Cross-Border Penalty Coordination: Owing Penalties in Both Countries

Cross-border filers can owe penalties to both the IRS and the CRA at the same time, often for the same underlying failure. If you filed your Canadian return late, you owe the CRA a late-filing penalty. If you also filed your US return late (which frequently happens for the same reason), you owe the IRS a separate late-filing penalty. If you missed the T1135, you owe the CRA an information return penalty. If you also missed the FBAR and Form 8938, you owe the IRS separate penalties for each. The penalties do not offset each other, the treaty does not prevent double penalties, and there is no credit for penalties paid to one country against penalties owed to the other. Each country’s penalty stands on its own. But the resolution strategy can be coordinated to minimize the total exposure.

Why are penalties not creditable?

Foreign tax credits under IRC 901 (US) and ITA 126 (Canada) apply to income taxes, not to penalties. A penalty is not an income tax. The US foreign tax credit is available for “the amount of any income, war profits, and excess profits taxes paid or accrued” to a foreign country. A Canadian late-filing penalty or a Canadian information return penalty is none of those things. The same applies in reverse: the Canadian foreign tax credit is for foreign “income or profits tax,” which does not include an IRS penalty.

The treaty does not change this. Article XXIV (elimination of double taxation) provides credits for taxes, not penalties. Article XXVI (Mutual Agreement Procedure) addresses “taxation not in accordance with the provisions of this Convention,” which covers tax, not penalties. There is no treaty provision that prevents both countries from assessing penalties on the same conduct.

The practical result: if the CRA assesses a $2,500 T1135 penalty and the IRS assesses a $10,000 FBAR penalty for the same unfiled foreign account information, you owe both. There is no mechanism to reduce one by the amount of the other.

What are the common dual-penalty scenarios?

Late filing in both countries. A cross-border filer who misses both the Canadian and US filing deadlines owes the CRA’s late-filing penalty (5% of the balance owing plus 1% per month, up to 12 months, under ITA 162(1)) and the IRS’s failure-to-file penalty (5% per month up to 25% under IRC 6651(a)(1)). These are separate penalties in separate countries.

Information return penalties in both countries. Missing the T1135 (CRA penalty: $25/day up to $2,500/year) and the FBAR (IRS penalty: up to $16,987 per account per year for non-willful violations). Missing Form 3520 for a TFSA (IRS penalty: 35% of the distribution or 5% of the trust value) and failing to report the TFSA income on the Canadian return (no direct CRA penalty for this, but the T1135 penalty may apply if the TFSA crosses the $100,000 threshold when combined with other foreign property).

Accuracy penalties in both countries. If both countries reassess the same income (the CRA adds unreported income and the IRS adjusts the foreign tax credit), both may assess accuracy penalties: the CRA’s gross negligence penalty (50% of the tax on the understatement under ITA 163(2)) and the IRS’s accuracy-related penalty (20% of the underpayment under IRC 6662).

Voluntary disclosure penalties. If you come into compliance through both the CRA VDP and the IRS streamlined procedures, the CRA may reduce some penalties (Track 1 = full relief on gross negligence penalties, partial relief on other penalties; Track 2 = no relief on gross negligence penalties) while the IRS streamlined foreign offshore procedures impose no penalty (SFOP) or a 5% miscellaneous offshore penalty (SDOP). The net penalty exposure depends on which programs you qualify for and the sequencing.

How do I coordinate the abatement requests?

The abatement mechanisms are different in each country, but the underlying facts are the same. The coordination strategy:

Step 1: Identify all penalties in both countries. List every penalty assessed or likely to be assessed in both countries, the statute or section it falls under, the amount, and the available relief mechanism.

Step 2: Resolve the country with the stronger relief first. If the IRS has first-time abatement available (clean three-year history), resolve the US side first because FTA is nearly automatic. If the CRA has a strong taxpayer relief case (reliance on a professional, income was reported, prompt correction), resolve the Canadian side first.

Step 3: Use the first country’s outcome to support the second. If the IRS grants penalty relief, cite that outcome in the CRA request: “The IRS reviewed the same facts and determined that reasonable cause existed.” The CRA is not bound by the IRS’s determination, but it is persuasive evidence. The same applies in reverse: if the CRA waives penalties under taxpayer relief, cite that in the IRS reasonable cause letter.

Step 4: Address each country’s specific requirements. The IRS reasonable cause standard (ordinary business care and prudence, IRM 20.1.1.3.2) and the CRA taxpayer relief standard (extraordinary circumstances, section 220(3.1)) are not identical. Tailor each request to the specific standard, even if the underlying facts are the same.

Step 5: If both countries assess accuracy penalties on the same income, consider Competent Authority. If the CRA assesses a gross negligence penalty on unreported income and the IRS also assesses an accuracy penalty on the same income (because the foreign tax credit was wrong), the Competent Authority process may help resolve the underlying double taxation, which may also affect the penalty calculations.

What if one country waives and the other does not?

This is the common outcome. The relief standards are different, and one country may grant relief while the other denies it. There is no mechanism to force the second country to match the first country’s decision.

If the CRA waives the T1135 penalty but the IRS does not waive the FBAR penalty, you owe the FBAR penalty. If the IRS grants FTA on the late-filing penalty but the CRA denies the taxpayer relief request, you owe the Canadian late-filing penalty.

After a denial, each country has its own appeal process: the CRA allows judicial review of a denied taxpayer relief request in Federal Court; the IRS allows appeal to IRS Appeals and then to Tax Court or district court depending on the penalty type.

What should I do next?

List all penalties assessed or expected in both countries. Identify the available relief mechanism for each penalty in each country. Determine the sequencing: which country to resolve first based on the strength of the relief argument. File the relief requests with consistent facts. If one country denies relief, appeal through that country’s process. If double taxation on the underlying income persists after both audits are resolved, file a Competent Authority request.

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.