Inheriting an Estate with Offshore Accounts – FBAR, FATCA & IRS
Inheriting an Estate with Offshore Accounts – FBAR, FATCA & IRS Rules
With the introduction and enforcement of FATCA, it is becoming much more common for individuals who inherit money from individuals who have assets, income or investments overseas to realize that the person leaving the inheritance may not have been in IRS compliance regarding their foreign accounts, including not having filed FBARs.
Offshore Accounts & The Estate
The situation of probate, estate planning and the discovery of foreign accounts is a very common issue. Luckily, especially in situations in which the estate, decedent and/or the beneficiary was non-willful, there may be a relatively simple and straightforward means to resolving the issue — by entering the streamlined offshore disclosure program, and bringing the estate into IRS compliance.
Michelle is the administrator of her mother’s trust. Her father passed away many years ago and her mother only recently passed away. While Michelle is going through her mother’s belongings, she finds bank statements and a passbook for bank accounts in Hong Kong that she never knew existed.
In following up with the bank, Michelle learns that these accounts have been opened for several years (Michele’s mom is originally from Hong Kong).
It turns out that the bank account had accumulated wealth over time and is now worth in the neighborhood of $400,000.
While this is a bit of a treasure trove for Michelle, she has to make sure she handles the reporting and disclosure properly.
What are Michelle’s Next Steps?
Review Mom’s Tax Returns
Even though Michelle did not know about the accounts, that does not mean that Michelle’s mom and her CPA may not have been aware of the accounts. It’s not like our parents tell us everything, right? Therefore, Michelle’s first step is to contact her mother’s CPA or accountant (presuming there was one) to determine whether these accounts will properly reported to the IRS. Otherwise, Michelle should review the returns herself or with a Tax Attorney.
Since the value of the account is around $400,000, it would presume that in the last few years, Michelle’s mom had a few reporting requirements involving schedule B of the 1040, FBAR & FATCA.
When Michelle contacts her mom’s accountant, she learns that the accountant was none the wiser either. As such, the accounts were not disclosed on Michelle’s moms tax returns.
Therefore, Michelle has two issues:
- Amending the prior returns, and
- Filing her mom’s last tax return, as well as the estate tax return.
Why Michelle Should Do Something
Sometimes, it is easier to let sleeping dogs lie and not bother resolving a situation in which Michelle has no knowledge or background. The problem is that in this situation, there is a bit of an ongoing problem. Why?
- The IRS can still audit the estate
- The foreign bank may have already reported Michele’s mom to the IRS
- Michelle has to file her mom’s last tax return, which would introduce these foreign accounts for the first time
- Michelle has to file the estate tax return
Is There Prior Unreported Income
The United States follows a citizen-based taxation/worldwide income model. That means that even though income generated in Hong Kong through passive means such as bank interest is typically tax-free in Hong Kong, that does not make it tax-free in the United States.
In other words, Michelle’s mom had a requirement to file her tax returns and include her worldwide income – even income that is tax-free in a foreign country. If it is the type of income which is exempted under a tax treaty, then that income is also included in the tax return — typically along with a reference to the specific paragraph in the tax treaty exempting the income from taxation.
What If Michelle Doesn’t Disclose?
This could be a problem. First, in accordance with FATCA, more than 300,000 Foreign Financial Institutions are reporting millions of US account holders to the IRS. Therefore, at this time it is impossible to determine whether the IRS already has the information.
Therefore, if Michelle files for mom’s last return or the estate’s return without disclosing the information, it could lead to the IRS believing Michelle was willful and failing to report the account. Thus, since Michelle now has the knowledge of the accounts — if she does not report them and is considered to be “willful,” it could lead to excessive fines and penalties.
Typical Reporting Requirements
Since Michelle’s mother’s account exceeds $10,000, chances are she will be required to file the FBAR. The FBAR is the Report of Foreign Bank and Financial Account Form. The IRS has the authority to issue very stiff penalties against any individual who fails to properly disclose their foreign accounts in the annual FBAR Report. The FBAR is due at the same time that the tax return is due, but it is not filed with the tax return — it is submitted online directly to FinCEN.
FATCA is the Foreign Account Tax Compliance Act. It is a relatively new law that somewhat mimics the FBAR, but is filed along with a person’s tax return and has much more intensive reporting. Unlike that FBAR which only requires the reporting of the accounts maximum balance during the tax year, FATCA requires an individual to disclose a history of the income generated from the FATCA assets within form 8938. Over the years, the form has expanded and the reporting requirements are more intense than for the FBAR. Also, since form 8938 is included directly on the tax return, it is very important to stay in compliance.
In most circumstances, as long as willfulness is not an issue, and there is no knowledge that her mom was required to disclose the accounts, the estate should qualify for the streamlined filing compliance procedures. These are IRS procedures in place to assist individuals and estates, that are non-willful.
As a result, Michelle can enter the estate/her mom through this program, pay a small penalty, and then the estate can move forward clean.
There is an alternative to the Streamlined Program, which is called reasonable cause — and involves a penalty waiver request. The problem is the person must show reasonable cause and since Michelle will be filing on behalf of her mom (who has now passed), it may prove difficult to show whether or not Michelle’s mom had reasonable cause in not reporting the information on previous returns.
**In the situation, it is important for Michelle to speak with her mom’s CPA or accountant to determine the background and see if a penalty waiver request is a possibility. Reasonable cause varies based on the facts and circumstances of each situation.