Foreign Account Disclosures Continue

As stated by the IRS, taxpayers who have reported and paid tax on all taxable income should not use the voluntary disclosure process. One may ask, shouldn’t this also be the case if the taxpayer failed to report a few dollars of interest income from a foreign account?

The penalties is $10,000, per return with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. In the mid-2000s, the IRS began aggressively pursuing foreign financial institutions for information concerning deposits held by those institutions on behalf of U.S. taxpayers. That effort has resulted in an unprecedented period of world-wide intra-governmental cooperation to identify unreported accounts and untaxed income.

The 2009 and 2011 voluntary disclosure programs were so successful because of the clearly-stated penalties and procedures for participating in the program. As FATCA becomes more of a reality, the voluntary disclosure calculation for individual taxpayers will become more intense as taxpayers will know that foreign banks have turned over information to the IRS about their accounts.

Pursuant to the Streamlined Program, they will be required only to file three years of tax returns that should be amended to include any and all unreported income and they will be required to file FBAR reports for the prior six years. There will be no penalty assessed on foreign bank deposits of those United States taxpayers who are residents abroad. The taxpayer will then be required to include in the amended tax returns any and all income not reported from the foreign bank accounts and pay the tax on such income. This tax will be subject to a 20% accuracy penalty and will, in addition, be charged with interest on unpaid taxes.

Beginning September 1, 2012, such taxpayers, provided they are deemed not to be compliance risks, may simply submit delinquent tax returns for the past three years, FBARs for the past six years, and certain other information without being subject to a civil or criminal penalty. This special dispensation may be particularly helpful for long-time residents of Canada or other nations who remain U.S. taxpayers.

The IRS states that it has identified, and will continue to identify, amended tax returns reporting increases in income, presumably with attention to those returns reporting increases in income from foreign sources. The IRS will closely review these returns to determine whether enforcement action is appropriate.

The streamlined procedures are designed to provide to taxpayers in such situations with a streamlined procedure for filing amended or delinquent returns and resolving their tax and penalty obligations. Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities ,etc.

Again, for individual taxpayers with foreign assets, the calculation will soon change since the US government will be receiving mountains of data relating to foreign assets owned by US citizens. The voluntary disclosure program provides only limited protection for a failure to file but will provide no relief for criminal exposure for other tax-related crimes, money laundering or other financial crimes. Non-willful taxpayers who are residents of the United States will be permitted to enter into the Streamlined Program for resident taxpayers.

It appears that the IRS is attempting to ferret out taxpayers making "quiet" disclosures where the IRS would prefer that they make their disclosure in a "noisier" fashion. The IRS routinely reviews amended returns but makes a point in the OVDP FAQs discussion of "quiet" disclosures that it is reviewing amended returns and could select any amended return for examination.

If a return is selected for examination, the 5% offshore penalty allowable under the streamlined program would not be available. The determination of which of the three relief programs offered by the IRS, is the appropriate program for the reader begins with the legal determination of whether the taxpayer is willful or non-willful. This is because in the event the taxpayer has been "willful" in their failure to file the appropriate bank reporting accounts, the taxpayer can be subject to a vast array of penalties. Even the willful taxpayer who is not in compliance to the IRS will be able to come into compliance with the United States laws and avoid the array of penalties that could very well devastate the fortunes of the "willful" taxpayer. The willful taxpayer has the chance to join one of the IRS programs.

It is unlikely that the IRS would recommend criminal prosecution of a taxpayer who innocently underreported a few dollars of income from a foreign account. FATCA was enacted in 2010 in an effort to help combat tax evasion by U.S. taxpayers holding accounts and financial assets outside of the United States. FATCA requires certain individual taxpayers with offshore accounts and assets exceeding a total value of $50,000 to report information about their offshore holdings to the Internal Revenue Service. These taxpayers are required to file IRS Form when they file their annual income tax return.

The Form 114 is an annual report that must be filed independent of a taxpayer’s tax return on or before June 30 of every year. The monetary penalty can lead to inequitable results for many taxpayers, especially given the market fluctuations since 2008. The IRS appears to recognize that the voluntary disclosure programs many not be appropriate for all taxpayers. For example, certain non-resident taxpayers as well as dual citizens may be allowed to correct their prior income and reporting delinquencies without entering a voluntary disclosure program.

The IRS is presently very serious about the reporting of foreign accounts and paying U.S. tax on the income earned on foreign assets. Recently, some prominent U.S. taxpayers have been caught and are facing jail time (you may have heard about billionaire H. Ty Warner, the creator of Beanies Babies). But it's not only the prominent and super-wealthy that need to be careful. For example, if your child studied abroad in Israel, you may have set up a bank account there for them and he/she will need to report any income held in Israel on their U.S. tax return.

It can be difficult navigating through the complexities of these programs. We will complete a factual and legal analysis of your particular situation to determine the best solution for your case. We keep the client involved in the process so they have a better understanding of the various options available to them. Offshore voluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing.

Under no circumstances will taxpayers be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes. For example, if a taxpayer had $100,000 in an offshore bank account in only one year and foreign income-producing real estate with a fair market value of $1,000,000, only the bank account would be subject to the FBAR penalty. Consequently, the maximum FBAR penalty would only be $100,000 (that is, the greater of $100,000 or 50% of the amount in the foreign account), which is substantially less than the offshore penalty of $302,500 (27.5% of $1,100,000). If this FBAR penalty, plus tax, interest and all other applicable penalties are less than what is due under this offshore initiative, the taxpayer will pay only the lesser amount.

The IRS voluntary disclosure programs represent a portion of a larger push by the US government to identify United States taxpayers with undeclared foreign income and assets. The Foreign Account Tax Compliance Act was enacted in 2010, and is aimed at foreign financial institutions and other financial intermediaries to prevent tax evasion by US citizens and residents through use of offshore accounts. The IRS allows almost all taxpayers with unreported accounts to come into compliance through various offshore voluntary disclosure and streamlined programs.

A person who is required to file Form 114 and fails to do so may be subject to a penalty not to exceed $10,000 per violation. A person who wilfully fails to file or report an account may be subject to a penalty equal to the greater of $100,000 or 50 percent of the balance in the account.

The Offshore Voluntary Disclosure Program allows taxpayers to come forward and disclose their foreign bank account to the IRS and pay a penalty and any back-taxes related to the account. The penalties that are due vary based on whether the underlying non-disclosure was willful or not. With the help of an experienced tax attorney, many OVDP participants are able to argue their way into the non-willful group, a classification that carries only penalty of 5% of the undisclosed account’s account balance. If the IRS subsequently considers the taxpayer’s conduct to be willful, the penalty jumps to 50% per year per account up to a maximum of 250% of the offshore account plus the possibility of criminal conviction.

Pursuant to this Streamline Program, they will be required only to file three years of tax returns that should be amended to include any and all unreported income and they will be required to file FBAR reports for the prior six years. There will be a five percent penalty assessed on foreign bank deposits of those United States taxpayers. Non-willful taxpayers who are nonresidents outside of the United States will be permitted to enter into the Streamlined Program for nonresident taxpayers.

This is very possible where the taxpayer used a tax professional and that asked about the existence of foreign accounts and the taxpayer hid the existence from the tax advisor. In general, voluntary disclosure minimizes the risk of IRS criminal prosecution.

But it’s not only the prominent and super-wealthy that need to be careful. If you are married and file a separate income tax return from your spouse, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year. If you are married and file a separate income tax return from your spouse, you satisfy the reporting threshold only if the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000. Unfortunately, the IRS takes the same strict position in the OVDP with persons evading millions as it does with persons who have not reported very small amounts in income.

The Bank Secrecy Act and the Foreign Account Tax Compliance Act require both foreign financial institutions and U.S. taxpayers to disclose the non-U.S. Compliance failures can result in both civil and criminal penalties and interest charges. The IRS reports that its programs have gathered approximately $11 billion in delinquent tax, penalties, and interest, and more than 1,500 indictments in recent years. Our FBAR and FATCA compliance team understands the complex challenges you face with foreign asset reporting regulations, the IRS voluntary disclosure program, and the disclosure and withholding requirements imposed on foreign financial institutions. If you are one of the many U.S. residents who own overseas assets and were not aware of the disclosure requirements for these accounts, you should consider disclosing your offshore assets and becoming tax compliant without delay.

New information-sharing agreements between the United States, foreign governments, and foreign financial institutions are closing the door on bank secrecy and are exposing non-compliant taxpayers who hold undisclosed assets abroad. The IRS’s Offshore Voluntary Disclosure Program offers a path for U.S. tax residents to become compliant with their outstanding filing obligations while mitigating or minimizing the penalties associated with non-compliance — however, this program can close at any time. Alternatively, the IRS could choose to limit the types of taxpayers who may enter into the streamlined program, or increase the penalties offered within the framework. Once the program closes, taxpayers may once again face full audits and investigations, full FBAR penalties, and potential prosecution. Depending on the aggregate amount of a taxpayer’s offshore assets, penalties could reach as high as 50% of the value of each overseas account per year.