By: Jeanmarie Dunn-Kane, Esq. and Steven A. Loeb, Esq.
Many United States citizens and residents have assets in foreign countries, or earn income that is generated in foreign countries. The U.S. tax system taxes all income earned by U.S. citizens and residents, no matter if it is earned in the United States or abroad. The U.S. has tax treaties with many foreign countries where any taxes paid to the foreign country on the income earned there can be credited against taxes due to the U.S. for the same income. Furthermore, under the FATCA laws, all U.S. citizens and residents must provide the IRS with information on any and all financial assets that have an account balance of more than $10,000 and that they have in interest in or control over located in foreign countries by filing Form 8938 with their annual tax returns and/or FinCEN Form 114, Report of Foreign Bank and Financial Accounts (“FBAR”).
The penalties for failing to report income earned abroad and foreign financial assets can be severe, and include (but are not limited to) the following:
• The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
• The penalty for failing to file each Form 8938 information return is $10,000, 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.
• Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
• A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
• A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
• An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty. (Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014, located at https://www.irs.gov/individuals/international-taxpayers/offshore-volunta..., last updated February 8, 2016.)
U.S. citizens and residents who have not complied with foreign financial account and income reporting requirements may be able to avoid or reduce some of these penalties by participating in one of several programs established by the IRS. Which program a U.S. citizen or resident participates in will depend on whether or not their failure to report the foreign earned income or foreign financial account was willful or not, and the nature of reporting failure. “Willful” in this context is a legal standard that the U.S. citizen or resident should discuss with qualified legal counsel. The penalties due will depend on the program the taxpayer can utilize and the amount of the income earned abroad and/or foreign financial assets that went unreported.
A. Offshore Voluntary Disclosure Procedure
Under the 2014 Offshore Voluntary Disclosure Program (“OVDP”), a taxpayer that has failed to disclose foreign accounts or assets is subject to the following penalties:
1. Pay 20% accuracy-related penalties under IRC § 6662(a) on the full amount of your offshore-related underpayments of tax for all years (Offshore Voluntary Disclosure Program, Frequently Asked Questions and Answers, # 7; http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntar..., September 10, 2014; hereinafter “FAQ”);
2. Pay failure to file penalties under IRC § 6651(a)(1), if applicable (id) ;
3. Pay failure to pay penalties under IRC § 6651(a)(2), if applicable (id);
4. Pay, in lieu of all other penalties that may apply to the undisclosed foreign accounts, assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, a miscellaneous Title 26 offshore penalty equal to 27.5 percent (or 50 percent in certain circumstances) foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure (id).
a. Beginning on August 4, 2014, any taxpayer who has an undisclosed foreign financial account will be subject to a 50-percent miscellaneous offshore penalty if, at the time of submitting the preclearance letter to IRS Criminal Investigation: an event has already occurred that constitutes a public disclosure that either (a) the foreign financial institution where the account is held, or another facilitator who assisted in establishing or maintaining the taxpayer’s offshore arrangement, is or has been under investigation by the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person; (b) the foreign financial institution or other facilitator is cooperating with the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person or (c) the foreign financial institution or other facilitator has been identified in a court- approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a “John Doe summons”) at the foreign financial institution or have accounts established or maintained by the facilitator. Examples of a public disclosure include, without limitation: a public filing in a judicial proceeding by any party or judicial officer; or public disclosure by the Department of Justice regarding a Deferred Prosecution Agreement or Non-Prosecution Agreement with a financial institution or other facilitator. (Id at # 7.2.)
Under the OVDP, there is no need for a Taxpayer to certify that the failure to file and pay was not willful. Upon timely and truthful completion of the OVDP and execution of a Closing Agreement on Final Determination Covering Specific Matters, Form 906, the IRS will not recommend criminal prosecution to the Department of Justice. (Id. at # 3).
B. Streamlined Filing Compliance Procedures.
1. The Streamlined Filing Compliance Procedures (the “Streamlined Program”) is available to “taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part.” (IRS Streamlined Filing Compliance Procedures, http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Res..., last updated September 25, 2015; hereinafter “Streamline Procedures”). In order to qualify for the Streamlined Program, a taxpayer must meet the following criteria:
a. fail to meet the applicable non-residency requirement (id);
b. have previously filed a U.S. tax return (if required) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed (id);
c. have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR (FinCEN Form 114, previously Form TD F 90-22.1) and/or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset (id, emphasis added), and
d. such failures resulted from non-willful conduct. (id)
2. A taxpayer in the Streamlined Program does not have to pay the failure to file and failure to pay penalties. A Title 26 penalty of five percent (5%) on the highest aggregate account balance is imposed. (Id.)
C. Delinquent International Information Return Submission Procedure
1. Taxpayers who do not need to use Streamlined Program to file delinquent or amended tax returns to report and pay additional tax, but who:
a. have not filed one or more required international information returns,
b. have reasonable cause for not timely filing the information returns,
c. are not under a civil examination or a criminal investigation by the IRS, and
d. have not already been contacted by the IRS about the delinquent information returns
should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file (the “Reasonable Cause Statement”). (IRS Delinquent International Information Return Submission Procedures, http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-Intern..., last updated September 25, 2015).
2. If a Reasonable Cause Statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures. (Id.) A Reasonable Cause Statement must be attached to each delinquent information return filed for which reasonable cause is being requested. (Id.)
3. Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns. (Id.)
Each of these programs has its own set of rules and procedures that must be followed properly. Qualified legal counsel should be engaged if a U.S. citizen or resident believes that they have foreign income or financial assets which have not yet been reported to the IRS.
For more information please contact via email Steven A. Loeb, Esq. or by phone at 973-538-4700 ext. 229.
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