From Temporary Visa to U.S. Resident – Qualify for Streamlined Foreign Offshore?
- 1 Do I Qualify for Streamlined Foreign Offshore?
- 2 Streamlined Offshore Example
- 3 Streamlined Foreign Offshore – 6-Year FBAR Compliance Period
- 4 Streamlined Foreign Offshore – 3-Year Tax Compliance Period
- 5 Streamlined Certification: Two Options:
- 6 Analysis
- 7 Substantial Presence Test (SPT) vs. Foreign Resident (330-Day)
- 8 Substantial Presence Test – Non-U.S. Person
- 9 Understanding Substantial Presence Test. (SPT)
- 10 Who Qualifies under the Substantial Presence Test?
- 11 Summary of Substantial Presence Test
- 12 Tax Liability – Substantial Presence Test
- 13 Substantial Presence Test – Exception
- 14 330-Day Foreign Resident Rule
- 15 Applying the 330-day Non-Resident Rule
- 16 What if the 330-Days is Staggered?
- 17 Now I am a U.S. Person – What Can I Do?
- 18 Option 1:
- 19 Option 2:
- 20 Why is this important?
- 21 Case by Case
- 22 Be Careful!
- 23 Want to Learn More about Offshore Disclosure
- 24 When Do I Need to Use Voluntary Disclosure?
- 25 Golding & Golding – Offshore Disclosure
- 26 The Devil is in the Details…
- 27 What if You Never Report the Money?
- 28 Getting into Compliance
- 29 1. OVDP
- 30 2. Streamlined Domestic Offshore Disclosure
- 31 3. Streamlined Foreign Offshore Disclosure
Despite what some inexperienced Offshore Disclosure Lawyers who are eager to sell you on their services may tell you, not everyone who applies for the Streamlined Voluntary Disclosure Program will qualify for it, and not everyone who submits a Certification Form 14654 or Form 14653 will be accepted.
Specifically, the Streamlined Foreign Offshore Procedures can be very complex, and many ‘new’ Offshore Disclosure Lawyers are giving very bad (and dangerous) advice to potential clients.
One question we recently received after a client spoke with another law firm deserves its own summary — due to all the incorrect information being provided. We highly recommend that before making any affirmative representation to the IRS, you speak with an experienced attorney to properly evaluate your specific facts and circumstances.
Do I Qualify for Streamlined Foreign Offshore?
The question was a bit long-winded, which is unavoidable: “If I want to file for Streamlined Foreign Offshore Procedures (aka Penalty Waiver) and I became a U.S. Citizen or Legal Permanent Resident in the second or third year of the tax filing compliance period (and do not meet the 330-day Foreign Resident rule during this year) can I use the Substantial Presence Test to prove I was a Non-Resident for either of the first two years in the Three-Year compliance period (if I do not meet the 330-day non-resident rule during any of the three years)?
Trust us, the question sounds way more complex than it is. An example may help you better understand:
Streamlined Offshore Example
Example: Jon came to the United States as an F-1 Student. Thereafter, he married a U.S. person and became a Legal Permanent Resident. A few years later, John realized he was out of tax compliance and wants to get back into compliance. He wants to file for the Streamlined Foreign Offshore Procedures and avoid the penalty – since during the first year of the three-year tax compliance period, John lived in the United States on an F-1 Visa (SPT exempt)
While John does not meet the 330-day rule as a Foreign Resident (which Legal Permanent Residents and/or U.S. Citizens are required to meet), as an F-1 Visa holder he would not be considered a U.S. Person during his first 5-years in the U.S. on an F-1 Visa since an F-1 Visa Holder will (usually) be exempt from reporting under the Substantial Presence Test during the first 5 years in the U.S. on an F-1 visa).
To clarify, during the 1st year of the 3-year tax compliance period he qualifies as a non-resident. But, he is now considered a U.S. Person (and the Substantial Presence Test does not apply to future years, once he became a U.S. Person)
Streamlined Foreign Offshore – 6-Year FBAR Compliance Period
When it comes to filing past FBAR forms, the applicant has to go back six years. Technically, if a person is on an F-1 visa (or similar non-resident visa) for a part of the compliance period, then they are not considered to be a U.S. person for U.S. Tax Resident status and therefore, they may not have to file an FBAR for that portion of the complying period.
For example, let’s say Jeffrey came to the United States in 2010 on an F-1 visa and then became a Legal Permanent Resident through marriage in 2012. Presuming that Jeffrey had foreign accounts that would require an FBAR filing for the entire period (if he was a resident for the entire 6 year period), Jeffrey could make the argument that he only has to file an FBAR for the years 2012 to the present, since for 2010 in 2011 he is considered a non-tax resident.
Either way, the FBAR is merely a reporting form and sometimes it is better to simply report all of the FBARs for the entire six year compliance period — to avoid any further issues from the IRS (who do not always know the different visa statuses and what is considered a tax resident or not)
Streamlined Foreign Offshore – 3-Year Tax Compliance Period
When it comes to the tax compliance, it is entirely different story. Technically, the streamlined program requires a person to go back (unless the current year is being filed correctly) three (3) years and amend prior returns to reflect properly reported foreign income, accounts, and specified foreign assets.
Under the Streamlined Foreign Offshore Procedures, a person qualifies for the program if they can show that during any one of the three years within the compliance period (depending on their current status) they either did not meet the Substantial Presence Test, or can meet the 330-day foreign resident test — both which result in a penalty waiver.
But, what if a person used to be a noncitizen/permanent resident (during the 1st year or 2nd year of 3-year tax compliance period), but is now considered to be a U.S. person — and they still want to qualify to have their prior F-1 visa status (qualifying them as a non-resident) to be considered in order to avoid the penalty?
In other words, they want to use the fact that they did not meet the Substantial Presence Test in the first year of the compliance period (but did not reside outside the U.S. for at least 330-days as U.S. Persons are required to show) to avoid the penalty, even though at the time they are applying for the Streamlined Foreign Offshore Procedures, they are a U.S. person — who would otherwise have to show they meet the foreign residence, 330-day rule?
Streamlined Certification: Two Options:
The 14653 Streamlined Certification is required to be filed when a person submits to the Streamlined Foreign Offshore Procedures.
There are two options: One of the options is for individuals who are considered to be U.S. persons (who meet the 330-day foreign resident test) and one option is for people who are considered to be non-U.S. persons (does not meet the Substantial Presence Test)
Technically, there is no distinction on the form for individuals who are former non-U.S. citizens/legal permanent residents, but are now considered to be a US citizen or legal permanent resident but want to rely on their prior non-US status to avoid the penalty.
The IRS likes to keep things unclear. When it comes to the Streamlined Foreign Offshore Procedures, the IRS is very strict with the terms and phrases it uses within the certification forms and instructions.
This can become a very serious problem for individuals who were in the United States previously on an F-1 visa or other type of visa that exempts them from the Substantial Presence Test (which is a good thing), but later changed statuses to become either a U.S. Citizen or Legal Permanent Resident and are currently a U.S. person when they are applying for the Streamlined Foreign Compliance Procedures.
Substantial Presence Test (SPT) vs. Foreign Resident (330-Day)
What is the difference between the Substantial Presence Test and 330-Day Rule?
Substantial Presence Test – Non-U.S. Person
When a person is a Non-U.S. person (a.k.a. Non-U.S. Citizen or Non-Legal Permanent Resident), in order to avoid the harsh reality of the U.S. taxing them on their worldwide income, they must show that they did not meet the Substantial Presence Test.
Therefore, when a person wants to qualify for Streamlined Foreign Offshore Procedures and they are currently (at the time they are applying for the Streamlined Foreign Offshore Procedures) a non-U.S. Citizen or non-Legal Permanent Resident, they will show that they do not meet the Substantial Presence Test, and therefore do not qualify as being a US person – which means they meet the requirements for a penalty waiver.
Understanding Substantial Presence Test. (SPT)
The United States is one of the only countries in the world the practices Citizen-Based Taxation (CBT). In other words, the United States taxes US persons on their worldwide income.
When a person is a U.S. Citizen, Legal Permanent Resident (“Green Card Holder”), or long-term Legal Permanent Resident who did not properly relinquish their Green Card, a person will be taxed on all of the income they earn worldwide. It does not matter if they earned the income while living in the United States or abroad. It also does not matter whether the income is sourced in the United States or outside the United States – it must be reported on the US tax return.
Who Qualifies under the Substantial Presence Test?
The Substantial Presence Test takes the matter one step further, in order to tax individuals who are neither a U.S. Citizen, Legal Permanent Resident (“Green Card Holder”), or long-term Legal Permanent Resident who did not properly relinquish their Green Card. Even if a person does not meet one of the aforementioned U.S. Citizen/Resident categories, but meets a certain “Resident Test “- he or she will have to pay tax on their worldwide income in the United States just as it they were a U.S. Person
Usually, it will involve individuals who are in the United States on a work visa. For example, David was transferred to the United States by his company on an L-1 visa. As a result, even though David may have no intention of trying to obtain U.S. Legal Permanent Residency, if he meets the substantial presence test that you will have to pay tax on his worldwide income.
For David, the tax results will be catastrophic. Why? Because in David’s home country of Hong Kong, the country does not tax individuals on their passive income. David has amassed a significant nest egg abroad, and is earning upwards of 8% on $2 million he has saved in his bank account. While that money cannot be taxed by Hong Kong, the United States can tax his “worldwide income” which would include the hundred and $160,000 a year he is earning in interest income.
**Since Hong Kong does not tax this category of income, David would have no tax credits to apply to reduce his tax liability – as opposed to Australia for example where individuals are tax similar to the United States.
Summary of Substantial Presence Test
As a non-US citizen and non-US green card holder, you are generally only required to pay tax on your “US Effectively Connected Income” (money you earn while working in the United States). However, if you qualify for the Substantial Presence Test, then the IRS will tax you on your WORLDWIDE income.
IRS Substantial Presence Test generally means that you were present in the United States for at least 30 days in the current year and a minimum total of 183 days over 3 years, using the following equation:
- 1 day = 1 day in the current year
- 1 day = 1/3 day in the prior year
- 1 day = 1/6 day two years prior
Example A: If you were here 100 days in 2016, 30 days in 2015, and 120 days in 2014, the calculation is as follows:
- 2016 = 100 days
- 2015 = 30 days/3= 10 days
- 2014 = 120 days/6 = 20 days
- Total = 130 days, so you would not qualify under the substantial presence test and NOT be subject to U.S. Income tax on your worldwide income (and you will only pay tax on money earned while working in the US).
Example B: If you were here 180 days in 2016, 180 days in 2015, and 180 days in 2014, the calculation is as follows:
- 2016 = 180 days
- 2015 = 180 days/3= 60 days
- 2014 = 180 days/6 = 30 days
- Total = 270 days, so you would qualify under the substantial presence test and will be subject to U.S. Income tax on your worldwide income, unless another exception applies.
Tax Liability – Substantial Presence Test
Once a person meets the substantial presence test, they are required to report their worldwide income in the United States on a 1040 instead of at 1040 NR. Depending on any tax treaties the United States has with any particular country, the foreigner may find himself or herself under heavy tax scrutiny by the United States.
Substantial Presence Test – Exception
There is an exception to this filing rule, depending on the purpose of the foreigner being in the United States and what role/job the person is doing in the United States.
The IRS provides the following involving the substantial presence exception:
Do not count days for which you are an exempt individual. The term “exempt individual” does not refer to someone exempt from U.S. tax, but to anyone in the following categories:
- An individual temporarily present in the U.S. as a foreign government-related individual under an “A” or “G” visa, other than individuals holding “A-3” or “G-5” class visas.
- A teacher or trainee temporarily present in the U.S. under a “J” or “Q” visa, who substantially complies with the requirements of the visa.
- A student temporarily present in the U.S. under an “F,” “J,” “M,” or “Q” visa, who substantially complies with the requirements of the visa.
- A professional athlete temporarily in the U.S. to compete in a charitable sports event.
If you exclude days of presence in the U.S. for purposes of the substantial presence test because you were an exempt individual or were unable to leave the U.S. because of a medical condition or medical problem, you must include Form 8843, Statement for Exempt Individuals and Individuals With a Medical Condition, with your income tax return. If you do not have to file an income tax return, send Form 8843 to the address indicated in the instructions for Form 8843 by the due date for filing an income tax return.
If you do not timely file Form 8843, you cannot exclude the days you were present in the U.S. as an exempt individual or because of a medical condition that arose while you were in the U.S. This does not apply if you can show, by clear and convincing evidence that you took reasonable actions to become aware of the filing requirements and significant steps to comply with those requirements.
Closer Connection Exception to the Substantial Presence Test
Even if you passed the substantial presence test you can still be treated as a nonresident alien if you qualify for one of the following exceptions;
- The closer connection exception available to all aliens. Please refer to Conditions for a Closer Connection to a Foreign Country.
- The closer connection exception available only to students. Please refer to The Closer Connection Exception to the Substantial Presence Test for Foreign Students and Sample Letter.
330-Day Foreign Resident Rule
Unlike the Substantial Presence Test, the Streamlined Foreign Offshore Procedures “Non-Resident Test” for U.S. Persons is much different – and much more stringent. Why? Because the United States government does provide as much deference to individuals who are considered citizens or permanent residence and therefore “should have known the rules.”
Under these circumstances, the person must meet a very strict 330-day rule.
Applying the 330-day Non-Resident Rule
It is almost as simple as it sounds – a person must have resided outside the United States (in either one country or multiple countries) for at least 330 days in any one of the three years being included in the tax submission, and without having a U.S. Abode.
Example: Scott is originally from California but was transferred to Singapore for five (5) years by his company to run research operations for his company. He brought his family with him, and therefore did not come back to the United States at all during the five-year time period. This would be an example of someone who lived outside the United States for at least 330 days. Presuming he did not have a U.S. Abode, he would be fine.
What if the 330-Days is Staggered?
Without getting too complicated, the 330-Day rule for the Streamlined Foreign Offshore Procedures is not the same as the 330-Day rule for the Foreign Earned Income Exclusion.
To qualify under the streamlined foreign, a person must have been outside of the United States for at least 330 days in any one or more of the most recent three years for which the tax return due date has already passed – and there must not be any abode in the United States.
In other words, it includes a full tax year. So for the example above, Scott would have no issue. On the other hand, let’s say Peter lived outside of the United States for 330 days, but the years were staggered so that he was outside United States from May 2014 to April 2015. Even though he was outside the United States the 330 days it was not in one of the most recent three taxes – rather, it was staggered over to tax years and generally will not qualify.
**With that said, each individual has different circumstances and the IRS has been known to bend or lean in certain situations and so it never hurts to contact the IRS and ask them (anonymously, through your counsel) whether the IRS may allow for a variance.
Now I am a U.S. Person – What Can I Do?
The issue becomes more complicated when a person is now a U.S. person. Why? Because the Streamlined Certification does not provide an option to show that you used to be a nonresident, but now you are resident. Thus, can a person rely on the fact that they were not considered a U.S. Person during year-1, if now they are a U.S. Person and would otherwise have to show they meet the 330-day rule (but do not meet the 330-day rule)?
The 14653 certification provides Taxpayers with two options:
If you are a U.S. Citizen or Legal Permanent Resident… You have to show that you lived outside of the United States for at least 330 days in any one or more of the most recent three years for which a US tax return (or properly applied for extended due date) has passed.
*In this scenario, if a person is a US citizen than they have to show they lived outside the United States for at least 330 days in any one or more of the most recent three years.
**The IRS streamlined certification form does not make reference to an option as to individuals who may not have been a citizen or legal permanent resident during the entire three-year compliance period.
Thus, if you are currently a U.S. citizen, then the option of proving you do not meet the Substantial Presence Test because you at some point during the disclosure you are on an F-1 visa may no longer be an option.
In other words, if you are currently a U.S. Citizen or Legal Permanent Resident, then there is an ambiguity involving what happens regarding prior two years within the three-year compliance in which a person may have been a non-citizen/non-legal permanent resident.
And whether you can use non-citizenship/non-permanent residency during that time will depend on the specific facts and circumstances of your scenario – specifically, if you can still obtain a penalty waiver if you are currently considered a US citizen or legal permanent resident.
If you are not a US citizen…You have to show you did not meet the Substantial Presence Test from any one of the last three years.
**If you are still considered to be a nonresident/non-U.S. Citizen, and can show that you did not meet the Substantial Presence Test (through F-1 visa status or other non-residency status) during any one of the last three years, you would presumably qualify as a foreign resident and have the penalty waived.
Why is this important?
It is important, because there are attorneys and CPAs who are providing inaccurate advice to individuals leading them to believe that they may automatically qualify for penalty waiver when they may not. Especially, when a person was a former Non-U.S. Person during the 1st or 2nd year in the compliance period, but are now considered to be a U.S. Person — and do not meet the 330-day rule.
If you are considering filing for the Streamlined Foreign Offshore Procedures, it is important to evaluate the facts and circumstances very carefully, as well as the pros and cons of entering the program on facts that do not automatically meet the threshold requirements.
That is because of the IRS declines your streamlined foreign application (while you may have the opportunity to submit to the Streamlined Domestic)you may not (if you receive a notice of examination) – before you have a chance to resubmit.
Case by Case
This is a very complex nuance of the law. Even if someone is on F, J, M, Q or a related type of visa, it is important to determine many different factors:
– How long have they been on an F, J, M, Q or a related type of visa? For example, were they on an F-1 for 6 or 7 years as a Student/Graduate Student and no longer qualify for the exclusion from the Substantial Presence Test?
– Do they have a spouse who is also on F-1 or an alternate SPT exempt visa, or not — and who owns the majority of the money subject to the penalty?
– How much is the penalty, and is it worth the headache from the IRS if the submission is rejected for not meeting the Foreign Residence Test?
At Golding & Golding, we limit our entire practice to Offshore Disclosure. Since we receive many clients who worked with, or spoke with less experienced attorneys first and received bad advice, we recommend the following:
– If the attorney you are considering handles multiple areas of Tax – what percentage of their practice is limited to Offshore Disclosure?
– How many Offshore Disclosure Applications have been submitted to the IRS (Streamlined and OVDP)
– Are they a one-person office in a virtual or executive suite (you can Google their address) or do they have an established address?
– If they “worked for the IRS,” find out for how long, in what capacity, and what department at the IRS did they work for? (For example, were they an Attorney… or working as an Auditor – which would help you none in your offshore application)
-Do they have an advanced degree, such as an LLM?
-Do they have an advanced certification, such as a CPA License or EA Certification?
**If the Fee seems to too low, you usually get what you pay for…
Want to Learn More about Offshore Disclosure
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
Getting into Compliance
There are five main methods people/businesses use to get into compliance. Four of these methods are perfectly legitimate as long as you meet the requirements for the particular mechanism of disclosure. The fifth alternative, which is called a Quiet Disclosure a.k.a. Silent Disclosure a.k.a. Soft Disclosure, is ill-advised as it is illegal and very well may result in criminal prosecution.
We are going to provide a brief summary of each program below. We have also included links to the specific programs. If you are interested, we have also prepared very popular “FAQs from the Trenches” for FBAR, OVDP and Streamlined Disclosure reporting. Unlike the technical jargon of the IRS FAQs, our FAQs are based on the hundreds of different types of issues we have handled over the many years that we have been practicing international tax law and offshore disclosure in particular.
After reading this webpage, we hope you develop a basic understanding of each offshore disclosure alternative and how it may benefit you to get into compliance. We do not recommend attempting to disclose the information yourself as you may become subject to an IRS investigation insofar as you will have to answer questions directly to the IRS, which you can avoid with an attorney representative.
If you retain an attorney, then you will get the benefit of the attorney-client privilege which provides confidentiality between you and your representative. With a CPA, there is a relatively small privilege which does provide some comfort, but the privilege is nowhere near as strong as the confidentiality privilege you enjoy with an attorney.
Since you will be dealing with the Internal Revenue Service and they are not known to play nice or fair – it is in your best interest to obtain an experienced Offshore Disclosure Attorney.
OVDP is the Offshore Voluntary Disclosure Program — a program designed to facilitate taxpayer compliance with IRS, DOT, and DOJ International Tax Reporting and Compliance. It is generally reserved for individuals and businesses who were “Willful” (aka intentional) in their failure to comply with U.S. Government Laws and Regulations.
The Offshore Voluntary Disclosure Program is open to any US taxpayer who has offshore and foreign accounts and has not reported the financial information to the Internal Revenue Service (restrictions apply). There are some basic program requirements, with the main one being that the person/business who is applying under this amnesty program is not currently under IRS examination.
The reason is simple: OVDP is a voluntary program and if you are only entering because you are already under IRS examination, then technically, you are not voluntarily entering the program – rather, you are doing so under duress.
Any account that would have to be included on either the FBAR or 8938 form as well as additional income generating assets such as rental properties are accounts that qualify under OVDP. It should be noted that the requirements are different for the modified streamlined program, in which the taxpayer penalties are limited to only assets that are actually listed on either an FBAR or 8938 form; thus the value of a rental property (reduced by any outstanding mortgage) would not be calculated into the penalty amount in a streamlined application, but it would be applicable in an OVDP submission.
An OVDP submission involves the failure of a taxpayer(s) to report foreign and overseas accounts such as: Foreign Bank Accounts, Foreign Financial Accounts, Foreign Retirement Accounts, Foreign Trading Accounts, Foreign Insurance, and Foreign Income, including 8938s, FBAR, Schedule B, 5741, 3520, and more.
What is Included in the Full OVDP Submission?
The full OVDP application includes:
- Eight (8) years of Amended Tax Return filings;
- Eight (8) Years of FBAR (Foreign Bank and Account Reporting Statements);
- Penalty Computation Worksheet; and
- Various OVDP specific documents in support of the application.
Under this program, the Internal Revenue Service wants to know all of the income that was generated under these accounts that were not properly reported previously. The way the taxpayer accomplishes this is by amending tax returns for eight years.
Generally, if the taxpayer has not previously reported his accounts, then there are common forms which were probably excluded from the prior year’s tax returns and include 8938 Forms, Schedule B forms, 3520 Forms, 5471 Forms, 8621 Forms, as well as proof of filing of FBARs (Foreign Bank and Financial Account Reports).
The taxpayer is required to pay the outstanding tax liability for the eight years within the disclosure period – as well as payment of interest along with another 20% penalty on that amount (for nonpayment of tax). To give you an example, let’s pick one tax year during the compliance period. If the taxpayer owed $20,000 in taxes for year 2014, then they would also have to include in the check the amount of $4,000 to cover the 20% penalty, as well as estimated interest (which is generally averaged at about 3% per year). This must be done for each year during the compliance period.
Then there is the “FBAR/8938” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (accounts which were previously reported are not calculated into the penalty amount).
For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all of their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.
Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe and remember that by entering the program, the applicant is seeking to avoid criminal prosecution!
2. Streamlined Domestic Offshore Disclosure
The Streamlined Domestic Offshore Disclosure Program is a highly cost-effective method of quickly getting you into IRS (Internal Revenue Service) or DOT (Department of Treasury) compliance.
What am I supposed to Report?
There are three main reporting aspects: (1) foreign account(s), (2) certain specified assets, and (3) foreign money. While the IRS or DOJ will most likely not be kicking in your door and arresting you on the spot for failing to report, there are significantly high penalties associated with failing to comply.
In fact, the US government has the right to penalize you upwards of $10,000 per unreported account, per year for a six-year period if you are non-willful. If you are determined to be willful, the penalties can reach 100% value of the foreign accounts, including many other fines and penalties… not the least being a criminal investigation.
Reporting Specified Foreign Assets – FATCA Form 8938
Not all foreign assets must be reported. With that said, a majority of assets do have to be reported on a form 8938. For example, if you have ownership of a foreign business interest or investment such as a limited liability share of a foreign corporation, it may not need to be reported on the FBAR but may need to be disclosed on an 8938.
The reason why you may get caught in the middle of whether it must be filed or not is due largely to the reporting thresholds of the 8938. For example, while the threshold requirements for the FBAR is when the foreign accounts exceed $10,000 in annual aggregate total – and is not impacted by marital status and country of residence – the same is not true of the 8938.
The threshold requirements for filing the 8938 will depend on whether you are married filing jointly or married filing separate/single, or whether you are considered a US resident or foreign resident.
Other Forms – Foreign Business
While the FBAR and Form 8938 are the two most common forms, please keep in mind that there are many other forms that may need to be filed based on your specific facts and circumstances. For example:
- If you are the Beneficiary of a foreign trust or receive a foreign gift, you may have to file Form 3520.
- If you are the Owner of a foreign trust, you will also have to file Form 3520-A.
- If you have certain Ownerships of a foreign corporation, you have to file Form 5471.
- And (regrettably) if you fall into the unfortunate category of owning foreign mutual funds or any other Passive Foreign Investment Companies then you will have to file Form 8621 and possibly be subject to significant tax liabilities in accordance with excess distributions.
Reporting Foreign Income
If you are considered a US tax resident (which normally means you are a US citizen, Legal Permanent Resident/Green-Card Holder or Foreign National subject to US tax under the substantial presence test), then you will be taxed on your worldwide Income.
It does not matter if you earned the money in a foreign country or if it is the type of income that is not taxed in the country of origin such as interest income in Asian countries. The fact of the matter is you are required to report this information on your US tax return and pay any differential in tax that might be due.
In other words, if you earn $100,000 USD in Japan and paid 25% tax ($25,000) in Japan, you would receive a $25,000 tax credit against your foreign earnings. Thus, if your US tax liability is less than $25,000, then you will receive a carryover to use in future years against foreign income (you do not get a refund and it cannot be used against US income). If you have to pay the exact same in the United States as you did in Japan, it would equal itself out. If you would owe more money in the United States than you paid in Japan on the earnings (a.k.a. you are in a higher tax bracket), then you have to pay the difference to the U.S. Government.
3. Streamlined Foreign Offshore Disclosure
What do you do if you reside outside of the United States and recently learned that you’re out of US tax compliance, have no idea what FATCA or FBAR means, and are under the misimpression that you are going to be arrested and hauled off to jail due to irresponsible blogging by inexperienced attorneys and accountants?
If you live overseas and qualify as a foreign resident (reside outside of the United States for at least 330 days in any one of the last three tax years or do not meet the Substantial Presence Test), you may be in for a pleasant surprise.
Even though you may be completely out of US tax and reporting compliance, you may qualify for a penalty waiver and ALL of your disclosure penalties would be waived. Thus, all you will have to do besides reporting and disclosing the information is pay any outstanding tax liability and interest, if any is due. (Your foreign tax credit may offset any US taxes and you may end up with zero penalty and zero tax liability.)
*Under the Streamlined Foreign, you also have to amend or file 3 years of tax returns (and 8938s if applicable) as well as 6 years of FBAR statements just as in the Streamlined Domestic program.
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