IRS Offshore Penalties – Examples & Explanations of the Different Penalties
IRS Offshore Penalties
IRS Offshore Penalties are tough, and unnecessarily complicated — but our goal is to try to make it simpler for you to understand. Therefore we are provided Examples & Explanations of how the Penalty Reduction works.
Yes, even the OVDP 27.5% or 50% Penalty is a reduction of IRC Penalties that can quickly reach 100% value of the foreign accounts, investments, assets, etc.
OVDP Penalties are Tough
The traditional offshore voluntary disclosure program (OVDP) has multiple penalties that may be issued against the applicant, with FBAR/Undisclosed Asset penalties alone reaching as high as 50% of the highest year’s maximum balance of the annual aggregate total of unreported account balances.
Offshore Disclosure Penalty Example
If a person has unreported foreign accounts and assets, which have a max balance of $2 million for the highest year within the compliance period (eight years), and that money is held in “a bad bank,” the applicant may be subject to a $1 million penalty, instead of a $550,000 (if the money was not in a bad bank). This penalty is in addition to the unreported tax liability, interest on the unpaid taxes, and annual 20% penalty against taxes that were due, and other penalties such as failure-to-file and failure-to-pay (if applicable).
Streamlined Offshore Disclosure Penalties
Due to the fact that there was no outlet for individuals who are non-willful — aside from entering traditional OVDP and then opting out later in the process (a major undertaking) — unless they met very strict requirements for the very limited “OVDP Streamlined Application,” the IRS took mercy. Even the IRS understands the traditional OVDP is too much of an undertaking for the typical individual who was non-willful.
For example, if a person resides in the United States but maybe has a wealthy (and generous) grandma who lives overseas and left the U.S. Person individual an inheritance overseas — for this type of applicant it was unfair (if not egregious) to require them to enter OVDP just to get into compliance.
As a result, the Modified Streamlined Program, aka Streamlined Offshore Disclosure Program (also known as Streamlined Filing Compliance Procedures) was born.
Streamlined Domestic Offshore Disclosure
The Streamlined Domestic (domestic refers to the residence of the applicant, not the fact that the application must include foreign accounts) Offshore Disclosure Program is for individuals who reside in the United States and were non-willful in their failure to be in compliance. In order to qualify for the program, a person must have filed U.S. tax returns for prior years, and agree to pay a 5% penalty.
With the Streamlined Domestic Offshore Disclosure Program, a person is only required to amend three (3) years of tax returns instead of eight (8) years as required under OVDP. Moreover, the applicant is only required to file FBARs (Report of Foreign Bank And Financial Account) for six (6) years, and there is no 20% penalty for annual taxes that were due. The applicant will also pay a 5% penalty on the highest year and balance of unreported foreign accounts.
*Under the streamlined program, the penalties based on the year-end value, whereas for OVDP the penalties based on the max value for the year. The purpose is as follows: if you are non-willful and your account happened to be artificially high during the year – maybe due to a stock sale or home sale – the IRS does not want you to pay an inflated penalty for a brief spike in the account balance. For OVDP, since you were willful – the IRS does not care.
Streamlined Foreign Offshore Disclosure
If a person can meet the Foreign Residence Requirement, and was non-willful — then they may qualify the Streamlined Foreign Compliance Procedures. The reporting requirements for the streamlined foreign program are even more lax than the streamlined domestic program.
Moreover, a person who meets the foreign residence requirement (330 days outside of the United States in any one of the last calendar tax years) can enter the program even if they have not filed original tax returns in the last three years and the program the 5% penalty is waived.
As such, by entering the streamlined foreign program, a person can get into compliance for prior tax years without having to pay any penalty to the United States government.
Example of Avoiding Taxes and Penalties
Here is a common example of how our client may avoid paying any money to the US government:
David and his wife reside overseas as expats. David works for a foreign company that pays him the equivalent of $99,000 annually. David works in a tax jurisdiction in which taxes already withheld at source. David has $800,000 overseas in foreign accounts. He also owns a rental property that generates income, but the expenses wash away any earnings.
David’s Salary Qualifies for FEIE or FTC:
Since David earns less than $100,000 a year, he may qualify for the Foreign Earned Income Exclusion. The exclusion provides that if a person earns less than hundred thousand dollars a year (adjusted annually) and meets the foreign residence or presence requirement (more lax than for the Streamlined Foreign Program), the hundred thousand dollars of “earned” income is excluded from tax liability. Therefore, David’s salary is not taxed by the US government. Alternatively, depending on what the tax amount is overseas, David may qualify for a Foreign Tax Credit so that he can apply the taxes he already paid overseas against any taxes he would owe in the United States.
**Even though David is filing his tax return late and therefore may not qualify for the FEIE, since he is filing under the streamlined program he should be fine. The Foreign FTC (Foreign Tax Credit) is generally not impacted by a late filing.
The Rental Property
Unlike traditional OVDP, the value of the rental property is not subject to any penalty under the streamlined program. Moreover, David can claim the deductions he would ordinarily claim for rental property in the United States for his foreign property – aside from the fact that depreciation is extended to 40 years. Since many countries do not recognize depreciation as a deduction, once David files his schedule E to report all of his expenses and deductions, he will show no income and thus there is no tax liability on the earnings.
Foreign Bank Accounts
Since David lives overseas for at least 330 days, he qualifies for the streamlined foreign program. As a result, the 5% penalty for unreported bank balances is waived. Thus, even though under the domestic version of the program David would have to pay a $40,000 penalty ($800,000×5%) – the 5% penalty is waived under the streamlined foreign program.
** Result: David is now in Compliance, with NO MONEY due to the U.S. Government!
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)
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