10/01/2015 12:27 EDT | Updated 10/01/2016 05:12 EDT

FATCA Court Challenge Fails to Make a Dent

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Canadian banks have already begun sharing information with the IRS

As expected, the court challenge to the Foreign Account Tax Compliance Act (FATCA) by two Canadians failed to stop the flow of information between the Canada Revenue Agency (CRA) and Internal Revenue Service (IRS) happening in the last half of September. Lawyers for the Canadians argued that the agreement was an unlawful use of the tax treaty and a violation of the Charter of Rights and Freedom and was unconstitutional but a Federal Court judge disagreed.

FATCA is part of the new Intergovernmental Agreement (IGA) and is designed to help the IRS make sure no American citizens are shirking their tax obligations. Unlike the Canadian system, the U.S. tax code is based on residency and citizenship. So even if you don't live in the U.S., citizens usually are required to file a tax return with the IRS every year unless they renounce their citizenship. This includes accidental U.S. citizens that don't even realize they are. For example, if you were born on U.S. soil, you are considered a U.S. citizen even if you never lived in the country or you moved away as a small child.

For U.S. citizens living in Canada, they have been dragged into getting tax compliant in recent years because the U.S. government is looking for more revenue. Even though Canada has higher taxes and can hardly be seen as a tax haven, FATCA allows the IRS to step up their ability to track down U.S. citizens who have not been filing their taxes.

The federal court dismissed the attempt by two Canadians who are also U.S. citizens by saying the transfers of information from financial institutions was "legally authorized" and consistent with the existing U.S. Canada Tax Treaty arrangements. The judge did not provide relief to stop the information sharing that happened in September but did make his decision without prejudice so the two Canadians could pursue their claim further.

Even though I think the two Canadians had some strong arguments against FATCA, I doubt any further challenges to the legislation will be successful. The U.S. has imposed FATCA on all nations in their hunt to find citizens hiding assets in foreign accounts. Though the IRS may boost its revenue, the implications for the average U.S. citizen living abroad can be high.

It includes paperwork to report all your investments and accounts if you meet certain thresholds. Form 8938 reports certain foreign financial accounts and assets and is separate and distinct from the Report of Foreign Bank and Financial Accounts (FBAR) which is sent to the Treasury Department.

If you are a U.S. citizen living in Canada, time is running out to get compliant. If you want to renounce, you need to investigate your options. I have had clients that have scheduled appointments within weeks while others have had to go to a consulate outside of Canada. You may have some tax obligations before you hand over your U.S. citizenship to avoid the exit tax. There is a streamlined tax filing program that is still available to help with catching up. The U.S. tax code is complex so make sure you do your homework and understand the implications of your decisions.

If you are not sure if you are a U.S. citizen, there are some resources that can help you decide. You may be a U.S. citizen and not realize it. For example, some communities along the Canada-U.S. border share a hospital. If you were born in a U.S. hospital because it was the closest, you are a U.S. citizen even if you have lived your entire life in Canada. If you haven't properly turned in a green card, the IRS may also be expecting you to file.

The U.S. tax code is archaic. It was enacted in 1861 to prevent wealthy Americans from avoiding taxation during war time by fleeing the country. It is the only first world nation that taxes based on citizenship and residency. Though the system seems unfair to most, there is no desire in the U.S. to make drastic changes to the legislation. There may be tax cuts or credits added but for the IRS, the tax code allows it to look for new sources of revenue from all kinds of U.S. citizens.


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