The U.S Taxation of Foreign Retirement Accounts by the Internal Revenue Service is a very complex analysis. There are various factors that will determine whether a person’s foreign retirement will be subject to US tax, such as whether:

  • The foreign retirement account is comprised of pre-tax or post-tax dollars;
  • The foreign retirement fund is part of a government public fund or private fund;
  • There been any distributions to the taxpayer; 
  • There is a tax treaty a place; and
  • Have Foreign Taxes already been paid
Golding & Golding – U.S. and International Tax Lawyers

                   

Tax Treaty

The United States has entered into income tax treaties with several different countries (more than 50). The purpose of the tax treaty is to both establish tax rules and boundaries between certain countries and to avoid double taxation. The United States has certain specific rules that have been written into code, such as the tax treatment of Canadian Registered Retirement Savings Plans (RRSP) and Canadian Registered (RRIF) income funds.

In years past, the owner of the account would have to make an annual election on a form 8891 but this requirement has been abolished. Thus, if a person resides in the United States and has an RRSP and/or RRIF in Canada and they automatically qualify the deferral tax just as a U.S. 401(k) receives tax deferral treatment.

Since there are so many different countries that have so many different types of retirement funds, there is not a specific rule for each fund. For example, if someone has a superannuation fund in Australia there are several factors that will help determine whether the person should be taxed or not taxed on current earnings in the retirement fund – which requires a case-by-case; in other words, there is not one uniform rule to be applied to retirement funds.

                   

Foreign Tax Credit

The United States has a foreign tax credit rule which generally provides that if a person pays tax on earnings in a foreign country, then the person will get a credit for those earnings within the United States. Whether a person can use the full amount of the credit or not is determined by the amount of their US income, as well as the foreign tax rate as compared to the US tax rate.

If you reside in the United States and are required to file a 1040, it is important that you discuss these matters with an experienced international tax lawyer to determine whether a full analysis is required and what steps you should follow when filing your tax return, in order to facilitate preferential tax treatment.

                   

FATCA

The way that many individuals are getting into some trouble with foreign retirement funds is due to FATCA (Foreign Account Tax Compliance Act). In accordance with FATCA, individuals and businesses are required to report and disclose their worldwide income. 

Depending on what type of retirement fund a person has and in which particular country they have the fund, there are reporting issues depending on whether it is considered an employment benefit trust or a grantor trusts. Each of these trusts have different reporting rules depending on the amount of ownership of the fund, structure of the trust trust, and whether the owner received any distributions.

In accordance with FATCA, a person may also been required to file FBARs disclosing their foreign accounts – failing to do so can have serious consequences.

                   

FBAR Filing Requirements

Not everyone who has foreign accounts is required to file an FBAR. Rather, it is required to be filed by all U.S. Taxpayers with accounts overseas that reach an “annual aggregate total” that is more than $10,000. That means if a U.S. Taxpayer (including Legal Permanent Residents “aka Green Card Holders”) maintain foreign accounts, including banks accounts, financial accounts, income-producing property, or insurance policies that have a combined value of more than $10,000, then that person is required to file an FBAR statement

                    

What are the Penalties for Failing to File an FBAR

Recently, the Internal Revenue Service issued a memorandum which details how the IRS believes agents should penalize individuals in accordance with their authority. Essentially, there are two sets of penalty structures and their are based on whether the taxpayer was willful or non-willful. As you can imagine, dealing with the Internal Revenue Service is not easy to begin with and then trying to determine whether the facts and circumstances of a particular situation is considered willful or non- willful is a whole another ball of wax.

                                         

FBAR Penalty – Willful

Essentially, somebody’s willful they intentionally invaded taxes. In other words, they willfully or knowingly “knew” about the requirement to disclose and report overseas assets, accounts, and income but chose not. In these situations, the Internal Revenue Service has the authority to penalize the taxpayer upwards of 50% of the value of the assets per audit year.

Generally, audits last three years and the Internal Revenue Service has made it known that they will not penalize the individual beyond the value of the Accounts for the audit periods at issue. Thus, if you had $1 million in your form bank account and you knowingly did not report this information to the IRS and the audit you for three years and they can take all of your $1 million.

FBAR Penalty – Non-Willful

When a person is not willful, it generally means they were unaware of the requirement to file an FBAR. In this situation, the IRS takes mercy – but nowhere near as much mercy as you can imagine certain people deserve (example: individuals who relocated from overseas and have foreign accounts that they simply did not use or earn much income on or individuals for inherit overseas money.)

In these situations, the ever-powerful IRS has four options in terms of penalizing the taxpayer:

  1. The IRS agent can simply issue a warning letter instead of a monetary penalty to the taxpayer. This will rarely happen (although Golding and Golding has achieved this results are multiple occasions for individuals who have been audited and did not follow or statements and otherwise do not qualify for one of the IRS offshore voluntary disclosure program).
  2. The IRS agent could penalize the taxpayer $10,000 for all of the yearsthat the taxpayer did not file FBAR statements. For example, if you are audited for three years and did not file FBARs for those three years, the IRS to penalize you $10,000 for the total amount of the audit.
  3. The IRS Agent could penalize the taxpayer $10,000 for each year that the FBAR was not filed.So using the example above, if the taxpayer is audited three years and did not file an FBAR for three years, then the IRS could penalize the taxpayer $30,000 – usually not beyond the value of the account
  4. The IRS agent could penalize the taxpayer $10,000 per account per year. In other words, if the taxpayer has four different bank accounts and was audited for three years – the IRS could penalize taxpayer $120,000.

One very important thing to remember is that the penalty scheme listed above is for non-willful. In other words, even though the IRS knows the taxpayer did not intentionally attempt to evade tax, the IRS has the power to still issue tens, if not hundreds of thousands of dollars of penalties in a non-willful situation. Think about that the next time you want to go in yourself and negotiate with the IRS and see how serious they kick you without representation.

Whether a person is willful or non-willful is a complex evaluation which requires a comprehensive factual analysis by an experienced FBAR lawyer to ensure you are informed before making any representation to the IRS.

               

IRS Tax Compliance

If you, your business or retirement fund is required comply with FATCA but you’ve not done so, you should consider entering one of the offshore disclosure programs to try and get compliant before it is too late.

A summary of the two main different programs is summarized below:

Should I enter OVDP or the IRS Modified Streamlined Program?

We receive this question often, and in order to assist you understand the distinction between the two different IRS foreign account disclosure programs, we are providing the following summary for your reference:

If you or your business has unreported or undisclosed foreign accounts, offshore assets, or foreign income then you may be considering whether you should enter the Offshore Voluntary Disclosure Program (OVDP) or the modified streamlined program.

Both programs provide peace of mind to the taxpayer – but it will depend on the facts and circumstances of each taxpayer’s situation, to determine which program(s) they qualify for.  It is important to note that the failure to properly submit to the correct program can have serious consequences to the taxpayer.

                                    

Why Comply with IRS Foreign Disclosure Laws?

Because if you fail to do so, the IRS has the authority to penalize you upwards of 100% of the value of your offshore assets and accounts as well as prosecute you for criminal tax fraud and tax evasion if it is found that you acted willfully in failing to report your assets and foreign income.

The reason why international tax law compliance has taken center stage is because under the new FATCA (Foreign Account Tax Compliance Act) laws, foreign countries are actively reporting the bank and financial accounts of US citizens and US legal permanent residents. If a foreign country is interested in working with the United States, the foreign country will enter into an “ Intergovernmental Agreement” (IGA). These agreements are reciprocity agreements, which means not only will the foreign country report the information to the IRS, but the IRS will also reciprocate by providing the same information to foreign country tax authorities.

                                       

Why Enter either OVDP or the Modified Streamlined Program?

Individuals and businesses who are looking for a way to avoid the very steep penalties may seek to voluntary disclose, pay a penalty (unless abated), and avoid criminal prosecution.

There are the only two approved programs by the Internal Revenue Service that can bring a taxpayer into compliance. Instead of entering the programs, taxpayer may qualify to directly report under the reasonable cause exception, in which the taxpayer directly submits the forms with a statement explaining why they were not properly filed.

*Please note, the IRS is not known to be sympathetic and if the IRS does not believe you and audits you anyway then you are disqualified from entering either the OVDP or streamlined program AND the IRS is have more of your overseas/foreign financial information you would like probably like.

Moreover, if the taxpayer improperly submits the forms to the IRS it can be considered “silent disclosure” or “quiet disclosure,” in which if detected by the IRS, the IRS will penalize you heavily as well as probably initiate criminal proceedings against you. In this scenario, not only with the IRS seek to take all of your money and assets through the implementation of penalties and levies, but chances are you will also be spending the next 2 to 20 years in prison for tax evasion or tax fraud.

                                 

What is the Difference between OVDP and the Streamlined Program?

Before making a decision regarding voluntary disclosure, it is important to understand the difference between the two main programs.

OVDP (Offshore Voluntary Disclosure Program Requirements)

OVDP stands for the Offshore Voluntary Disclosure Program, which came into effect in 2009 and was modified again in 2011, 2012 and 2014.

Before the implementation of the modified streamlined program (which is strictly for individuals who were non-willful in their failure to report their overseas assets and income) the penalty structure was generally (and continues to be for willful participants) 27.5% of the highest years annual aggregate total and 50% if any of your money was held in one of the identified “bad banks.”

In other words, if you have foreign accounts that were unreported to the IRS and Department of Treasury, then to determine your penalty structure you would need to total up all of your unreported overseas and accounts for each year, for the last eight years, and then take the highest year’s highest balance and multiply it by 27.5% to arrive at the penalty amount due. (A complete breakdown of OVDP requirements can be found on our OVDP Page, by Clicking Here)

                                       

OVDP is Unfair for Non-Willful Taxpayers

Before the implementation of the modified streamlined program, it was difficult for individuals who were non-willful (no specific definition, but generally without intent to deceive or defraud) to become compliant. Why? Because if you are non-willful, you still had to go through the filing procedures as if you were willful, and then opt out of the penalty structure and open yourself up for audit.

Not such a big deal, except for the fact that you also had to pay 20% penalty on the outstanding taxes that you owed along with a 27.5% penalty on the highest year’s annual aggregate (unless you successfully “opted out” from the penalty structure – which came with a whole other set of headaches). As you can imagine, for individuals who simply inherited some money overseas, had no international dealings, and had no idea that they were required to report foreign passive income (Interest income) in a country that does not tax its own citizens on passive income earnings — providing this information to the IRS was a huge burden.

                                       

What is the Modified Streamlined Program?

In order to avoid “non-willful” applicants from having to go through the entire OVDP process before opting out, the IRS and Department of the Treasury modified a small program in existence, called the streamlined program, which was very limited. The IRS expanded the program to basically allow anyone who was non-willful to enter the program.

The program reduced the amount of documentation that applicants were required to file to only three years of amended tax returns and six years of FBAR (Foreign Account Reporting Statements). In addition, there was no penalty on the tax amount that was due, no penalty on the value of foreign real estate that was not previously disclosed, and the 27.5% penalty was reduced all the way down to 5%, or completely waived if the foreign residence requirements were met.

Penalty Waiver: there is a small facet of the modified streamlined program called the Modified Foreign Offshore Program.  If a person qualifies for the modified stream of program (which means they acted non willfully) and they can prove they lived overseas in any number of different countries for a total of 330 days out of the tax year in any year within the last three years, then they may qualify to have the penalty waived.

The Streamlined Programs sounds great, right? Well it is, unless you are attempting to wrongfully evade the 27.5% penalty by entering the program when you knew you were willful.

                                       

What if you are caught trying to sneak into the Streamlined Program?

I cannot stress to you enough to not enter the streamlined program if you do not qualify; in other words, suck it up and pay the penalty. Why? Because if you knowingly enter the streamlined program and it is found that you acted willfully in your failure to disclose and report your overseas and foreign assets and income you will most likely be prosecuted by the IRS.

The IRS made this fact known in a recent public relations statement in March 2015. Essentially, from the IRS’ perspective if you wrongfully enter this program in order to avoid paying the full penalty amount what you have done is stolen 27.5% or 50% of the penalty amount due to the IRS – and this does not make the IRS very happy.

Even worse is that not only are you subject to criminal prosecution – but now you’ve already disclosed all the foreign financial information and thus you’re in a pretty difficult position to defend yourself. The IRS has let it be known that they will enforce criminal tax prosecution laws in these types of situations.

                                        

Why is the Modified Streamlined program in Jeopardy?

Just like in everything in life, a few bad apples spoil the whole bunch. The IRS has gotten wind that several individuals who were willful in their failure to report undisclosed foreign tax and bank information are trying to sneak into the modified streamlined program and thus reduce their penalty to 5%. As you can imagine, this upset the IRS who created this modified program for the sole purpose of assisting taxpayers who otherwise would be overburdened and having to enter the OVDP and opt out of the penalty structure.

                                       

There is No Reason to be Scared of the OVDP or the Streamlined Programs

The goal of this article is not to scare you. Rather, it is to warn you to just be cautious if you are entering into these programs. Way too many inexperienced and unscrupulous attorneys, CPAs and enrolled agents see these programs as a way to scare individuals.

                                     

If You are going to enter a Foreign Disclosure Program, use an Attorney

While CPAs and enrolled agents (who are not also attorneys) may charge less than an attorney is important to note that you do not have an attorney client privilege with CPAs and enrolled agents. What that means, is that if it turns out you wrongfully entered the streamlined program and the IRS wants to speak with your representative, unless your representative is an attorney, there is no privilege between a CPA and Taxpayer when a Criminal Matter is at issue.