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.
U.S. persons are required to file the FinCEN Form 114 Report of Foreign Bank and Financial Accounts (FBAR) to report a financial interest in or signature authority over foreign accounts. There is a $10,000 civil penalty for the non-willful failure to the file the FBAR. The penalty for the willful failure to file the FBAR is the greater of $100,000 or 50% of the balance in the foreign account at the time of the violation. Under the statutory authority for such penalties, the monetary penalty for the willful failure to file the FBAR applies for each year. Criminal penalties such as criminal prosecution and imprisonment also may apply for the willful failure to file the FBAR.
On May 13, 2015, the IRS issued Interim Guidance to IRS employees regarding the procedures for the administration of FBAR penalties. These procedures recognize that IRS examiners have the discretion to determine whether FBAR violations are willful. In most cases, with willful violations over multiple years, the total penalty amount for all years under examination will be limited to 50% of the highest aggregate balance of all unreported foreign accounts during the years under examination. The IRS guidance states the following example to demonstrate the calculation of the penalty.
IRS Example: Assume highest aggregate balances of $50,000, $100,000 and $200,000 for 2010, 2011 and 2012, respectively. The total penalty amount is $100,000 (50% of the $200,000 highest aggregate balance during the years under examination).
Based on these procedures, the 50% penalty is not applied to each year. However, the IRS examiner is allowed to recommend a penalty that is higher or lower than 50% of the highest aggregate balance of all unreported foreign accounts based on the facts and circumstances. The total penalty will not exceed 100% of the highest aggregate balance of all unreported foreign financial accounts during the years under examination.
For non-willful violations, the penalty will be determined for each year based on the aggregate balance of all unreported financial accounts subject to a $10,000 limitation per year. The IRS guidance states that the IRS examiner with certain internal approvals may assert a single $10,000 penalty for one year only in the case of non-willful FBAR violations as warranted under the facts and circumstances. The procedures note that some facts and circumstances may warrant asserting the $10,000 penalty for each year in the case of non-willful violations.
The publication of these IRS procedures may be particularly helpful to U.S. taxpayers in the Offshore Voluntary Disclosure Program who are considering whether to opt out of the OVDP penalty structure.
There is more to expatriating for U.S. federal tax purposes than relinquishing U.S. citizenship or a U.S. green card. It is necessary to comply with certain expatriation requirements in order to be cleared of any continuing U.S. federal tax reporting and payment obligations. The date of expatriation for U.S. federal tax purposes is the later of the date when the U.S. federal Form 8854 expatriation statement is first filed with the IRS or the date when the individual notifies the U.S. Department of State or the U.S. Department of Homeland Security of the expatriating act. A former U.S. individual continues to be subject to U.S. federal tax reporting requirements on their worldwide income until the Form 8854 is filed with the IRS and the relevant U.S. federal agency is notified of the expatriation.
U.S. federal expatriation tax rules apply to covered expatriates. The definition of a covered expatriate includes an individual whose net worth is $2 million or more U.S. dollars on the date of expatriation. A covered expatriate generally must file U.S. federal tax returns for the five years preceding the date of expatriation, including the Form 8854 expatriation statement, and pay any exit tax that is due. A dual citizen is subject to the expatriation rules, including the exit tax applicable to covered expatriates unless they file the Form 8854 and U.S. federal tax returns for the five years preceding the date of expatriation.
The IRS has certain amnesty programs available for U.S. taxpayers who are delinquent in reporting offshore assets, foreign accounts and any corresponding taxable income. Currently, the IRS Offshore Voluntary Disclosure Program (OVDP) is open to U.S. taxpayers with willful or intentional foreign reporting delinquencies. The IRS also has streamlined domestic and foreign offshore filing compliance procedures available for non-willful foreign reporting delinquencies.
Due to the enactment and implementation of the Foreign Account Tax Compliance Act (FATCA), there are many foreign financial institutions that are in the process of transferring information regarding their U.S. account holders either directly or indirectly to the U.S. government. Individuals who hold U.S. citizenship or U.S. green card status while living in foreign countries are now facing the serious consequences of not complying with U.S. foreign reporting requirements. The severe penalty risk and exposure have motivated an increasing number of individuals to voluntarily relinquish their U.S. citizenship or U.S. green cards. In some cases, such individuals may have expatriated for U.S. immigration purposes but their final U.S. federal tax reporting and payment obligations remain unfulfilled
The IRS has advised that it will allow a former U.S. citizen or U.S. green card holder to file their final five years of U.S. federal tax returns, including the Form 8854, and pay any exit tax due within the scope of either the OVDP or the streamlined filing compliance procedures. This option provides the opportunity for former U.S. citizens and U.S. lawful permanent residents to come into compliance with their U.S. federal tax filing obligations. The benefit is that the former U.S. individual will be able to travel to the United States on approved visa status for business or personal reasons without having to live in the shadows with the risk of criminal liability, being denied entry into the United States or having U.S. property or assets seized by the U.S. government.
What do I do if I had unreported offshore assets or foreign accounts for prior years?
What is the risk of not filing U.S. foreign reporting forms for prior years?
These are questions that U.S. international tax reporting and compliance specialists hear often these days. Surprisingly, the average tax return preparer does not have specialized capability to address the issues that arise when a U.S. taxpayer has offshore assets or foreign accounts. As a result, reliance on someone without this capability can lead to U.S. foreign reporting delinquencies.
Resolution of prior year delinquencies can be a very expensive and time consuming process for U.S. taxpayers, and the failure to address these delinquencies can result in substantial penalty exposure, including criminal prosecution for the intentional or willful failure to file. So, what options are available to a U.S. taxpayer who discovers that offshore assets or foreign accounts should have been reported but were not?
The answer depends on two critical factors:
If all of the taxable income was reported and the failure to file the U.S. foreign reporting forms was due to non-willful conduct, it is possible for the U.S. taxpayer to file the delinquent forms for the prior years and attach a reasonable cause statement. In this case, the IRS will not impose the civil penalties for late filing the FinCEN Form 114 (f/k/a Form TD F 90-22.1) Foreign Bank Account Report (FBAR) and Forms 8938, 5471, 8865, 3520, etc. This procedure actually replaces FAQs #17 and 18, which are no longer in effect.
If some or all of the taxable income was not reported and the failure to file the U.S. foreign reporting forms was due to non-willful conduct, there are two main options. First, the IRS has new Streamlined Offshore filing compliance procedures that allow the U.S. taxpayer to file three years of amended U.S. federal tax returns and six years of FBARs. The cost of the filing is a 5% Streamlined Offshore penalty plus additional tax and interest on the tax due with the amended tax returns. There is some risk of audit with a Streamlined Offshore filing but the IRS will not impose the civil failure to file penalties which are generally $10,000 USD per form per year unless there is evidence of fraud on the original federal tax returns. Second, there is the quiet disclosure option to which the IRS is seriously opposed and which invites audit risk for all open years including the risk of all applicable penalties being imposed. If the U.S. foreign reporting forms were required but they were not filed, the statute of limitations will still be open on the prior year’s federal tax return.
If some or all of the taxable income was not reported and the failure to file the U.S. foreign reporting forms was due to intentional or willful conduct, then the main option is the IRS Offshore Voluntary Disclosure Program (OVDP). In 2014, the IRS has extended the amnesty available under the protection of the OVDP. The cost of the filing is a 27.5% offshore penalty which, in some circumstances, could be higher if the U.S. taxpayer has foreign accounts with a foreign financial institution that has been identified on a specific list by the U.S. government. The main incentive offered with the OVDP is protection from criminal prosecution and possible imprisonment as a penalty for intentional or willful delinquencies.
On June 18, 2014, the IRS released updated “Frequently Asked Questions and Answers” about the terms of the Offshore Voluntary Disclosure Program (OVDP). The IRS currently has an amnesty program which allows U.S. taxpayers to file delinquent foreign reporting forms and pay tax on unreported income related to offshore accounts and assets. The IRS also has released information regarding the streamlined filing compliance procedures. The new streamlined procedures are designed for taxpayers with a non-willful failure to file U.S. foreign reporting forms, including the FinCEN Form 114 Foreign Bank Account Report.
The streamlined filing compliance procedures allow U.S. taxpayers to voluntarily come into compliance with their U.S. foreign reporting obligations by filing three years of amended federal tax returns and six years of Foreign Bank Account Reports (FBAR). The conditions to qualify for the streamlined procedures require the U.S. taxpayer to have filed federal tax returns for the prior three years and to certify that their foreign reporting delinquencies are based on non-willful conduct. The streamlined procedures offer a much better option for U.S. taxpayers whose delinquencies may not be appropriate for a full-fledged disclosure and rigorous penalty structure in the formal OVDP. U.S. taxpayers filing streamlined disclosures are required to pay a 5% offshore penalty that applies to the highest year’s aggregate balance or value of all unreported foreign accounts for the six year FBAR disclosure period. A streamlined filing is a viable option for U.S. taxpayers with unreported taxable income from foreign accounts and assets where the delinquencies are not intentional or willful.
A significant change to the OVDP is stated in new FAQ #7.2 which provides a 50% offshore penalty in the event that the foreign financial institution that holds the unreported foreign account is subject to a public disclosure. The increased penalty applies if the foreign financial institution is the subject of an investigation by the IRS or Department of Justice at the time that the taxpayer files the pre-clearance letter as the initial request to enter into the Offshore Voluntary Disclosure Program.
The IRS has outlined the improved options that are available for U.S. taxpayers who would like to voluntarily come into compliance with their prior year foreign reporting obligations. The options still include a voluntary filing of some types of delinquent foreign reporting forms without penalties where the U.S. taxpayer did not fail to report any taxable income from the foreign accounts or assets. Otherwise, where unreported taxable income is at issue, the IRS now provides procedures to distinguish between non-willful delinquencies and more serious offenses which involve willful, intentional or criminal conduct.
Please contact Aronson LLC international tax advisor Alison Dougherty at 301.231.6290 for more information.