New U.S. law threatens tax delinquents with passport confiscation

Find out why U.S. citizens with “seriously delinquent” tax debt — including those who live in Canada — are in danger of losing their passports or being denied renewal under a controversial new law.

The U.S. Fixing America’s Surface Transportation (FAST) Act, which took effect in January 2016, deals primarily with funding surface routes and other transportation issues. But it’s the section on the revocation or denial of passports for U.S. citizens with tax debts over US$50,000 that’s making headlines.

“In my opinion, U.S. citizens living outside the U.S. will feel the impact of this the most,” says Everett Colby, FCPA, FCGA, a principal with Colby McGeachy Professional Corporation in Almonte, Ontario.

“Unfortunately, many U.S. citizens who live outside the U.S. refuse to file [U.S. tax returns]. This is partly because many have not lived in the U.S. for so long and feel no connection to the U.S. that the thought of having to pay taxes to a country from which they receive no support is discouraging. Many also do not feel the U.S. has any ability to enforce this requirement on them. In such situations, I think this may be the only tool the U.S. government has to force these people to meet their tax filing obligations.”

Teli Beris, a tax partner with Grant Thornton LLP in Toronto, believes this legislation seems reasonable “on the surface.” It requires due process on the part of the Internal Revenue Service (IRS), and there are mechanisms for the IRS to correct erroneous certification of an individual classified as having a serious tax debt, he says.

Kevyn Nightingale, CPA, CA, a tax partner with MNP LLP in Toronto, notes that it is relatively easy for an American living outside the U.S. to inadvertently rack up a huge debt to the IRS.

“It is a very common thing for an American who lives in Canada to come to me and say, ‘I didn’t know that I needed to file U.S. tax returns. I’ve just found out. Can you tell me what I need to do? And what is my exposure to the IRS right now?’” says Nightingale.

That person often ends up on the hook for hundreds of thousands of dollars in theoretical penalties even though — through a combination of their Canadian tax liability, the U.S. foreign tax credit and foreign-earned income exclusion — they rarely owe much, if any tax, he explains.

But American expatriates also need to file multiple annual forms with the IRS, even when they don’t owe tax, and each one they miss can subject them to a US$10,000 penalty. If they miss five years, that can be US$50,000 right there, notes Nightingale, who is critical of the law’s basic premise.

“I’m not a believer in connecting immigration status, or ability to travel, to tax. I think that it is an inappropriate tool to use against people who don’t pay their taxes,” he says.

Nightingale notes that the U.S. is the only country that applies comprehensive taxation to its citizens no matter where in the world they live. He believes that constitutes territorial overreach.

Beris notes that the question of overreach can be viewed from different perspectives.

“If you are a U.S. citizen, and you know what the law is, how is that overreach? If you are an accidental U.S. citizen — for example, you were born in the U.S. or one of your parents was a U.S. citizen, but you yourself have little ongoing connection with the U.S. — you might consider this to be territorial overreach,” he says.

There could be an inadvertent oversight, say, if somebody was born in the U.S. but has lived in Canada since they were a young child and they have never filed a U.S. tax return because they were unaware of the need to do so, acknowledges Colby. But over the past several years, there has been so much publicity about the need for U.S. expatriates to file as a result of, for example, the Foreign Account Tax Compliance Act that it would be difficult for somebody to claim they didn’t know.

“Even if they decide to relinquish their U.S. citizenship, they’re still going to be required to bring their taxes up to date. The U.S. government won’t let you relinquish until you do that,” he adds.

Nightingale says a rule like this can lead to significant audit errors, catching people who aren’t intended to be caught, and missing people who are supposed to be caught. “And this is a rule which is so disconnected from tax that errors are going to be huge,” he predicts.

The real target is likely a U.S. citizen and resident who regularly crosses the border to do business in other countries, such as Canada, whose livelihood could be seriously affected by having their passport confiscated if they remain negligent about paying their tax debt, says Nightingale.

“And that is probably fair game, although I don’t like this particular remedy,” he says.

This new law does not apply in situations where a tax debt is being disputed before the courts.