All About Foreign Information Tax Returns & IRS Penalty Basics

Everything About IRS Foreign Information Tax Return Penalty Basics

Everything About IRS Foreign Information Tax Return Penalties 

Each year, millions of U.S. taxpayers worldwide are required to report their foreign accounts, assets, and investments to the IRS and the U.S. government on various international information reporting or ‘foreign information’ IRS returns. There are many types of reporting forms that the taxpayer may have to file, depending on the category and value of the assets they hold. Some taxpayers may only have to file just one international reporting form for the year, while others may have to file several forms — and may even have to report the same account on multiple forms in the same year. For taxpayers who are out of compliance, there are various potential fines and penalties that they may face, but it is important to note that the IRS does offer several foreign information return amnesty programs to assist them with getting into compliance. While this summary cannot provide absolutely everything taxpayers need to know (and still keep you awake), the article will provide you with all the beginner knowledge taxpayers should know to prepare themselves in case they find themselves in this situation.

The Basics of Foreign Information Tax Return

The United States follows a worldwide income tax model for taxpayers considered U.S. persons for tax purposes. That means U.S. persons are required to report their worldwide income, whether they live in the United States or abroad. The same concept goes for international reporting forms. Thus, a U.S. taxpayer living overseas is still required to report their foreign accounts, assets, and investments even if they do not reside in the United States. Taxpayers who make a treaty election to be treated as a nonresident alien for tax purposes should note that there was a recent case a few years back that allowed the taxpayer to avoid FBAR penalties because they had made a treaty election — noting that technically the FBAR is not a tax form.

What is a ‘Foreign Information Return’

A foreign information return is an IRS form used to report certain information about foreign accounts, assets, and investments. This is different from  IRS Tax Form 1040, for example, which is the form used to report and calculate tax liability. In other words, the taxpayer may have several foreign information returns that are required to be filed even though they do not have any outstanding tax liability generated from that foreign income.

Who Must File a Foreign Information Return

In general, U.S. persons for tax purposes with foreign accounts and assets are the taxpayers who may be required to file foreign information returns. This may include entities as well as individuals, but for individuals, this will include U.S. citizens, lawful permanent residents, and foreign nationals who meet the substantial presence test.

What About Making a Treaty Election?

Some taxpayers who reside in a treaty country may make an election to be treated as a non-resident alien for tax purposes. This means that the taxpayer may only have to report their U.S.-sourced income for tax purposes and not their worldwide income. But when it comes to foreign information returns, the IRS takes the position that taxpayers are still required to report these forms even if they live overseas and made a treaty election. As mentioned above, this may not apply to FBAR — and it should also be noted that Form 8938 is only required if the taxpayer is required to file a Form 1040 and is not filing independently of the IRS Form 1040 filing requirement.

Which Foreign Assets are Reportable?

All different types of foreign accounts and assets are reportable for foreign information return filing purposes. Some of the most common examples include bank accounts, security accounts, foreign life insurance policies (with cash/surrender value), foreign pension plans, direct ownership of stock, and potentially even cryptocurrency, depending on which form and what position the taxpayer takes as to the reporting.

Which IRS Forms are Required to Report Foreign Investments?

Just as there are many different foreign assets the taxpayer has to file, there are many different forms the taxpayer may have to report as well. Some of the more common forms include the FBAR (FinCEN Form 114), Form 8938 (FATCA), Form 3520, Form 3520-A, and Form 8621.

What are the Foreign Information Return Penalties?

The type of penalty the taxpayer may be subject to will vary depending on the specific type of form.

For example, when it comes to the FBAR, the taxpayer will be penalized differently depending on whether it is a criminal (rare) or civil penalty, and whether the taxpayer is deemed willful or non-willful. Likewise, taxpayers who are penalized for Form 8938 could be subject to a $10,000 penalty per year as well as a $50,000 continuing failure to file penalty. Other forms, like Form 8621, may not carry a monetary penalty, but the failure to file the form may keep the tax return open indefinitely for potential audit or investigation.

How to Challenge the IRS Foreign Information Return Penalties?

Taxpayers who have not yet been penalized can avoid or minimize penalties by submitting to one of the several IRS offshore amnesty programs. Being eligible for these programs depends on whether the taxpayer is willful or non-willful, whether the taxpayer has unreported income (along with the unreported foreign accounts and assets), and the taxpayer’s overall risk tolerance level.

Amnesty vs. Abatement

It is important to note that once the penalty has been assessed, it is much more difficult to get the penalty abated or waived than it is to proactively make an offshore disclosure submission to the IRS to avoid penalties or minimize penalties in the first place. Depending on whether it is an IRS penalty per se or whether it is an FBAR penalty, we’ll determine how penalties are enforced and how taxpayers may challenge the penalties. Unfortunately, taxpayers who have been assessed FBAR penalties do not have the right to go to Tax Court, but they may also not have to prepay the penalty if they decide to go to federal court, as is typically required.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.