This week the IRS released statistics on the number of returns it received in 2010 from US citizens with foreign trusts. The results are startling (you may find the report by clicking here). In all of Canada only 324 returns were filed that report ownership in a non-US trust, which likely means hundreds of thousands of US citizens residing in Canada had not filed the appropriate returns.  This is important for two reasons: first, the penalties for not filing are draconian (but waivable); and second, last week the US Government Accountability Office (GAO) issued a report that encouraged IRS to pursue those taxpayers who file late returns using a technique known as "quiet disclosure."

Background

The US State Department knows of more than 687,000 US citizens residing in Canada but most experts agree that the actual number is several times that number.  Many common Canadian retirement and savings vehicles are considered foreign trusts under US law. These vehicles include registered education savings plans (RESPs), tax free savings accounts (TFSAs), registered disability savings plans (RDSPs) and the like. Of course, typical Canadian trusts used for income splitting and succession are also considered foreign trusts and carry the same reporting obligations. Any US citizen who owns, contributes to, or receives a distribution from any of these trusts must report that interest on the appropriate form at the appropriate time or face severe penalties.

Penalties for Failure to File

Contributions to or distributions from any of these trusts triggers the obligation to file US tax form 3520 on or before the due date of the US income tax return (form 1040). The failure to file penalty for the form 3520 is a minimum of $10,000. In addition, an ownership interest in any of these vehicles triggers the obligation to file the US form 3520-A on or before March 15. The failure to file this form triggers a minimum $10,000 penalty. Both of these penalties can be waived if the taxpayer has "reasonable cause" for not having filed.

2010 Filing Statistics for Foreign Trusts

The following is a summary of the number of returns filed in respect of Canadian trusts and the income and financial information about the trusts:

Form

Number of Forms Filed

Average Income

Total Income

Average Net Assets

Total Net Assets

3520-A

324

$292,000

$94,869,000

$3,544,000

$1,148,000

Form

Number of Forms Filed

Average Value Transferred

Total Value Transferred

3520

49

$1,299,000

$63,685,000

Given the size of the asset values and the value transferred it appears that the trusts and owners that filed the forms were likely typical Canadian trusts, and not TFSA, RESP, RDSP, etc.

IRS hates "Quiet Disclosures"... and they really mean it!

When a taxpayer has missed a return or two there are basically three options to bring these filings current. First he may participate in one of the IRS's voluntary disclosure programs. Second, if he qualifies, he may participate in the new Streamlined Filing Procedure. Third, he may simply file the late returns or ignore the late returns and become compliant prospectively. This third option is commonly referred to as a "quiet disclosure." The IRS hates quiet disclosures.

On April 26, 2013 the GAO released a report (which you may find by clicking here) that encouraged the IRS to seek out off-shore filers who have circumvented the IRS's recent Voluntary Disclosure programs in favor of quite disclosure. The IRS agreed with the Report's recommendations and, as a result, those taxpayers who have or plan to engage in quiet disclosure likely face significantly increased risk of IRS examination.

Conclusion

The IRS's statistics on foreign trust filings for Canadians are shocking, but they are a bit out date. The figures reflect the 2010 compliance year, which was before the big media splash made by the 2011 Offshore Voluntary Disclosure Initiative and subsequent programs. Even so however, there are likely a lot of taxpayers who have yet to get caught up on their filings. There are options for bringing these filings current but, as the GAO report indicates, quiet disclosures should not be one of them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.