017 and, on or before September 30, 2018 will be reduced by the fiscal year 2018 sequestration rate of 6.6% irrespective of then the IRS received the original or amended return.
LB&I is initiating a campaign for taxpayers improperly restoring the sequestered Alternative Minimum Tax (AMT) credit to the subsequent tax year. Refunds issued or applied to a subsequent year’s tax, are subject to sequestration and are a permanent loss of refundable credits. Taxpayers may not restore the sequestered amounts to their AMT credit carryforward.
S Corporation Distributions
The IRS has identified three issues with respect to S Corporation distributions: (1) when an S Corporation fails to report gain upon the distribution of appreciated property to a shareholder; (2) when an S Corporation fails to determine that a distribution, whether in cash or property, is properly taxable as a dividend, and (3) when a shareholder fails to report non-dividend distributions in excess of their stock basis that are subject to taxation.
In IRS Notice 2014-21 the IRS opined that virtual currency is property for U.S. federal tax purposes. The Notice also provided information on the U.S. federal tax implications of convertible virtual currency transactions. Taxpayers with unreported virtual currency transactions are urged to correct their returns as soon as practical. The IRS is NOT contemplating any type of voluntary disclosure programs to specifically address tax non-compliance regarding virtual currency.
Repatriation via Foreign Triangular Reorganizations
In December 2016, the IRS issued Notice 2016-73, which curtailed the claimed “tax-free” repatriation of basis and untaxed controlled foreign corporation earnings following the use of these transactions. The IRS is hoping to identify and challenge these transactions.
Section 965 Tax
Section 965 requires United States shareholders to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. Taxpayers may elect to pay the transition tax in installments over an eight-year period. For some taxpayers, some or all of the tax will be due on their 2017 income tax return. The tax is payable as of the due date of the return (without extensions).
The IRS updated their Section 965 webpage on June 26, 2018. The IRS wishes to raise awareness of these filing and payment obligations.
We are Cadesky U.S. Tax strive to keep you up to date on the latest U.S. tax news. If you have any questions please do not hesitate to reach out to any member of the Cadesky U.S. Tax team.
As Canadian companies grow their business into the United States one area of planning that is often overlooked is the potential impact of state sales tax. In general, sales tax is imposed on sales of tangible personal property. Many, but not all companies, plan for U.S. federal income taxes (and whether they have a permanent establishment or not) and some even look at state corporate income tax nexus but it has been our experience that many companies do not address the state sales tax issue.
Historically, out of state sellers have relied on the Commerce Clause of the United States Constitution (Article 1, Section 8, Clause 3). The clause states that the United States Congress shall have power “to regulate Commerce with foreign Nations, and among several States, and with Indian Tribes.”
In a prior United States Supreme Court decision (Quill Corp. v. North Dakota, 504 U.S. 298) the court ruled that the ability of a state to impose sales tax on an out of state seller, that had no physical presence in the state, was prohibited under the Commerce Clause. The court opinion stated “The State’s enforcement of the use tax against Quill places an unconstitutional burden on interstate commerce.” The Commerce Clause required the seller to have a “substantial nexus”.
The basic rule for collecting sales tax from online sales is: if your business had a physical presence or “nexus” in that state, the company was required to collect and remit applicable sales taxes from on-line customers in that state. If the company did not have a physical presence in that state, the company did not generally have to collect sales tax from on-line sales into that state. That has now changed.
The U.S. Supreme Court on June 21, 2018, in the case of South Dakota v. Wayfair, Inc. et al, in a 5-4 decision, has overturned Quill. The court held, “Because the physical presence rule of Quill is unsound and incorrect, Quill Corp. v. North Dakota, 504 U.S. 298, and National Bellas Hess, Inc. v. Department of Ill., 386 U.S. 753m are overruled.” Thus unless Congress acts to change the law, states will now be allowed to collect sales tax from out of state sellers, including internet sellers.
Many states have access to U.S. customs documents showing the sale and delivery of goods into their state. Historically, because of Quill, state sales tax authorities did not approach the sellers as they did not have the constitutional authority to collect the sales tax. No doubt, this will change. As states have revenue shortfalls they will look at collecting as much revenue as possible. An easy target is foreign sellers (since in reality they don’t vote and wouldn’t have a say in the law).
It should be noted, however, that the nexus standard for the imposition of state corporate income tax and state sales taxes are, in many cases, different and indeed vary state by state. Though the initial Quill decision was in the context of collecting sales tax, The Interstate Income Act of 1959 (P.L. 86-272, Sept. 14, 1959) had previously restricted a state’s ability to impose state corporate income tax on out-of-state sellers.
In light of the Wayfair decision, a question may be raised as to whether a state may now try to impose state corporate income taxes as well. Many states have introduced, in addition to the current physical nexus standard, an economic nexus standard.
Anyone who is remote seller selling tangible personal goods into the U.S., whether directly or via a third party distributor (i.e., Amazon) needs to review their sales tax exposure and take appropriate action. Absent any sales tax exemption certificate they may be liable for collecting and remitting state sales tax.
They may also wish to review their state nexus to determine if they may now also be subject to any state income tax.
We can help
Cadesky U.S. Tax can assist in determining whether you have sales tax nexus or income tax nexus with a state, registering with that state and the filing of any returns. Please reach out to your Cadesky U.S. Ltd contact for more information.
On June 4, 2018 the IRS issued News Release IR-2018-131. In this release the IRS address some concerns in regards to penalties associated with the late payment of the first instalment of the transition tax.
New IRC §965, enacted on December 22, 2017 as part of the Tax Cuts and Jobs Act (P.L. 115-97), imposes a one-time tax on untaxed foreign earnings and profits (E&P) of foreign corporations owned by “United States shareholders”, as defined under the Internal Revenue Code, by deeming those earnings to be repatriated as a subpart F income.
Earnings and profits held in the form of cash and cash equivalents are taxed at an effective rate of 15.5 percent, for corporations, and up to 17.5 percent for individuals. The remaining earnings and profits are taxed at an effective 8 percent rate, for corporations, and up to 9 percent for individuals.
The transition tax generally may be paid in installments over an eight-year period when a taxpayer files a timely election under section 965(h).
Many taxpayers have struggled with understanding these new rules especially given the fact that the IRS continues to issue guidance. Much of this guidance has been issued AFTER the filer’s original due date. Though extensions can be filed, the first instalment payments were due by the original due date.
The Release states:
“In some instances, the IRS will waive the estimated tax penalty for taxpayers subject to the transition tax who improperly attempted to apply a 2017 calculated overpayment to their 2018 estimated tax, as long as they make all required estimated tax payments by June 15, 2018.
For individual taxpayers who reside outside the United States, the IRS has previously announced that they would allow the first instalment payment to be made by June 15th, 2018, the “normal” due date for these taxpayers. This is evident in the last sentence of the first bullet point. It is not clear, however, if the IRS would also allow nonresident taxpayers to defer their first instalment payment to April 15, 2019.
While providing penalty relief is a step in the right direction, we would hope that the IRS and/or Congress would see fit to exclude United States expatriates from the provisions altogether. It is clear that the intent of this legislation was to encourage (force?) large U.S. based multi-national enterprises to bring the offshore money back “home” and re-invest in the U.S. to create U.S. jobs. For individual United States shareholders abroad, it is doubtful that any of these “repatriated” funds would actually be re-invested in the U.S. In many cases the foreign countries would be the beneficiaries as planning is being undertaken to accelerate foreign tax to eliminate any potential double taxation. We are hopeful that further IRS guidance will be forth coming.
The recently enacted U.S. Tax Cuts and Jobs Act introduced new IRC §965, “Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation.” This onetime tax imposes a “repatriation or transitional tax” on United States shareholders of “specified foreign corporations”.
The term “specified foreign corporation” is defined to mean “(A) any controlled foreign corporation, and (B) any foreign corporation with respect to which one or more domestic corporations is a United States shareholder.”
Many U.S. persons (U.S. citizens or lawful permanent residents) who are resident in Canada own interests in Canadian companies. If that U.S. person owns 10% or more of the votes or value (the value test being new as of January 1, 2018) then that person is defined to be a “United States shareholder”. If “United States shareholders,” in aggregate, own more than 50% of the votes or value of the Canadian company that company is a controlled foreign corporation (CFC) and hence a specified foreign corporation for purposes of the repatriation or transitional tax.
The timing of the income inclusion to the shareholder, which then determines when the transitional tax is due, is based on the year end of the specified foreign corporation (i.e., Canadian company). If the company follows a calendar year the income inclusion is December 31, 2017. If the company follows a fiscal period, the income inclusion is the year end of the last fiscal period that began before January 1, 2018. For example, if the fiscal year was October 1, 2017 to September 30, 2018, the income inclusion occurs on September 30, 2018.
Many Canadian companies select a fiscal period other than that of the calendar year. This could be for natural business reasons. For example retailers may select a January 31 year end instead of December 31 to account for the Christmas season. Others may choose a non-calendar year end to defer the taxation of income as long as possible. In many cases it is not an issue for Canadian tax purposes. For U.S. tax purposes, however, the company may not have a choice.
IRC §898 outlines what the taxable year should be of certain foreign corporations. In general, the determination of the “required year” is
Let’s look at a typical situation in Canada, a U.S. citizen resident in Canada who owns 100% of the shares of a Canadian operating company. The Canadian company is a CFC for U.S. tax purposes since the U.S. citizen Canadian resident owns 100% of the votes and value of the company. As he is the majority U.S. shareholder, the year of the company should be the same year as he has.
IRC §441(a) states “Taxable income should be computed on the basis of the taxpayer’s taxable year.” The provision then goes on to define the term “taxable year” to mean the calendar year if certain conditions are not met.
In general, a calendar year is mandatory for an individual who keeps no books, does not have an annual accounting period, or has an annual accounting period that does not qualify as a fiscal year. It is possible for an individual to have a fiscal year but in the vast majority of cases the conditions are not met meaning that they would default to a calendar year filer.
What this means, in our example, is that the reporting period for U.S. tax purposes, of the Canadian company, should be the calendar year NOT a fiscal year since the majority U.S. shareholder’s taxable year is the calendar year.
In our experience the IRS has not addressed the issue of fiscal reporting periods of Canadian CFCs. This could be for many reasons including (i) there is no loss to the U.S. treasury (since non subpart F income is only taxed when distributed); (ii) the taxpayers may to be too small to warrant IRS examination; (iii) the IRS may not be aware of this issue or possibly; (iv) Congress simply does not understand the issues of U.S. citizens living abroad (as evidenced by many of these new rules).
With respect to the IRC §965 income inclusion it raises a potential issue – do fiscal specified foreign corporations need to adjust to a December 31st, 2017 year end to be in compliance with the Internal Revenue Code? To date, the IRS has not issued any guidance on this point. Taxpayers, however, need to be aware that they may not be technically in compliance.
Yesterday, April 2, 2018, the IRS released Notice 2018-26, the long-awaited additional guidance related to the one-time repatriation tax under new IRC section 965, “Treatment of deferred foreign income upon transition to participation exemption system of taxation.” This tax impacts those United States persons who own interests in specified foreign corporations, which includes an interest in a Controlled Foreign Corporation (CFC). While we are still reviewing the Notice to assess its impact on our clients, we want to timely share one item of relief that the IRS has provided.
As we have mentioned in previous U.S. Tax Tips, an election is available under new IRC Section 965(h)(1) to pay the one-time repatriation tax in instalments over an eight-year period with a payment of 8% of the tax being due this year. Section 965(h)(2) then states that in order for the election to be valid the first payment is required by the due date of the tax return without regard to any extension of time for filing the return. As such many taxpayers were struggling to come up with a realistic estimate of their cumulative E&P in order to make the required payment.
In the Notice the IRS has provided some relief for a subset of taxpayers. In Section 2.18 of Notice 2018-26 the IRS recognizes that United States citizens or residents whose tax homes and abodes, in a real and substantial sense, are outside the United States and Puerto Rico are granted an extension of time for filing income tax returns and for paying any tax shown on the return until the fifteenth day of the sixth month following the close of the taxable year under Reg. 1.6081-(5)(a). For individual taxpayers on a calendar year, this extends the due date of Form 1040 until June 15.
In Section 3.05(e) the IRS addresses the question as to whether the timely payment rule under Section 965(h)(2) negates the extension of time to pay that is available under Regulation 1.6081-5(a). In its response, the IRS states that, “The Treasury Department and the IRS intend to issue regulations providing that, if a specified individual receives an extension of time to file and pay under §1.6081-5(a), then the individual’s due date for an installment payment under section 965(h) is also the fifteenth day of the sixth month following the close of a taxable year.”
Therefore, it appears that those U.S. persons who own shares in a U.S. Controlled Foreign Corporation, and who live outside the United States, will automatically receive a two-month extension for the payment of the Section 965 repatriation tax. Extensions granted under Reg. 1.6081-5(a) do not have to be filed in advance, but instead require a statement attached to the tax return stating that the individual is qualified for an extension under Section 1.6081-5(a)..
We will continue to review the IRS guidance on the repatriation tax and will release U.S. Tax Tips as the information becomes available.
The due date for a U.S. personal income tax return will depend on both the residence of the taxpayer, the category of the taxpayer and the type of return filed.
Filing Form 1040, “U.S. Individual Income Tax Return”
The regular due date for the filing of a U.S. personal income tax return is generally April 15th of the following year. If the 15th falls on a Saturday, Sunday or legal holiday, the due date is extended to the next business day. Since April 15th, 2018 falls on a Sunday, the due date would be extended to the next business day. Monday, April, 16th. However in Washington D.C., Monday April 16th is Emancipation Day, a legal holiday. As such, the due date is Tuesday, April 17th, 2018.
If the taxpayer is a U.S. citizen or resident whose tax home and abode, in a real or substantial sense, is outside the United States, the Regulations allow for an automatic extension until June 15th, 2018. The two-month extension is obtained by attaching an explanation to the taxpayer’s return when it is filed.
If the taxpayer is a U.S. citizen or resident whose tax home and abode are within the United States but is “out of the country” on the regular due date, the taxpayer is allowed the extra two month extension to June 15th, 2018.
Both U.S. resident taxpayers and U.S. taxpayers abroad, however, can file Form 4868, “Application for Automatic Extension of Time to File U.S. Individual Income Tax Return” for additional time to file. The filing of this form extends the due date for an additional six months in the case of a U.S. domestic filer, to October 15th, 2018. For U.S. taxpayers abroad, however, the additional extension is only 4 months to October 15th, 2018 as the extension request runs concurrent with the additional 2 month extension allowed per the Regulations. The IRS cannot refuse this extension request. The extension must be timely filed, by the regular due date, for the extension to be allowed.
Extensions can be electronically or paper filed. A paper extension will be considered timely filed if it is postmarked by the due date and mailed in an envelope that is properly addressed and has enough postage.
In addition to the six-month extension, taxpayers who are out of the country may request an additional two month extension to December 15th, 2018. This extension, however, is not automatic and at the discretion of the IRS. To request this extension, taxpayers must send a letter to the IRS (before October 15th, 2018) explaining why the additional two months is needed. If the extension is allowed the IRS will NOT respond to your request. They will only respond if they deny the request. When this extension request is denied, taxpayers have an additional 10 days to file before the return will be considered late.
Filing Form 1040NR, “U.S. Nonresident Alien Income Tax Return”
The due date for non-resident aliens, who do not earn wages subject to U.S. income tax withholding, is June 15th, 2018. Filing Form 4868 extends the due date to December 15th, 2018.
If the nonresident alien has wages, subject to U.S. withholding, the due date is April 18th, 2018. Again an extension to October 15, 2018 is available.
Form 8840, “Closer Connection Exception Statement for Aliens”
If you are filing a Form 1040NR, because you have U.S. source income, Form 8840 should be attached to Form 1040NR and filed by the due date (including extensions). If you do not have to file Form 1040NR, then Form 8840 should be filed, independently, by the due date (including extensions) for filing Form 1040NR.
The filing of an extension does not, however, extend the payment due date.
For U.S. resident taxpayers or non-resident aliens with wages subject to U.S. income tax withholding, the payment due date is April 18th, 2018.
For other non-residents aliens and for U.S. citizens and residents abroad, the payment due date is June 15th, 2018.
If a return is not timely filed, including extensions, the IRS will impose a failure-to-file penalty of 5% for each month or part of a month up to a maximum of 25%. The penalty is based on the amount of unpaid taxes, if any, owed by the filing due date.
If at least 90% of the ultimate balance due has not been paid by the original due date, the IRS will impose a failure-to-pay penalty of 0.5% per month up to a maximum of 25%. If the failure-to-file penalty and the failure-to-pay penalty both apply in any month, the combined maximum penalty for that month will be 5%.
The IRS will also impose interest on any unpaid balance until paid (this includes tax and any penalties). The interest rate is determined quarterly and is the federal short-term rate (known as the applicable federal rate or AFR) plus 3%. The short-term AFR for April 2018 is 2.12%.
In most countries an individual’s tax residency is determined by their residential ties, which considers one’s own unique “facts and circumstances”. In Canada, for example, there is no statutory definition of “residency” contained in the Canadian Income Tax Act.
In the United States, however, tax residency is a more rigid process. If you are not a U.S. citizen nor a lawful permanent resident (i.e. green card holder) residency is determined by the number of days an individual is physically present in the country. For this purpose, each part of a day in the U.S. is counted as a day, whether for business or pleasure (or both). An individual who spends “too many days” in the U.S. may unintentionally become a U.S. tax resident.
Substantial Presence Test
How does the U.S. determine what is “too many days”? This is computed under the “Substantial Presence Test” or “SPT”. First the individual must have at least 31 days of physical presence in the current year. If the individual has less than 31 days in the current year, the SPT does not apply. If the individual has 31 days or more then the SPT applies the following formula:
All of the days in the current year +
1/3 of the days in the preceding year +
1/6 of the days in the second preceding year
If the result is 183 days or more, then the individual meets the SPT and will be considered a U.S. tax resident, under US domestic tax law, unless an exception applies.
Exceptions to the Substantial Presence Test
There are a few exceptions to the Substantial Presence Test. These include:
Exempt individuals must file a Form 8843, “Statement for Exempt Individuals and Individuals with a Medical Condition” along with their U.S. tax return, or if no tax return is required by June 15, in order to claim the exemption.
If a Form 8840 or 8843 is not filed on time, an individual cannot claim an exemption from the Substantial Presence Test. This will not apply if the individual can prove that he took reasonable action to become aware of the filing requirements and significant steps to comply with those requirements.
Canada-United States Tax Convention (1980) aka the “Treaty”
If an individual meets the SPT and does not meet one of the exceptions listed above, he is a U.S. tax resident under U.S. domestic law. What happens, however, if the individual spends more than 183 days in the current year alone?
Individuals who are also Canadian tax residents and who maintain residential ties closer to Canada, than the U.S., can use the residency tie breaker rules, contained in Article IV, to override U.S. domestic law. This is done by filing a U.S. Form 1040NR, “U.S. Nonresident Alien Income Tax Return, by the due date along with a Form 8833, “Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)” claiming an exception from U.S. taxes under the Treaty. If there is no U.S.-source income to report, then there is no U.S. tax to pay.
The downside of this is that the Treaty only reduces or eliminates any potential U.S. tax. It does not eliminate any filing obligations the nonresident may have. Individuals who are considered U.S. nonresidents, by way of a Treaty, are still subject to the foreign reporting requirements of a U.S. resident. Keep in mind that anything Canadian is considered “foreign” in this context. Some of these additional filings may include:
Foreign bank accounts – FinCEN 114, “Report of Foreign Bank and Financial Accounts”
Foreign corporations – Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”
Foreign partnerships – Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships
Foreign trusts – Form 3520, “Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts”
Foreign trusts – Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner”
Foreign mutual funds – Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”
If an individual becomes a tax resident and is unable to claim an exception or use the Treaty, then he will be required to report his worldwide income to the U.S. and comply with all foreign reporting required of U.S. persons. While foreign tax credits may offset some or all of the U.S. tax payable, it can still be a timely and expensive process.
It’s important to keep in mind that the Substantial Presence Test, the exceptions, and the Treaty override are all related to U.S. federal tax residency rules. Each individual state has its own residency rules as well. These should be reviewed as well.
Cadesky U.S. Tax can analyze your unique situation and help you keep onside with the U.S. tax residency rules. Please contact us for an appointment to discuss your situation.