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U.S. Tax Update

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Originally published in Canadian Tax Highlights, Volume 19, Number 2, February 2011. Reprinted with permission.

Tax cuts extended. On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which extends tax cuts set to expire at the end of 2010 and creates other tax benefits. Marginal income tax rates are maintained (the highest individual rate is 35 percent); capital gains and qualified dividends continue to be taxed at 15 percent; and the 0 percent rate on capital gains for individuals in the 10 and 15 percent brackets is preserved. Both the marginal tax rates and the capital gains/qualified dividends rates are extended until December 31, 2012.

Other significant individual tax benefits include a payroll tax cut of 2 percent in 2011 for employees and self-employed individuals; patching (indexing for inflation) the alternative minimum tax for 2010 and 2011; extension of the child tax credit and the dependant care credit through 2012; extension of the election to take an itemized deduction for state and local general sales taxes rather than for state and local income taxes for 2011; and extension of the deduction for mortgage premiums as qualified residence interest in 2011. Provisions for businesses include the retroactive reinstatement and extension for 2011 of the research credit, the new markets tax credit, the work opportunity tax credit, and other tax breaks.

2011 VDP. On February 8, 2011, IRS Commissioner Douglas Shulman announced that the IRS is implementing a second offshore voluntary disclosure program: the 2011 offshore voluntary disclosure initiative (OVDI). OVDI reduces penalties for a taxpayer who failed to report foreign (non-US) financial accounts and assets on an FBAR (IRS form TD F 90-22.1, “Report of Foreign Bank and Financial Accounts”) and income therefrom on his or her US income tax returns. The 2011 OVDI responds to the success of a similar 2009 program and to the thousands of voluntary disclosures received after that program ended on October 15, 2009.

The 2011 OVDI has an eight-year lookback from 2003 through 2010. Penalties consist of (1) a one-time 25 percent penalty on the highest aggregate annual balance in the unreported accounts in the lookback period (20 percent under the 2009 program); and (2) a 20 percent accuracy-related penalty or delinquency penalties on US income tax that should have been paid on any unreported income from non-US accounts in the period. A taxpayer whose aggregate offshore accounts or assets did not exceed $75,000 in any relevant calendar year qualifies for a 12.5 percent penalty rate on that balance. The IRS indicates that eligible taxpayers who came forward under the 2009 program can retroactively claim the 12.5 percent rate. A 5 percent rate may also apply in limited circumstances, apparently including situations in which certain foreign residents were unaware of their US citizenship. A taxpayer with an interest in a passive foreign investment company, such as a foreign mutual fund, may use a modified mark-to- market election to determine income therefrom.

The 2011 OVDI is available to those taxpayers who come forward after October 15, 2009 and by August 31, 2011. By the latter deadline, a participating taxpayer must submit all original and amended tax returns and information returns (including FBARs) and must also pay back taxes, interest, the applicable one-time penalty on the highest aggregate annual balance in the unreported accounts, and the 20 percent accuracy-related penalty or delinquency penalties.

The 2011 OVDI forgoes other potential penalties, such as those for civil fraud (75 percent of unpaid tax); for failure to file various information returns (such as form 5471); and for willful failure to file the FBAR (the greater of $100,000 and 50 percent of the foreign account balance). All of these penalties apply annually. Participants who come forward by August 31, 2011 also mitigate the risk of criminal prosecution.

There are likely to be unanswered questions and issues about the new program, but it is not yet known whether the IRS will issue additional guidance. US citizens residing in Canada should be aware of the 2011 OVDI if they have not annually reported non-US (including Canadian) financial accounts or assets on an FBAR or have failed to report the income therefrom on their US income tax returns.

James M. Bandoblu Jr.
Hodgson Russ LLP, Buffalo