Fixing Mistakes in Prior Tax Returns: 2023 International Edition

Fixing Mistakes in Prior Tax Returns: 2023 International Edition

Fixing Prior Mistakes in Past Tax Returns 

It is not uncommon that when a US Taxpayer gets ready to prepare their current US Tax year return and start reviewing the prior returns — they realize that they made some mistakes in the prior tax filings. It could be that the taxpayer recently engaged with a new tax professional who reviewed the prior returns, or possibly the taxpayer may have attended a webinar or conference where they learned new information that impacted how their prior tax returns should have been filed. When taxpayers mistakes on their prior tax returns, generally there are various strategies they can use to safely get into compliance, especially in the world of international tax and reporting. Noting, that making a mistake with a tax filing is different than when the taxpayer intentionally files incorrect taxes to artificially reduce their tax liability. In the latter situation, the Taxpayer intentionally avoided reporting income or other types of fraud and these types of situations would not be considered ‘mistakes’ by the IRS. Let’s look at a few common mistakes on tax returns with international reporting components — then and go through the different programs that Taxpayers may use to resolve the issue.

Not Filing Taxes at All

One of the biggest misconceptions that many expats have is that if they reside outside of the United States they are not required to file US taxes – but this is incorrect. The United States follows a worldwide income tax station model. That means if a US citizen, lawful permanent resident, or other US tax person resides overseas, they are still technically considered a US person and still must file US tax returns to report their worldwide income.

Not Reporting Worldwide Income

For some expats, they do file their US tax returns — but they only report their US income. If an Expat resides outside of the United States and has income from many different sources, then all of those sources of income must be included on the US tax return. As stated another way, even if a person resides outside of the United States and earns income from sources both within the United States and outside of the United States, all domestic and foreign sources of income must be reported on the tax return.

Reporting Net instead of Gross with FTC

When a person has earned income overseas and has paid foreign tax credits on that income, it is generally always better to report the gross income and the total foreign tax credits than to report the net income only. Here is an example: The taxpayer earned $1,000 of foreign interest income and paid $200 of foreign income tax. If they report their net income of $800, then they will now pay US tax on $800. If they report the $1,000 of income but then report $200 of foreign tax credits, they may qualify to have most if not all of their US tax liability on that foreign-sourced income eliminated.

Failing to Report Foreign Assets

When a person resides in the United States or abroad, if they have foreign financial assets then they are required to disclose these assets on various international information reporting forms each year if they meet the threshold, such as the FBAR. There are other forms they may have to file as well such as Form 3520, Form 5471 Form 8938. Failure to report may result in significant fines and penalties – but amnesty may reduce or eliminate penalties.

Failing to Make a Treaty Election

Oftentimes, if a person is a permanent resident of the United States but resides overseas as an expat, they may qualify for a treaty election to be treated as a foreign person for US tax purposes. This may reduce if not eliminate their US tax liability. But, to make the election, the expat must be in a treaty country and qualify under the specific treaty. In other words, a person cannot just move overseas and stop filing taxes because want to be considered a foreign person; rather they must file taxes and notify the IRS by filing the proper IRS Form 8833.

Continuing Not to File

Just because the US government has not caught up to you yet, does not mean that they may catch up to you at some point. While they generally do not pursue foreign assets — although they can — they may make it very difficult for you to travel — by revoking or denying the renewal of your US passport. They may also issue a levy, lien, or even seize your US property.

Different Prior Year Tax Options Available

The Internal Revenue Service continues to move full steam ahead on enforcement matters involving noncompliance with FBAR reporting (Foreign Bank and Financial Account Reporting aka FinCEN Form 114). As the FBAR is not part of the 1040 tax return, many tax professionals are (understandably) unaware of the existence of the FBAR filing requirements when counseling their clients. As a result, it is not uncommon for a US Taxpayer to be several years out of compliance before realizing they missed the required FBAR and other international reporting form filing requirements. Despite all the fear-mongering Taxpayers will undoubtedly find online, there are actually several safe options available for Taxpayers to safely get into compliance with the US Government for FBAR and other international information reporting forms. These offshore compliance programs vary based on the facts and circumstances of the Taxpayer — and not all Taxpayers will qualify for every program. Let’s review the basics of the different delinquent FBAR late-filing submission procedures:

Delinquent FBAR Submission Procedures (DFSP)

When a Taxpayer does not have to make any substantive changes to their tax return involving unreported income, they may qualify for the Delinquent FBAR Submission Procedures. This program is typically limited to Taxpayers who have no unreported income and are not required to file other delinquent forms in addition to the FBAR. For Taxpayers who qualify for these submission procedures, there is generally no penalty applied for prior-year noncompliance.

Delinquent International Information Return Submission Procedures (DIIRSP) 

Up until November of 2020, Taxpayers who had no unreported income (but missed filing international information reporting forms) could sidestep any offshore penalties by filing delinquent forms under DIIRSP. In November of 2020, the IRS rules changed and the IRS does not guarantee that filing delinquent forms will circumvent penalties — although with the right set of facts and circumstances, the Taxpayer may avoid penalties by showing reasonable cause (see further below).

Streamlined Domestic Offshore Procedures (SDOP)

The Streamlined Domestic Offshore Procedures are IRS procedures designed for Taxpayers who do not qualify as foreign residents, are non-willful, and filed their original tax returns timely. Under these procedures, a Taxpayer can opt to pay a 5% Title 26 Miscellaneous Offshore Penalty in lieu of all the other delinquent FBAR and FATCA penalties.

Streamlined Foreign Offshore Procedures (SFOP)

The Streamlined Foreign Offshore Procedures are probably the best of all the offshore tax programs for Taxpayers who qualify as eligible. This is because if a Taxpayer qualifies as a foreign person and is non-willful, they can avoid all offshore penalties under these procedures. In addition, Taxpayers can file original tax returns.

IRS Voluntary Disclosure Program (VDP) for Delinquent FBAR & FATCA

The IRS Voluntary Disclosure Program (VDP) has been in existence for many years. From 2009 to 2018, there was an offshoot of the VDP program — which was referred to as the Offshore Voluntary Disclosure Program (OVDP) — and was primarily for Taxpayers with undisclosed foreign income and assets.  In 2018, the IRS closed this program — but also expanded the traditional voluntary disclosure program on matters involving foreign and offshore income and asset disclosures.

Under the prior version of OVDP for delinquent FBAR, FATCA, etc. — even non-willful Taxpayers would submit to the program in order to both receive a closing letter and almost always avoid an audit (unless they opted-out). The new version of the VDP program is geared primarily for Taxpayers who are willful or are unable to certify under penalty of perjury that they are non-willful. It is still a great program in which Taxpayers can almost always avoid criminal prosecution — and it rarely if ever would have any impact on a person’s immigration status (unless the Taxpayer was also “criminally” willful and the government pursued that criminality against the Taxpayer, which is extremely rare).

Reasonable Cause for Delinquent FBAR and FATCA

In general, a Taxpayer cannot be subject to penalties for missing the filing of delinquent FBAR and other international information reporting forms if they can show reasonable cause and not willful neglect. This is not a program per se but rather an alternative submission package in which the Taxpayer seeks to avoid or minimize penalties without formally going through the programs listed above — while also avoiding making a quiet disclosure. If you are considering a reasonable cause submission, you should speak with a Board-Certified Tax Lawyer Specialist about your different options.

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 of the Streamlined Procedures. 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

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.