Important Message to all US Citizens Living in Canada
Many U.S. citizens living in Canada have invested in Canadian mutual funds. Most of these investors are not yet aware of the changes that have taken place that are exposing them to a great deal of taxation risks. Early in 2011, the U.S. Internal Revenue Service (IRS) clarified its views regarding Canadian mutual fund tax treatment. This review determined that a Canadian mutual fund will be classified as a corporation (instead of a trust) resulting in them being classified as Passive Foreign Investment Companies (PFICs).
The upside of this change is that any Canadian mutual funds that hold U.S. stocks no longer have to be reported as part of the gross estate for federal estate tax purposes upon death. The downsides however, are much greater. If a U.S. citizen receives income from a PFIC or recognizes any gain from the sale of a PFIC, this person is subject to a strict tax and reporting regime. With the lack of clear information that has been available thus far, many or most of these people affected have failed to meet their required U.S. tax and reporting obligations.
The IRS defines a PFIC as meeting either of the following two “tests”:
- 75% or more of its gross income for a taxable year is passive income; or
- 50% or more of assets held during the taxable year produce passive income or are held for the production of passive income
The reality is that the vast majority of Canadian mutual funds meet this definition.
Individuals holding an interest in PFICs must file numerous forms to both the IRS and U.S. Treasury department (for holdings over $10,000). These filings can create substantial accounting costs and both current and back taxes owing. For the third time since 2009, the IRS has opened its “Offshore Voluntary Disclosure Initiative” which allows people to come forward and disclose these holdings. According to IRS statements on this issue, non-wilful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
Starting in 2013, the IRS will require foreign financial institutions – banks, brokers, insurers, etc – to disclose all accounts held by U.S. citizens and green-card holders. Unfortunately there are many people that are not aware that they are being affected by these new rules – it’s estimated as many as 4,000 people with U.S. citizenship call the Okanagan home. They are ordinary citizens who pay their (higher) taxes here in Canada and are not aware they’ve done anything wrong.
An example shown on the IRS website shows a $1,000,000 investment earning $400,000 of interest and growth over an 8 year period. With voluntary disclosure, this investor would owe a total of $518,000 plus interest in taxes and penalties. By not disclosing, the penalties can be higher.
The good news in all of this is that there are fairly simple solutions to alleviate these problems. There are ways to shield your investments moving forward and keep you off IRS’ list next year (diligence in reporting and paying your taxes will still be necessary). If you are worried that this may affect you, feel free to send me an email for more information.