Mr. Dewees gets Smacked! U.S. District Court Upholds Multiple $10,000 Penalties (US$120,000 – NO Forms 5471) for USC Residing in Canada

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United States Citizens (“USCs”) and lawful permanent residents (“LPRs”) residing overseas should read the story of Mr. Dewees to learn what could happen if they go into the offshore voluntary disclosure program (“OVDP”); when he appears to have been a “good faith” taxpayer.  The IRS issued a press release in March 2018 – IRS to end offshore voluntary disclosure program; Taxpayers with undisclosed foreign assets urged to come forward now  The IRS explained that it will close the program next montNorth America Maph on September 28, 2018.  Take the story of the Dewees into consideration before rushing into the OVDP.

This is not a new case, as the U.S. District Court for the District of Columbia issued its opinion a year ago – Dewees v. United States, 2017 U.S. Dist. LEXIS 124989 (D.C. D.C. 2017).  However, it is an important case if anyone is confused about whether they should go into the OVDP.  See the story of the Dewees.

Mr. Dewees resided in Canada and did file U.S. income tax returns, but not all information returns. See a related previous post –  Why Most U.S. Citizens Residing Overseas Haven’t a Clue about the Labyrinth of U.S. Taxation and Bank and Financial Reporting of Worldwide Income and Assets

He also did not initially pay information reporting penalties assessed by the IRS regarding his Canadian company.   He resided in Canada where is business and company was located.  The Court noted that he “. . . voluntarily disclosed [to the IRS] his failure to file the required informational returns . . . ”  The Dewees were “rewarded” by their good faith efforts by the IRS which then turned around and ” . . .  assessed a statutory penalty of $120,000, $10,000 for each year of non-compliance . . . “

The Canadian revenue authority would not refund his Canadian tax refund until the IRS penalty was paid in full.  He eventually paid $120,000 of information penalties and brought a suit for refund in U.S. District Court.

The U.S. District Court first explained the obligations of USCs residing overseas with –

(i) controlling interests in foreign corporations (i.e., filing obligations under IRC IRS Form 5471 - page 1Section 6038 to file IRS Form 5471) – see an earlier related post Many Canadians have expressed frustration with U.S. tax policy of worldwide taxation of U.S. citizens., and

(ii) interests in foreign financial accounts (i.e., filing obligations of foreign bank account reports under Title 31) see a previous post, Nuances of FBAR – Foreign Bank Account Report Filings – for USCs and LPRs living outside the U.S.

The Court then dismissed the suit for refund on the grounds that Mr. Dewees failed to state a viable claim and the Court therefore lacked jurisdiction to hear his claims (which were “excessive fines”, “equal protection” and “due process” claims).

Here, the USC residing in Canada was apparently well intended, since the District Court said that Mr. “Dewees learned that he had failed to comply with these requirements . . . ” In another part of the opinion, the Court uses the word “neglected” to file information returns for over a decade.

Learned” and “neglected” certainly does not sound intentional, which is probably why the IRS did not attempt to pursue Title 31 willfulness FBAR penalties.

The USC entered the OVDP on the advice of a tax specialist and then withdrew after the IRS was proposing to assess an “OVDP in-lieu of penalty” of US$185,862.  Chart - OVDI Article Martin Ferreira

The IRS ultimately did not pursue any FBAR penalties in this case, not even the annual $10,000 per year penalty for failure to file the FBAR form.

Had Mr. Dewees lived in any other country (other than Canada) he probably would not have had the local taxman (i.e., the Canada Revenue Agency) step in to indirectly help the IRS collect the penalty amounts assessed.  See an earlier post,  U.S. Enforcement/Collection of Taxes Overseas against USCs and LPRs – Legal Limitations

The U.S.-Canada income tax treaty has a special “assistance in collection” provision, which provides in part as follows –

Article XXVI A
Assistance in Collection
1. The Contracting States  [referring to the U.S. and Canada] undertake to lend assistance to each other in the collection of taxes
referred to in paragraph 9, together with interest, costs, additions to such taxes and civil penalties, referred to in this Article as a “revenue claim”. 

I explained in an earlier post, how the “Revenue Rule” was a common law concept that generally prohibited the U.S. government from assisting in the collection of taxes of Passport Inside Back Page - USC Taxation Referenceanother country.  Hence, the U.S. Treasury renegotiated the treaties with five countries (including Canada) that now have a specific treaty provision such as XXVI A above:

As a result of these cases and the Revenue Rule, the U.S. and Canada modified their income tax treaty to (at least in theory) allow for the international enforcement of taxes.  The U.S. now has five income treaties with “mutual assistance” provisions: Canada, Sweden, France, Denmark, and the Netherlands (with a clause in the newly negotiated, but yet to go into force, Swiss treaty).

In the Dewees case, we learned that the assistance in collection provision is not merely a theoretical tool that can be used in collecting taxes.  The actions of both the Canadian (CRA) and U.S. governments (IRS and District Court Judge), made the provision effective.   The US$120,000 penalty, that has nothing to do with any U.S. taxes, was collected by the IRS.

Questions to ponder in this case:

  1. Would the USC have been better off, by getting proper advice as to how to file on a going forward basis?
  2. Why did the USC ever go into the OVDP program in the first place under these facts?
  3. Did the USC know about the “streamlined” filing procedures of the IRS for U.S. Taxpayers Residing Outside the United States?
    • In this case, the program did not exist at the time the taxpayers went into the OVDP in 2009.
  4. Why did Dewees not simply consider (assuming he had good faith facts) filing amended tax returns to include late filed IRS Form 5471 forms?
  5. Why did the IRS aggressively pursue these $120,000 in information penalties (presumably because he opted out of the OVDP program and they like to make examples out of those taxpayers that leave the program)?
  6. Would and will the IRS assess more $10,000 per year penalties for additional companies for a good faith failure to file IRS Form 5471 forms?  In other words, what if the Dewees had four Canadian companies, would the IRS have assessed US$480,000 (US$10,000 per year X 4 – per company – X 12 – the number of years the form was not filed)?
  7. Will the IRS have success with any other country that does not have a similar tax treaty provision on the collection of taxes as the unique U.S.-Canada provision?
    • What about Sweden, France, Denmark, and the Netherlands with specific provisions in the U.S. income tax treaties?  See a discussion of the U.S. District Court case in Georgia involving a Danish citizen, Torben Dileng v. Commissioner as discussed by Keith Fogg in the Procedurally Taxing Blog
  8. Will the aggressive actions of the IRS in this Dewee case to collect penalties backfire?  Will USCs residing overseas be less likely to go into specific IRS programs for fear of being smacked down to the tune of US$120,000 (plus legal fees and costs) for merely neglecting to file information returns when no U.S. taxes are even owing?


2 thoughts on “Mr. Dewees gets Smacked! U.S. District Court Upholds Multiple $10,000 Penalties (US$120,000 – NO Forms 5471) for USC Residing in Canada

    Patricia Moon said:
    August 13, 2018 at 5:01 am

    Mr. Dewees’ story continues to horrify. With regard to Questions 1, 2, & 4, it would seem likely that his tax lawyer failed to take proper action/give appropriate advice. I don’t recall hearing ANY stories of any advisers telling people to simply file on a forward going basis. In fact, expats discussed this publicly a great deal and the reaction of the tax compliance community was that this was leaving oneself open to huge penalty possibilities (as if OVDP were not the same thing for minnows…..). IOW, there were NO other options but to enter the program. There is no way I would have entered it (fortunately FS 2011-13 came along). Question 5 could be true (though that sounds a bit like scaremongering). Another possibly more likely reason was that IRS knew they would not be able to collect FBAR penalties, which is clearly in the US-Canada Tax Treaty. It is odd that CRA took the position they did as 5471 is also an information form/ not specifically about a tax. It is not clear if CRA aided the US simply because Mr. Dewees was not a Canadian. All of the countries with the Mutual Collection Agreements specify that they will not collect if the taxpayer was a citizen of that country at the time the tax was incurred. Since Dewees was not a citizen, he was not protected. It appears that Torben Dileng was not a US citizen so he was not protected. This is a very important distinction to point out/be aware of. If Dewees had had 4 companies is there any reason to doubt the IRS would not have assessed all of them the same way? There is no doubt that the hideously punitive attitude of the IRS from day one, particularly from Douglas Shulman, prevented many from coming into compliance and in fact, fueled the rise in renunciations. The number one reason I renounced was it was clear the U.S. government could not be trusted (FAQ35). It is a given that the Transition Tax/GILTI will prompt people close to retirement to renounce without becoming compliant. They simply will not be able to afford it. RO is still engaged in getting TTFI added to legislation before the midterms. People are still waiting to see if that happens before they are forced to renounce. It is clear that the majority of US persons abroad have not chosen to come into compliance. This is a situation that simply does not get better……..

    Norman Diamond said:
    August 13, 2018 at 10:47 pm

    “5.Why did the IRS aggressively pursue these $120,000 in information penalties”

    Because the IRS hates honest people. US courts do too. Non-compliance breaks US law, but compliance brings penalties.

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