American expats in Canada renouncing U.S. citizenship to avoid punitive taxation

Aviva West
Daily Brew

[International Business Times]

For American citizens living and working in Canada, these are stressful times. As tax season heats up, a growing number of American expats will begin the long, drawn-out process of renouncing their U.S. citizenship in a bid to avoid costly, complicated and onerous tax compliance obligations.

“In the last 24 months we’ve seen a tremendous increase in the number of people who are interested in or want to renounce their citizenship,” says Roy Berg, a lawyer and director of U.S. tax law at Moodys Gartner in Calgary.

In 2014, the U.S. Treasury Department reported that 2,999 people took the Oath of Renunciation. In 2015, that number jumped 43 per cent to 4,279.

Americans have always been expected to file U.S. taxes as well as taxes in their country of residence. The United States and Eritrea are currently the only countries that impose citizenship-based taxation, and up until recently, there was no real penalty for Americans who failed to file taxes in the U.S.

That all changed with the introduction of the Foreign Account Tax Compliance Act (FATCA) enacted by Congress in 2010.

Enforced in Canada through an intergovernmental agreement with the U.S., FATCA compels Canadian financial institutions to share information with the IRS on their customers who hold U.S. citizenship. In January of last year, Canadian banks sent out the first wave of letters to those with American citizenship requesting proof of loss of nationality. Last September, Canadian banks began sending information on U.S. account holders to the IRS.

“The reason we’ve seen such a big spike is because the individuals who may have been on the fence as to whether they get caught up with their filing obligations or whether they give up their citizenship, or if they just ignore it, they started to get notices from their financial institutions saying, ‘You either give us a certificate of loss of nationality to prove that you’re not a U.S. citizen, or we have to turn you in.’”

According to Berg, American citizens who want to renounce must become compliant with tax and filing obligations for a five-year period or else they are considered “covered expatriates” and subject to an exit tax of 40 per cent. In addition, Americans who have a U.S. tax liability of $160,000 over a five-year period, or who have a net worth of over US $2 million or who cannot certify five years of tax compliance are all also subject to the exit tax. Covered expatriates are officially barred from entering the U.S.

Renunciation involves becoming compliant with five years worth of tax obligations and swearing an Oath of Renunciation in front of officials at a U.S. embassy or consulate.

Tim, an American living in Ontario who asked that his full name not be used, is also concerned about FATCA and what it means for his future. Born and raised in the U.S., he immigrated to Canada after marrying a Canadian woman and has a young dual citizen son. He is in the process of becoming a Canadian citizen (a requirement for renunciation) and says he is still not sure what he will do regarding his U.S. status.

“I am amazed that the U.S. still wants me to file and I worry for my son,” he says. “He may never live in the States but will have to file and pay if he makes enough. It also gets tricky because tax-free savings accounts in Canada for instance are not tax-free in the U.S., and there a million other nuances that only great accountants know. I do my Canadian taxes myself because it is a pretty straightforward process, but my U.S. [taxes] are a mess and I struggle with whether it’s worth it.”

“I don’t know whether I will renounce my citizenship when I become a [Canadian] citizen,” Tim adds. “I might encourage [my son] to do so when he gets older so he’s not burdened with this.”

Toronto citizenship lawyer John Richardson has been working with clients seeking to renounce their citizenship for the past four years.

“Anybody who understands the issue wants out,” he says.

“What I’m finding is that the people who are tax compliant are the ones to want to exit because they realize, for example, they can’t invest in normal things like mutual funds without problems. How the hell are they supposed to live?”

‘Too punitive to maintain’

He adds that while he doesn’t think tax-filing obligations are what are driving the trend in renunciations, he does think it’s what they represent.

“I think American citizenship has value. That’s not the issue here. The problem is it’s gotten so difficult and punitive to maintain, the people are feeling they can’t do it anymore.”

“I see these rules as a form of terrorism against Americans abroad,” he adds. “It’s more than the tax, it’s the threat of penalties for not disclosing information about the bank account down the street.”

Kevyn Nightingale, a U.S. tax specialist at MNP LLP in Toronto, says he began to notice an upsurge in interest in renunciation in 2009 as the IRS ramped up efforts to find U.S. people and alert them to the need to comply with tax law. He believes that ordinary expat Americans have been collateral damage in a U.S. push to access untaxed money held by domestic Americans in offshore bank accounts.

“People who live in this country are already paying quite significant income taxes, so even if they file their U.S. taxes correctly, they’re likely to pay zero or very little U.S. tax,” he explains. “That means from a revenue perspective, if you’re the IRS, you’re not terribly interested in those people. But yet those are the people who end up being swept up in this drive to generate money from offshore accounts.”

He adds that the IRS is fond of saying its disclosure efforts have generated $6 billion in tax revenue.

“The U.S. budget is $3 trillion a year. It’s a rounding error on a rounding error. The people they are generating the money from, by and large, live inside the United States. They are conflating taxation of citizens abroad with Americans who are hiding money offshore.”

Nightingale says it can cost up to $3,000 a year in fees to simply prepare and file U.S. taxes, even if no money is actually owed.

For those hoping to become compliant through the United States’ voluntary disclosure process, costs can range from $5,000-10,000 for uncomplicated cases. Voluntary disclosure allows U.S. citizens to retain their citizenship by filing three years worth of taxes as well as six years worth of foreign bank financial reports. Those looking to renounce could be on the hook for as much as $15,000-20,000 in filing and preparation fees.

And as wait times for renunciation appointments increase at embassies and consulates in Canada, that could mean another year of taxes owed.

“The wait times at each post in Canada vary depending on demand, time of year, and other factors,” according to an embassy spokesperson.

“At the U.S. embassy and consulates in Canada, the increased volume of loss of nationality cases has resulted in wait times ranging from 1.5 to 10 months.”

“Due to the serious implications the decision to renounce U.S. citizenship carries, the process is intended to be deliberative in order to permit individuals to reflect upon their decision before returning to execute the Oath of Renunciation.”

With the incredibly murky nature of U.S. citizenship and tax laws, there is money to be made by those representing the thousands of Americans looking to relinquish their citizenship. Despite this, FATCA and its associated regulations seem to be universally disliked by those who know it best.

“There is an idea going around that people in the tax compliance industry are in favour of this system because it generates fees,” says Nightingale. 

“No question it generates fees. I have made a good living at it since 1988, but almost without exception, the people who work in the area that I work in would all be extremely happy if the U.S. did away with citizenship-based taxation because we all believe it’s stupid.”