One of the most common scenarios we deal with involving unintentional IRS Tax and FBAR non-compliance, is when elderly foreign parents and foreign relatives with U.S. Citizen/Legal Permanent Resident Children add their children’s names to the foreign accounts – without telling them first.
It is very common for our U.S. Taxpayer clients with foreign parents to contact us concerned that they are out of U.S. compliance, and may have not even known it until recently speaking with their parents or receiving a FATCA Letter.
In many cultures, it is very common for elderly parents to place their children on the foreign accounts. It can be because the parents are elderly, losing their cognitive skills and independent, and require the assistance of their children. In other scenarios, it could be that the elderly parents want to provide an early inheritance to their children.
Depending on the facts and circumstances of each situation, it can determine which option the taxpayer will have in terms of getting compliant with amending/filing IRS tax returns, as well as complying with FBAR reporting requirements.
Signatory Authority on Foreign Accounts
When a person is a US taxpayer and was placed on a foreign account as a signatory, they are in a very strong position to fight IRS penalties. That is because for the most part the IRS is not looking to penalize individuals when they do not have ownership of the foreign money. For example, if a parent has a $1 million in a foreign account, of which all the money belongs to the parent, it was earned by the parent, but the child was placed on the account when the parent was getting on in age, the IRS is more sympathetic.
Moreover, in certain countries they do not provide “signature authority” as they do in the United States and the child is essentially placed on the account as a joint owner – due to the fact that there are no other alternative. When this type of scenario is handled properly by an experienced international offshore disclosure tax lawyer, the matter can be resolved somewhat “painlessly.”
Early Inheritance of Foreign Money
In sharp contrast to signature authority, when a US taxpayer receives an early inheritance from a foreign person into a foreign account, this can spell trouble. Under general gift and estate rules, the recipients of an inheritance or a gift from a foreign person are not taxed in the US (at least at the federal level). The concept is that under a state tax laws, is the estate that is taxed – not the recipient (it is Estate Tax, not Inheritance Tax). Thus, if the estate is a foreign estate, then the IRS/US government has no authority (unless the foreign estate is owned by a US taxpayer) to tax the foreign estate.
For the US taxpayer who receive the gift/inheritance, the main issue is that the money has been sitting in a foreign account, and presumably earning foreign income which has not been reported to the IRS. In this scenario, key factors such as the factors listed below will help determine which compliance program the taxpayer should consider:
- Have taxes been withheld at source by the foreign financial institution;
- Have taxes been otherwise paid in the foreign country;
- Is the money in a tax-free country;
- how long has the money been sitting overseas in the US taxpayers name; and
- Several other factors unique to each situation
For most taxpayers, the best alternative in a situation which they were non-willful (Unintentional/Accidental) and now want to comply with foreign account reporting and foreign income tax disclosure, will be the IRS Streamlined Offshore Disclosure Program (Streamlined Filing Compliance Procedures).
Streamlined Program FAQs
The following is a list of FAQs (Frequently Asked Questions), pitfalls, and tips from the Tax Lawyers at Golding & Golding. Our firm is one of the only boutique tax law firms in the country that is focused exclusively on International Tax Law, and we have handled a diverse range of streamlined program applications ranging from under $100,000 to more than $30,000,000.
This is a summary of common Streamlined Program Questions we receive often. It does NOT constitute legal advice that can be relied upon as legal advice for your particular situation, since each person’s circumstances are unique and may impact the determination of whether he/she qualifies for the program.
How do I know if I Was Willful?
In reality, there is no concrete definition of the term Willful or Non-Willful. It is essentially a ‘smell test’ based on whether or not the facts and circumstances show that you knew or had any reason to know that you are required to disclose and report your foreign accounts and offshore income and made the decision not to do so. It is really that simple and for most people, if they did not know that there was a reporting requirement then they could not have known that they were required to report the accounts/income and would therefore fall into the non-willful category.
What if the IRS disagrees and Believes I was Willful?
This is a good question and without sounding like a salesperson, this is why you retain an experienced international tax lawyer to represent you throughout the application process. Yes, CPAs, Enrolled Agents and general practitioners will try to sell you that they can do it for cheaper and that you are “low-risk”, but once the IRS starts auditing individuals who are in the program you will be a much better position (mentally and physically) to know you are being represented by an experienced International Tax Attorney (under the attorney-client privilege).
Is there No Attorney-Client Privilege with a Non-Attorney?
If you are being represented by a non-attorney, then there is no attorney client privilege. There is a very limited privilege with a CPA or Enrolled Agent, but if it turns out the IRS believes you were willful and wants to pursue a criminal investigation against you, the CPA or enrolled agent can be forced to submit to an examination by the IRS (unless the CPA or Enrolled Agent is also an attorney).
Which Three (3) Years of Tax Returns do I have to Amend?
Generally, it has to be the last three years of tax returns that were filed. So for example, in January 2016 you decide you want to enter the program, you would amend your tax returns for tax year 2014, tax year 2013, tax year 2012. Alternatively, if you were to file your 2015 tax return timely and accurately (disclosing the information), then you could submit an original 2015 with the application as well as an amended 2014 and 2013 tax return.
On my Original Schedule B I Indicated I had no Foreign Accounts?
This is where many people start to “ride the line” between willful and non-willful. The fact of the matter is there are many reasons that we have come across in our practice as to why a person would indicate they did not have foreign accounts on the Schedule B when in fact they did – and would still be considered non-willful. Thus, if the only reason you believe you were willful is because of how you or your CPA/Accountant responded on schedule B, it may be in your best interest to contact an experienced streamlined disclosure lawyer to discuss.
I received a FATCA Letter, now what?
When you receive a FATCA Letter (Foreign Account Tax Compliance Act), it is important to realize that the clock started ticking. It means that the foreign financial institution/foreign bank is probably going to report your information to the United States at the IRS learns that you have outstanding foreign accounts that have not been reported on your tax return, it could lead to an audit or examination which may prevent your ability to enter the program.
I Cannot Locate All of my Account Information
If you are unable to find all of your account information, the most important information to obtain is the year-end balances. That is because it is the year-end balances that are utilized by the IRS to determine what your penalty will be (unless you qualify for a penalty abatement). Thus, while many foreign countries do not hold account information for more than three years and/or charge ridiculous fees for you to obtain the information — you can usually obtain the year-end information.
I do not Have to Pay Tax on These Accounts Overseas?
Welcome to the United States. If you are entering the streamlined program it is because you are required to file your taxes as if you were a US citizen and you are taxed on your Worldwide Income. Thus, as a US citizen, Legal Permanent Resident, or Foreign National otherwise subject to US income tax on a 1040 you are required to file a US tax return and report all of your foreign earnings. Just because you are not taxed on passive income in the country in which the accounts were held, that does not mean the income is tax-free in the United States. In fact, they are usually taxable under IRS Tax Law — but if you have already paid foreign tax you may qualify for the foreign tax credit.
I already Paid Taxes on These Earnings Overseas?
Even if you have already paid tax on the foreign earnings overseas you still must report the information and disclose the earnings on your US tax return. But, when you disclose the account information you also claim what is referred to as an FTC (Foreign Tax Credit). In other words, while you are required to disclose the information regarding your foreign taxes, it does not mean you are subject to double taxation – you get a ‘Foreign Tax Credit’ for taxes you already paid.
Are There Penalties on the Outstanding Tax Liability?
No. Unlike the Offshore Voluntary Disclosure Program (OVDP) in which you have to amend your tax returns for eight (8) years as well as paid 20% penalty on the total outstanding tax liability, under the streamlined program there is no additional penalty for the taxes; rather, there is a 5% penalty on the year-end account balances.
How is the 5% Penalty Calculated?
The penalties calculated as follows: a person will total their year-end balances for each year of the last six years. If you are in the streamlined program this does not include the value of unreported foreign real estate which generates real estate income. Thus, once you have the annual aggregate total of your foreign accounts for each year in the last six years, you pick the highest year-end total, multiply it by .05 (5%) and that will be your penalty. In addition to this penalty, you also have to pay any additional tax liability for the last three years that result from amending the tax return (if there is any taxes due) as well as interest on the taxes.
I live Overseas, Do I Qualify for the IRS Penalty Waiver?
The IRS Streamlined Program carved out a very small niche for foreigners who meet very specific residence requirements. In other words, if you reside overseas for at least 330 days in any one of the last three tax years in which you are filing an amended tax return, then you may qualify to have your 5% penalty abated. It is important to understand that this is not the same as the Foreign Earned Income Exclusion Test and the FEIF Bona-Fide Residence Exception under IRC 2555 does not apply (Click here for recent article we authored on this subject)
Is my Foreign Real Estate Calculated into the Equation?
This can become a very complicated discussion, but keeping it simple it goes like this: if you as an Individual own foreign real estate that generated income and you qualify for the streamlined program, the value of the real estate is not included in the penalty competition. In OVDP the value of foreign real estate that generates income is included in the penalty computation .
To complicate matters, if you own foreign real estate within an investment such as a foreign mutual fund or possibly a foreign self-directed IRA, then the value of the account will include all the investments held in the mutual fund and if that includes foreign real estate then you may indirectly be subject to a penalty on that foreign real estate.
*If you are in this type of situation, you should consider speaking when experienced international tax lawyer before making any submission.
What Type of Accounts Must be Reported?
Generally, all foreign accounts must be reported. For example, Foreign Account reporting would generally include: Foreign Bank Accounts, Foreign Savings Accounts, Foreign Investment Accounts, Foreign Securities Accounts, Foreign Mutual Funds, Foreign Trusts, Foreign Retirement Plans, Foreign Business and/or Corporate Accounts, Insurance Policies (including some Life Insurance), Foreign Accounts held in a CFC (Controlled Foreign Corporation), and Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
Must Foreign Insurance Policies be Reported?
If there is a surrender value, then generally insurance policy must be reported. Foreign life insurance and life assurance policies generally have an investment mechanism to them, which provides monthly, quarterly or annual interest/bonus payments – as well as a surrender value – and if so, the policy must be reported.
What if I am Under IRS Audit or Examination?
If you are currently under IRS audit or examination, than you generally will be disqualified from the program. The idea is that the streamlined program and OVDP are voluntary programs and once you are under audit you are no longer acting “voluntarily.”
Of course, not every IRS agent is fully aware of the parameters of the program and once you receive the notice of audit letter from the IRS it may not hurt you to try to submit to the program but it can cause a major issue depending on whether the audit has anything to do with for accounts and other very personal and confidential information.
*There seems to be some inexperienced CPA and “International” Tax Attorneys who do not have any litigation or actual law practice experience (or are CPA/Lawyers who try to combine their CPA/Attorney experience when they really have less than 10-15 years of Attorney experience and not understand the ramifications of their advice. These attorneys are motivated by the “dollar” and are all too quick to submit their client to the streamlined program after their client has already received a notice of audit or examination — just to make a quick buck.
**If the Attorney/CPA/Enrolled Agent does not properly vet the facts and circumstances of their clients unreported information, the client may face serious inquiries and the CPA/Enrolled Agent may be forced to submit to IRS questioning.
What is a Reasonable Cause Statement?
As an alternative to the streamlined program, some individuals opt to just submitting all of the prior documentation that was not previously disclosed or reported, along with a statement detailing why they have reasonable cause for failing to do so. This is a risky move, because by doing so the person is disclosing all of their financial information to the Internal Revenue Service without any guarantee of non-prosecution. Since the penalties for failing to file and FBAR are exorbitant and even the non-willful person can be subject to a $10,000 per account penalty per year the applicant must bec careful.
But I have no tax liability?
The threshold requirement is not whether you owe tax based on foreign earnings and foreign accounts, but whether you properly disclosed your foreign accounts and income. In other words, if you have foreign income from your bank but there also bank fees which reduces your foreign interest income to zero, that does not mean do not have to report and the failure to report the account and the “money” that was generated from the account is the problem and would still require disclosure. It also will not exempt you from tax and account reporting requirements.
What is Quiet Disclosure/Silent Disclosure
Honestly, it is a horrible idea to submit documents to the IRS via a Quiet Disclosure or Silent Disclosure. These type to disclosures occur when a person simply goes back and reports/discloses the accounts without entering any program or submitting a reasonable cause statement. If a person does this, than they may be subject to criminal prosecution. But if you have already done so you can still get right by the IRS and submit under the streamlined program if you are non-willful (there are some people who inadvertently filed a quiet disclosure or silent disclosure because they were did not know they were required to even submit to a program or pay a penalty)
Does my Foreign Inheritance Count Toward the Penalty?
Yes. A distinction must be made between estate tax, income tax and reporting requirements. When a person has a foreign inheritance there may not be any estate tax on receiving the money, but if the account generates income then there is income tax. In addition, if the account value exceeds $10,000 (or the annual aggregate total of all the foreign accounts exceeds $10,000) the person must still report the information and therefore the value of the account will go towards the penalty.
Do I Receive Criminal Protection under the Streamlined Program?
No. While a person is almost guaranteed protection against prosecution under OVDP, there is no criminal protection under the streamlined program. Although, if the streamlined submission goes as planned then the person is normally spared an IRS audit for the foreign account information. In other words, if a person successfully submits to the streamlined program, while they may not be audited for their foreign account information and income they can still be audited for domestic issues for the years included in the streamlined program submission.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.