Foreign Accounts, Offshore Assets, Ownership of Foreign Companies, Foreign Gifts and Inheritances, or Interests in a Foreign Trust?
It is a common misunderstanding that a person with U.S. citizenship or residency believes foreign accounts, foreign sources of income, and foreign assets do not need to be reported on their U.S. federal tax return. A failure to report such income to the IRS and other U.S. government agencies can result in substantial penalties. With increased enforcement in U.S. federal international tax reporting and compliance, many U.S. individuals are now becoming aware of reporting requirements.
A U.S. individual that owns or has signature authority over a foreign account may be required to disclose the account on the U.S. Foreign Bank Account Report (FBAR), which is filed with U.S. FinCEN. There is a $10,000 civil penalty per year for the non-willful failure to file the FBAR on time. Failure to report foreign account balances to FBAR can carry a penalty of up to $100,000 USD or 50% of the unreported foreign account balance for the intentional failure to file the FBAR. Furthermore, intentional or willful failure to file the FBAR can lead to criminal prosecution and imprisonment.
In addition to the FBAR, U.S. federal Form 8938 Statement of Specified Foreign Financial Assets also discloses ownership of foreign accounts. Form 8938 is required to be filed with a U.S. federal income tax return. Failure to file the form on time will result in a $10,000 USD penalty per year. Beginning for tax years ending on or after December 31, 2015, certain U.S. companies with foreign financial assets must file Form 8938. Previously, only U.S. individuals were required to file Form 8938. There are U.S. Treasury regulations, which now provide the rules regarding Form 8938 filing requirement for U.S. companies.
A U.S. individual may be required to file U.S. federal Form 5471, to report ownership of a foreign corporation, a Form 8865 to report ownership of a foreign partnership, or a Form 8858 to report ownership of a foreign disregarded entity. Failure to file any of these forms on time with a U.S. federal tax return carries a $10,000 USD penalty per year.
A U.S. individual may be required to file U.S. federal Form 3520, to report the receipt of a gift from a nonresident individual or an inheritance from a foreign estate. Failure to report a foreign gift or inheritance could carry a penalty up to 25% of the undisclosed amount.
A U.S. individual may be required to file U.S. federal Form 3520, to report a distribution from a foreign trust or Form 3520-A to report an interest as a U.S. grantor of a foreign grantor trust. Failing to file these forms could result in substantial penalties.
Amnesty programs provided by the IRS are available for U.S. individuals with prior year U.S. international tax reporting delinquencies. Under certain circumstances, the U.S. individual may be able to file the prior year U.S. international reporting forms without penalties.
To avoid penalties, consider working with a qualified U.S. international tax reporting and compliance expert who knows what options are available and can effectively prepare these forms for prior years as necessary. It is advisable to file prior year FBARS and Forms 5471, etc. before filing the current year tax return. Keep in mind that the current year tax return must still be filed on time to avoid penalties. Filing your current return can increase the chances of penalty abatement relief with respect to the prior year filing delinquencies.
Remember when international reporting disclosures required on U.S. Federal Form 1065 partnership tax returns were focused on foreign partner tax withholding? In 2017, partnerships that file U.S. federal partnership tax returns for the 2016 tax year using Form 1065, must make more extensive international tax reporting disclosures. Here are some items to pay close attention to on Form 1065.
These new disclosure requirements on U.S. federal Form 1065 partnership tax returns likely resulted from the IRS’s continuing efforts to increase compliance with U.S. international tax reporting requirements. With global expansion and increasing cross-border international activities, these reporting requirements are particularly important to discuss with a qualified U.S. international tax reporting and compliance expert. If your U.S. or foreign partnership files a U.S. federal Form 1065, these reporting requirements should be a top priority to avoid substantial penalties. Under some circumstances, it is possible for U.S. filers, including partnerships, to qualify for certain amnesty relief from penalties for prior year failure to file delinquencies. With proper guidance, a partnership can potentially qualify for certain IRS amnesty procedures that will allow late filing of Forms 5471 and FBARs, etc. without late filing penalties.
Historically, partnerships were required to disclose ownership of foreign corporations and partnerships on U.S. federal Form 1065, and ownership by foreign parties. These disclosures are still required on the 2016 U.S. federal Form 1065.
Avoid this common misunderstanding. U.S. corporate leaders may assume that their U.S. federal Form 1120 corporate income tax return does not need to be filed on time if the company has a loss for the year. If the U.S. corporation owns an interest in a foreign subsidiary corporation, this misunderstanding can cost a U.S. corporation with a net operating loss substantially in penalties.
The applicable penalties are assessed based on failure to file U.S. federal Form 5471 with the tax return on time. There is a $10,000 USD penalty per year, per foreign subsidiary corporation for failing to file the Form, which reports ownership of a foreign subsidiary corporation, on time.
U.S. federal corporate income tax penalties, such as late filing and late payment penalties are typically assessed on the unpaid tax due with the tax return. If the corporation has a net operating loss for the year and zero taxable income, then no tax is due with the tax return so certain penalties would not be assessed.
Late filing penalties are automatically assessed on any U.S. federal corporate income tax return that is filed after the due date with a Form 5471 attached. In some cases, a corporation may incur net operating losses for several years and stop filing U.S. federal corporate tax returns during that time. Resulting in a problem: how to resolve the prior year Form 5471 filing delinquencies when the corporation starts to earn a profit in subsequent years and starts filing tax returns again.
In addition to the prior year Form 5471 filing delinquencies, the U.S. corporation may have been required to file a prior year Foreign Bank Account Report (FBAR) to report foreign accounts owned by the foreign subsidiary corporation. Late FBAR filings can also lead to a minimum penalty of $10,000 USD per year.
It’s vital to speak to a qualified U.S. international tax reporting professional to resolve the prior year filing delinquencies. Form 5471 reporting and FBAR preparation often involve specialized skills in the area of U.S. international tax that many general tax practitioners may not have. A qualified U.S. international tax-reporting specialist can provide guidance on how to navigate certain IRS amnesty filing procedures including Form 5471 and FBAR penalty abatement.
With proper guidance, a corporation may qualify for certain IRS amnesty procedures that will allow late filing of Forms 5471 and FBARs, without any late filing charges. It is advisable for a corporation to catch-up with its prior year filings before filing its current year tax return, Form 5471, and FBAR. This approach will improve the corporation’s chances of qualifying for relief from the penalties.
A Section 338 election has the effect of recharacterizing a taxable stock acquisition as a deemed asset acquisition. The advantage to the buyer is the step up in the basis of the assets deemed acquired to the fair market value on the date of purchase. In the context of a cross-border acquisition, there are some advantages and disadvantages to making an I.R.C. Section 338(g) election when a U.S. buyer acquires stock of a foreign corporation.
The main possible disadvantage of a Section 338(g) election for a foreign target corporation is the effect of a provision referred to as I.R.C. Section 901(m). This provision effectively reduces foreign tax credits available to a U.S. corporate acquirer. The reduction occurs in order to account for increased foreign corporate taxes that are paid by the foreign target corporation. This happens because the stepped up basis in the foreign target’s assets from the Section 338(g) election may result in additional depreciation and amortization deductions which are allowable from the U.S. tax perspective but not for foreign tax purposes. Section 901(m) effectively disallows a foreign tax credit for foreign taxes paid on the foreign target’s income which otherwise would not be recognized for U.S. federal tax purposes.
Even with the impact of Section 901(m), the Section 338(g) election may prove to be more favorable in terms of the foreign target’s effective foreign tax rate as compared to not making the election. The Section 338(g) election may also provide other benefits, such as limiting the U.S. acquirer’s Subpart F income in the year of acquisition. The election results in a closing of the foreign target’s taxable year, which effectively eliminates the U.S. acquirer’s pre-acquisition Subpart F income. Other consequences of the election include a decrease in the foreign target’s earnings and profits by the depreciation and amortization deductions allowable for U.S. tax purposes. Subpart F income also could be decreased if those deductions are properly allocated and apportioned to such income based on U.S. federal tax principles.
It is important to quantify the impact of Section 901(m) and the differences in the foreign target’s effective foreign tax rate with and without a Section 338(g) election. Other possible disadvantages of a Section 338 election also should be considered for a U.S. seller of a foreign corporation.
Are you a U.S. taxpayer with foreign accounts or offshore assets? Have you reported all of the income from the foreign accounts or offshore assets on your U.S. federal tax return? Have you filed all required Foreign Bank Account Reports (FBARs) and other foreign reporting information returns, such as the Form 5471 to report ownership of a foreign corporation or the Form 8865 to report ownership of a foreign partnership? Are you in compliance with the FBAR filings and foreign reporting for prior years? Are you aware of the substantial penalty risk and exposure that could apply if you are not in compliance with FBAR filings and foreign reporting for prior years? The late filing penalty is $10,000 USD per form per year for the FBAR and certain foreign reporting information returns such as the Forms 5471 and 8865. The penalty for the willful failure to file the FBAR is the greater of $100,000 USD or 50% of the highest account balance or value per year.
The IRS currently has several amnesty programs available for U.S. taxpayers with unreported foreign accounts and offshore assets. The best available option typically depends on whether the U.S. taxpayer has unreported income from the foreign accounts or offshore assets in addition to delinquent FBARs or other foreign reporting information returns.
Delinquent FBAR Submission Procedures
The IRS will allow U.S. taxpayers to file delinquent FinCEN Forms 114 Report of Foreign Bank and Financial Accounts (FBARs) for prior years without imposing any penalties if all taxable income from the reportable foreign accounts was properly reported on the U.S. federal tax return. To qualify, the U.S. taxpayer cannot be under a current civil or criminal examination by the IRS. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquent FBARs prior to being submitted. The reason for filing the FBAR late should be included when the delinquent FBARs are filed. FBARs are not automatically subject to audit under these procedures but they may be subject to audit under the existing audit selection processes that are in place for tax and information returns.
Delinquent Information Return Submission Procedures
The IRS will allow U.S. taxpayers to file delinquent information returns without imposing the $10,000 late filing penalty for Forms 5471 and 8865, etc. if reasonable cause is demonstrated. To qualify, the U.S. taxpayer cannot be under a current civil or criminal examination by the IRS. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquent information returns prior to being submitted. The delinquent information returns should be filed with an amended U.S. federal tax return including a reasonable cause statement.
Streamlined Domestic/Foreign Offshore Filing Compliance Procedures
The IRS will allow U.S. individual taxpayers to file six years of delinquent FBARs and three years of amended U.S. federal tax returns with delinquent foreign reporting information returns attached. All of the applicable FBAR and information return late filing penalties and accuracy-related penalties will not be imposed unless the amended returns are selected for audit through the regular audit selection process and the IRS is able to detect fraud on the original U.S. federal tax return and/or the FBAR delinquency was willful. There is a 5% Streamlined Domestic Offshore filing penalty that is based on the highest year’s aggregate balance or value of unreported foreign financial assets as determined at the year end for each year. To qualify, the U.S. individual taxpayer must be able to certify under penalties of perjury that the delinquencies resulted from non-willful conduct. The U.S. individual taxpayer cannot be under a current IRS civil or criminal examination. This option is not available if the IRS has contacted the U.S. taxpayer regarding the delinquencies prior to filing the Streamlined disclosure.
Offshore Voluntary Disclosure Program (OVDP)
The IRS OVDP is designed for U.S. individual taxpayers with foreign reporting delinquencies that involve willful or intentional conduct. The OVDP penalty is 27.5% of the highest year’s aggregate balance or value of unreported foreign financial assets. If the U.S. government has identified the foreign financial institution where the unreported foreign accounts are maintained on a publicized list then the OVDP penalty is increased substantially. A significant advantage of the OVDP is that it protects U.S. individual taxpayers from criminal prosecution for willful FBAR delinquencies which otherwise could result in imprisonment.