201606.13
0

Foreign Real Estate Rental Income FAQ – FBAR & Streamlined Offshore Disclosure

Golding & Golding - International Business Tax Lawyers

Golding & Golding – U.S. and International Tax Lawyers

At Golding & Golding, we limit our practice to offshore disclosure. As such, we have worked with hundreds of clients to facilitate the reporting of foreign accounts, assets, income, and real estate.

Since foreign real estate is a major investment made by many of our clients, we have handled a diverse range of anticipated and unanticipated issues involving foreign real estate, International Tax and Offshore Disclosure

With Foreign Real Estate, there are five (5) key issues to keep in mind:

  1. Is the real estate own by an individual or foreign corporation?
  2. Is the foreign real estate that is held in a foreign corporation the type of foreign corporation that can be considered a disregarded entity?
  3. Are the proceeds from the foreign rental income placed directly into an account owned by the applicant or foreign corporation?
  4. Does the foreign Real Estate owned by the individual or Business have bank accounts under its name?
  5. Are foreign taxes being paid on the rental income?

These five (5) questions are the main issues that will determine whether there is a tax liability and/or reporting requirement for the individual. The answers will be different depending on whether the applicant applies for the Streamlined Program, Offshore Voluntary Disclosure Program, or Reasonable Cause submission:

Is the real estate owned by an individual or foreign corporation?

If a person is deciding whether or not they want to submit to OVDP or the streamlined program, they should keep in mind that real estate is not always computed into the penalty. Rather, if the real estate is owned by an individual, then the asset is not computed as part of the streamlined penalty.

Streamlined Penalty: Real Estate is only applied to the Penalty when the Real Estate is owned by a Business or Corporation; if it is owned by an Individual then the Real Estate is not computed into the penalty.

Conversely, if the real estate is owned by a corporation of which the applicant owns a percentage of, the total value of the ownership is usually included when computing the penalty – the real estate is not subtracted from the total amount of the assets of the Corporation.

OVDP Penalty: If a person is applying for OVDP, the value of the real estate is computed into the penalty regardless of whether it is owned by an individual or business.

Is the foreign real estate in a foreign corporation that can be a disregarded entity?

Briefly, when a foreign corporation is disregarded, it means that the entity itself does not have to file a separate and distinct tax return. Rather, the owner will file a tax return include the corporate information on a Schedule C.

In the United States, it is very common for individuals and married couples (in community property states) to form one and two member LLCs, which are disregarded.

Streamlined Program: If the streamlined disclosure applicant has his or her foreign real estate in a foreign corporation that can be disregarded for US purposes, than the person might be able to avoid paying a penalty on the value of the foreign real estate. That is because once the entity is “disregarded” the real estate is deemed owned and reported by the individual personally, and personal ownership of real estate is not considered to be owned by foreign corporation.

**This is a fact-based scenario. Anybody considering disregarding a foreign entity attempting to avoid paying a penalty to the IRS under the streamlined program for foreign real estate should speak with an experienced offshore disclosure lawyer before making any decision on how to proceed.

OVDP Penalty: If a person is applying for OVDP, the value of the real estate is computed into the penalty regardless of whether it is owned by a disregarded Entity or not.

Where Are the proceeds from the foreign rental income deposited into?

This will impact FBAR related issues for either Streamlined Program or OVDP.

An FBAR is a (Report of Foreign Bank And Financial Accounts) form. If a person is receiving rents and depositing them into a foreign account on which the person has ownership, beneficiary ownership, or signatory authority, then there is a strong possibility that the account (in aggregate total with other foreign accounts) will exceed $10,000. If it does, then the person will be required to file an annual FBAR statement – whether the account is owned by an individual or corporation/business.

If on the other hand, the rental income is deposited into an account on by property management company of which the individual is not named on the account, the applicant may not need to report that account on an FBAR. As a result, the value of the account will not be applied towards the $10,000 threshold requirement for FBAR Filings.

Does the Foreign Entity have bank accounts under its name?

This will impact FBAR related issues for either Streamlined Program or OVDP.

If the Foreign Real Estate is owned by a Foreign Entity of which the Applicant has ownership, the account must be reported. This is true, even if the foreign entity can be considered a disregarded entity for US tax purposes. In other words, the tax reporting of the foreign business structure it does not impact reporting requirements when it comes to an FBAR.

  • For example, if a person owns a foreign corporation that has several foreign bank accounts, those accounts must be reported on an FBAR – irrespective of whether the Corporation is considered a foreign corporation or qualifies as a disregarded entity.

Are foreign taxes being paid on the rental income

This will impact Tax Filing related issues for either Streamlined Program or OVDP.

If foreign taxes are already being paid on the earned income from the rent, the individual will usually have the opportunity to take a foreign tax credit. By taking a foreign tax credit, the individual will get “credit” for taxes he or she has already paid on the earnings in a foreign country.

  • The purpose of the foreign tax credit is to avoid paying double tax on income that is already been taxed abroad.

Streamlined Disclosure Program FAQ

For most individuals who have unreported foreign income and foreign accounts, the path of least resistance for getting into tax compliance with the IRS and DOT is the Streamlined Disclosure Program.

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 Offshore Disclosure Tax Law, and we have handled a diverse range of streamlined program applications ranging from under $100,000 to nearly $40,000,000.

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 disclose. 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 (covered by 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 has already started ticking. It means that the foreign financial institution/foreign bank is probably going to report your information to the United States, and when 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, A PLC

We have successfully represented clients in more than 1,000 streamlined and voluntary disclosure submissions nationwide and in over 70-different countries.

We are the “go-to” firm for other Attorneys, CPAs, Enrolled Agents, Accountants, and Financial Professionals across the globe.

International Tax Lawyers - Golding & Golding, A PLC

International Tax Lawyers - Golding & Golding, A PLC

Golding & Golding: Our international tax lawyers practice exclusively in the area of IRS Offshore & Voluntary Disclosure. We represent clients in 70+ different countries. Managing Partner Sean M. Golding is a Board-Certified Tax Law Specialist Attorney (a designation earned by < 1% of attorneys nationwide.). He leads a full-service offshore disclosure & tax law firm. Sean and his team have represented thousands of clients nationwide & worldwide in all aspects of IRS offshore & voluntary disclosure and compliance during his 20-year career as an Attorney.

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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
International Tax Lawyers - Golding & Golding, A PLC

Latest posts by International Tax Lawyers - Golding & Golding, A PLC (see all)