For us to get out, we'd have to renounce. To the tune of $2350 USD each.
The consular official was likely correct that your act of becoming Canadian was not an expatriating act because since you continued to believe you were a US citizen (as evidenced by filing US taxes), it was not your intent to give up US citizenship.
However, it does not follow that you need to pay for the renunciation process to relinquish citizenship. As I said, that is not the case.
To quote my previous post:
In particular, 8 USC § 1481(a)(2) provides that a US citizen gives up US nationality by voluntarily (and with the intention of relinquishing US nationality) taking an oath or other formal declaration of allegiance to a foreign state after turning 18. This is something that your wife can do at any time to relinquish US citizen for free (for nationality purposes).
Somewhat bizarrely, the tax laws actually contains a slightly different relinquishment regime. For nationality purposes, your wife would give up US citizenship simply by voluntarily performing an expatriating act while having the relevant intention. No notification to anyone is required. However, for tax purposes (pursuant to 26 USC § 877A(g)(4)), your wife will not be treated as giving US citizenship until she furnishes to the Department of State a "a signed statement of voluntary relinquishment of United States nationality confirming the performance of an act of expatriation". The law apparently does not require this to be in any particular form. Alternatively, instead of sending a statement, your wife could file Form DS-4079 (Request for Determination of Possible Loss of United States Citizenship) to obtain a certificate of loss of US nationality, the issuance of which also establishes relinquishment for tax purposes pursuant to 26 USC § 877A(g)(4)(C). The Form looks like more work than simply sending a statement and, moreover, using the Form allows the Department of State to disagree with you and not issue a certificate; whereas their opinion on your wife's statement would be irrelevant because the act of furnishing the statement itself establishes loss of nationality for tax purposes (no response is required).
Right now, at this very second, you can cease to be a US national for nationality purposes if you, voluntarily and with the intent of relinquishing US citizenship, make a formal declaration of allegiance to Canada. This does not need to be in any particular form. The purely private act of making that declaration with the correct intention causes you to no longer be a US national.
However, for tax purposes, a bit more is required: you also need to write to the Department of State and send them "a signed statement of voluntary relinquishment of United States nationality confirming the performance of an act of expatriation [namely, the voluntary formal declaration of allegiance to Canada, with intention of relinquishing US nationality]". After doing that, you also need to file the paperwork with the IRS as I mentioned in my post.
As for immigration law, it is correct that, pursuant to 8 USC § 1182(a)(10)(E), a former citizen who is "determined by the Attorney General to have renounced United States citizenship for the purpose of avoiding taxation by the United States" is inadmissible.
The good news is that this provision only applies to
renunciation.
In US nationality law, "relinquishment" is the general term for giving up US nationality. The term "renunciation" is a specific way to relinquish nationality by appearing before a US consular officer and paying the $2350 fee.
In order words, if you relinquish through an expatriating act other than the consular process, not only do you avoid the fee, but the inadmissibility provision does not apply to you, and you remain admissible to the US (unless you are inadmissible on other grounds).
As for government officials asking you questions, as a general rule, government officials can ask you whatever they want. That does not mean you have to answer, unless required by law.
