Increased Risk of IRS International Tax Prosecution & Penalties (2018)
Increased Risk of IRS International Tax Prosecution & Penalties (2018)
In the last year, much has happened with international tax law and the IRS. First, the IRS developed more than 20 new tax enforcement groups — many of which were designed exclusively to curtail tax fraud, tax evasion and money laundering of international money.
In addition, the IRS set a termination date for OVDP.
OVDP Terminates on 9/28/2018
Even though the IRS indicated that it would most likely provide the public at least a year leeway before terminating offshore disclosure, the IRS broke its own word, and in March 2018 provided the public with formal notice that September 28, 2018 would be the last day that a person could submit to OVDP (Phase 1, not just Preclearance).
The submission must include the first phase of OVDP – and therefore even if you have not received any response from the IRS regarding the preclearance letter (typical preferred method for commencing OVDP), September 28, 2018 is the last date to submit the subsequent phase 1 documentation.
International Tax Enforcement
For some reason, there are still attorneys who like to provide false advice and information to the public. They make statements that the reason the IRS is getting rid of OVDP is because it is antiquated or no longer viable – that is absolutely wrong.
In fact, even a cursory review of the National Tax Advocate’s recent summary about penalties shows that in general, the issuance of international tax penalties have skyrocketed – especially when it involves foreign trusts and foreign businesses.
Moreover, with the introduction of the new tax enforcement groups and the termination of OVDP, what is actually happening is that the IRS is removing the carrot and stick.
Therefore, if you know you were willful or acted with reckless disregard and were hoping that at some point you could submit to OVDP, pay a set penalty, and avoid an audit or criminal investigation – your window of opportunity is slowly closing.
This is not because the IRS is forgoing international tax enforcement, but rather the exact opposite is true.
Thus, while the IRS is aggressively pursuing international tax penalties, they will be no longer providing you with OVDP as an option to safely get into compliance for your overseas misdeeds.
Highly Trained IRS International Tax Agents
When the IRS indicated that it would be creating these new enforcement groups, they were also clear that the agents assigned to these cases would be highly experienced agents in the field of international tax law – experts as the IRS provided. Overall it will be much more difficult for you to hide your money overseas or abroad and avoid the long arm of the IRS – especially because now these agents will know exactly where to look to find your information.
In addition, and in accordance with FATCA, more than 110 foreign countries and more than 300,000 Foreign Financial Institutions are actively reporting US account holder information to the IRS.
Tax Enforcement Direct Penalties vs. OVDP
Essentially, here’s how it would work: Prior to FATCA and prior to the development and integration of these new International tax enforcement groups, the IRS would have little to go on to obtain the information regarding your undisclosed foreign accounts. The IRS needed you to enter the traditional OVDP, in order to obtain the necessary information regarding the foreign accounts.
But, in the more recent years with the enforcement of FATCA, along with implosions of former offshore tax have schemes, such as Swiss Bank Accounts and Panamanian Foundations, the IRS is receiving this information without the need for you to provide it by way of a voluntary disclosure.
As a result, the IRS is using direct tax enforcement to issue fines and penalties – because it no longer needs you to voluntarily disclose under OVDP.
Therefore, by getting rid of OVDP and integrating new tax enforcement groups, the IRS is simply going to penalize you first, and let you play defense to try to talk your way out of potential 50% or 100% penalties and/or a civil or criminal investigation versus letting you play offense, and proactively handling the situation, limit ingyour penalties, and avoiding an audit or investigation on the international tax issues.
What Can You Do?
You have a decision to make. First, you have to determine whether you were willful or non-willful. If you are non-willful, then you next have to determine whether you prefer to enter the streamlined program (or possibly reasonable cause) or prefer instead to enter the traditional OVDP (there are many reasons why a “non-willful” person would choose OVDP).
Then, you have to keep in mind the IRS deadline is looming — along with the fact that if the IRS contacts you before you enter either one of these programs, you are no longer eligible to enter the program.
*If before submitting Offshore Disclosure you find out that you are already under audit or examination by the IRS, you have to be very cautious. Why? Because the IRS may already have your information, and while you may think you are being subject to a simple audit, the IRS may already have your information, and you may actually be in the crosshairs of a reverse eggshell audit.
Out of IRS International Tax Compliance?
The first thing you should do is speak with an experienced offshore disclosure attorney.
What To Look For in an OVDP Attorney?
There are only a handful of Law Firms that focus their entire tax practice on IRS Offshore Voluntary Disclosure (We are one of them). We have represented several hundred clients in OVDP, Streamlined and Offshore Disclosure.
You will want to make sure you use an OVDP Attorney who has:
- Litigation Experience
- IRS Audit Experience
- At Least 15-20 years of Attorney Experience
- An advanced Master’s of Tax Law Degree (LL.M.); and
- Either a CPA or Enrolled Agent (EA) license.
Why? Because you never know how the OVDP or Streamlined submission will go. Sometimes, a person is already under IRS investigation and may not know it. Then, when the person submits to OVDP they are rejected. In this type of situation, you need an Attorney with all the above required experience.
Using a CPA or Junior Attorney with no real experience, is not going to help (and you will then realize why the fees they charged were so low). We know this, because each year we receive many inquiries from clients seeking to retain our services after their initial OVDP or Streamlined junior tax attorney (without the experience mentioned above) flubbed their submission and made numerous mistakes in the submission process.
Alternatively, once you are in OVDP, you may want to:
- Make an MTM Election
- Argue a FAQ 55 Penalty Reduction
As a result, for this highly specialized area of law, you need an OVDP Attorney who is experienced specifically in OVDP, but also has the background and experience to fight on your behalf.
Offshore Disclosure Options
There are typically four types of IRS Offshore Voluntary Disclosure programs, and they include:
- Offshore Voluntary Disclosure Program (OVDP)
- Streamlined Domestic Offshore Procedures (SDOP)
- Streamlined Foreign Offshore Procedures (SFOP)
- Reasonable Cause (RC)
IRS Voluntary Disclosure of Offshore Accounts
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 for one or more years, you were required to file a U.S. tax return, FBAR or other International Informational Return and you did not do so timely, then you are out of compliance.
Common Un-filed IRS International Tax Forms
Common un-filed international tax forms, include:
- 1040 (Tax Returns)
- Schedule B (Ownership or Signature Authority over Foreign Accounts)
- FBAR (FinCEN 114)
- FATCA (Form 8938)
- Form 3520 (Gift from Foreign Person)
- Form 5471 (Foreign Corporations)
- Form 8621 (Foreign Investments, aka PFIC)
- Form 8865 (Foreign Partnership)
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 IRS Offshore 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.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
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.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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