New IRS International Information Return Enforcement Risks
Contents
- 1 A Foreign Information Return Penalties Overview
- 2 International Reporting Requirements
- 3 First, Unfiled International Reporting Forms Lead to Indefinite Enforcement
- 4 Large Foreign Information Return Penalties and Several Methods of Enforcement
- 5 FBAR
- 6 Form 3520 Trust
- 7 Form 3520- Gifts
- 8 Form 3520-A
- 9 Form 5471 Penalties
- 10 Form 5472 Penalties
- 11 Form 8865
- 12 Form 8938 Penalties
- 13 Levy, Lien, or Seizure
- 14 Writ Ne Exeat Republica
- 15 Immigration Impact of Foreign Reporting Non-Compliance
- 16 Late-Filing Disclosure Options
- 17 Quiet Disclosure
- 18 Need Help Finding an Experienced Offshore Tax Attorney?
- 19 Golding & Golding: About Our International Tax Law Firm
A Foreign Information Return Penalties Overview
In recent months, there has been a significant increase in international and foreign account enforcement protocols by the Internal Revenue Service and U.S. Citizenship and Immigration Services. The U.S. government has been aggressively enforcing non-compliance with international information return filing, by not only issuing CP15 notices, but once the notice is issued, following up the notice with a CP508C Notice — the latter of which impacts a U.S. taxpayer’s right to obtain, maintain, and renew a passport. It was only recently that the IRS began aggressively enforcing passport revocations and denials — it was usually reserved in situations in which the IRS had spent several years trying to go after the taxpayer for unresolved tax and penalty debts. Making matters worse, is that the IRS can use this tactic in situations in which the taxpayer actually has no unreported income but only failed to file an international information reporting form such as a Form 3520 or Form 8938 (although passport revocation does not apply to FBAR penalties, since technically the FBAR is not an IRS tax form). Let’s take a brief look at how the failure to file international information returns can lead to penalties and immigration consequences.
*This Article was originally published in 2020 and updated to reflect recent changes in IRS enforcement protocols.
International Reporting Requirements
When it comes to international reporting penalties, there are many different violations that the IRS likes to go after for US taxpayers who did not properly report their foreign assets.
Some of the more common types of foreign money include:
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foreign bank accounts
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foreign investment accounts
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foreign trusts
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foreign corporations
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foreign gifts
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foreign pension plans, and
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foreign life insurance policies
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First, Unfiled International Reporting Forms Lead to Indefinite Enforcement
In most situations, the Internal Revenue Service has either three years or six years to enforce compliance with missed tax filings. Usually, unless the IRS can show the taxpayer acted fraudulently or the form was never filed in the first place, the IRS has a limited time to enforce compliance. Unfortunately, under IRS section 6501, the time to enforce international information reporting can continue beyond 6 years — even when the underlying tax return was filed, such as a Form 1040. In other words, even if a taxpayer files a tax return, if they fail to include or otherwise file the required international information reporting form, the IRS could take the position that the return remains open at least to the enforcement of the international component that was not complied with. This could lead to taxpayers being fined hundreds of thousands of dollars or more, even after six years have passed since the 1040 tax return was filed.
Large Foreign Information Return Penalties and Several Methods of Enforcement
The IRS has significant leeway when it comes to enforcing international reporting penalties. Depending on the type of form that the taxpayer failed to file and the value of the asset or account, the taxpayer could be looking at several hundred thousand dollars — and even millions of dollars — in penalties. For example, if a taxpayer receives a foreign inheritance of $5 million but fails to file Form 3520 after five months, they could be looking at a $1.25 million penalty. Likewise, if the taxpayer fails to file Form 8938 over multiple years, they could be looking at an annual $10,000 a year penalty as well. Thus, taxpayers who are required to file international reporting penalties have to weigh the pros and cons of trying to stay under the radar and not going back to file late-filed returns — and the reality that the IRS has many years to enforce these penalties against them. The IRS also has various enforcement protocols that can be used to collect on those penalties, including liens, levies, and collection assistance with the foreign jurisdiction — especially in countries where there is a tax treaty and the countries have entered into a mutual collection agreement protocol. Here are some common forms that result in penalties:
FBAR
Each year, taxpayers who have foreign bank and financial accounts are required to file an annual FBAR if they meet the threshold requirements for reporting. As a result of the new 2023 Supreme Court FBAR ruling, the penalty structure for civil non-willful FBAR violations has changed. For non-willful FBAR violations, the IRS is limited to $10,000 per year (adjusted for inflation). Willful civil FBAR penalties are still a 50% penalty on the maximum unreported value for each account, for up to six years. And while rare, the IRS (in limited circumstances) can refer the matter for criminal investigation. The following penalties are reproduced from the IRS, as follows:
Form 3520 Trust
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“Section 6677. A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable).
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35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust in Part I. -2- Instructions for Form 3520 (2022)
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35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution in Part III.
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5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information.
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If a foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A, which is otherwise due by the 15th day of the 3rd month after the end of the trust’s tax year) in order to avoid being subject to the penalty for the foreign trust’s failure to timely file Form 3520-A.
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For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for U.S. owners who are individuals), is considered to be timely filed. See section 6677(a) through (c) and the instructions for Part II of this form and Form 3520-A. Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. If the IRS can determine the gross reportable amount (defined later), then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross reportable amount. For more information, see section 6677.”
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Form 3520- Gifts
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Section 6039F.
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In the case of a failure to timely report foreign gifts described in section 6039F, the IRS may determine the income tax consequences of the receipt of such gift, and a penalty equal to 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. See section 6039F for additional information.
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Form 3520-A
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“The U.S. owner is subject to an initial penalty equal to the greater of $10,000 or 5% of the gross value (defined later) of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year if the foreign trust (a) fails to file a timely Form 3520-A, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c). If a foreign trust fails to file a Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for Form 3520-A) in order to avoid being subject to a penalty for the foreign trust’s failure to file a Form 3520-A. For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for the U.S. owners who are individuals) is considered timely filed.
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Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. If the IRS can determine the gross value (defined later) of the portion of the trust’s assets treated as owned by the U.S. person at the close of the tax year, then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross value of the trust. For more information, see section 6677.
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Criminal penalties may be imposed under sections 7203, 7206, and 7207 for failure to file on time and for filing a false or fraudulent return.”
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Form 5471 Penalties
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“A $10,000 penalty is imposed for each annual accounting period of each foreign corporation for failure to furnish the information required by section 6038(a) within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign corporation) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.
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Any person who fails to file or report all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure to the U.S. person, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038(c) (2) for limits on the amount of this penalty. See Regulations sections 1.6038-1(j) and 1.6038-2(k)(3) for alleviation of this penalty in certain cases. Failure to file information required by section 6046 and the related regulations (Form 5471 and Schedule O).
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Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction. If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000. See section 6679. Criminal penalties. Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file the information required by sections 6038 and 6046.”
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Form 5472 Penalties
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A penalty of $25,000 will be assessed on any reporting corporation that fails to file Form 5472 when due and in the manner prescribed. The penalty also applies for failure to maintain records as required by Regulations section 1.6038A-3.
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Filing a substantially incomplete Form 5472 constitutes a failure to file Form 5472. Each member of a group of corporations filing a consolidated information return is a separate reporting corporation subject to a separate $25,000 penalty and each member is jointly and severally liable. If the failure continues for more than 90 days after notification by the IRS, an additional penalty of $25,000 will apply.
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This penalty applies with respect to each related party for which a failure occurs for each 30-day period (or part of a 30-day period) during which the failure continues after the 90-day period ends. Criminal penalties under sections 7203, 7206, and 7207 may also apply for failure to submit information or for filing false or fraudulent information.
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Form 8865
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“Failure to timely submit all information required of Category 1 and 2 filers.
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A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information isn’t filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.
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Any person who fails to furnish all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038 (and the underlying regulations) for the maximum reduction, the exception due to reasonable cause, and the limits on the amount of these penalties. • Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information.
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Additionally, any person that files under the constructive owners exception may be subject to these penalties if all the requirements of the exception aren’t met. Any person required to file Form 8865 who doesn’t file under the multiple Category 1 filers exception may be subject to the above penalties if the other person doesn’t file a correctly completed form and schedules. See Exceptions to Filing, earlier.”
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Form 8938 Penalties
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You may be subject to penalties if you fail to timely file a correct Form 8938 or if you have an understatement of tax relating to an undisclosed specified foreign financial asset.
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Failure-To-File Penalty: If you are required to file Form 8938 but do not file a complete and correct Form 8938 by the due date (including extensions), you may be subject to a penalty of $10,000.
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Continuing Failure To File: If you do not file a correct and complete Form 8938 within 90 days after the IRS mails you a notice of the failure to file, you may be subject to an additional penalty of $10,000 for each 30-day period (or part of a period) during which you continue to fail to file Form 8938 after the 90-day period has expired. The maximum additional penalty for a continuing failure to file Form 8938 is $50,000.
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Levy, Lien, or Seizure
Just because a taxpayer may have missed reporting foreign income does not mean the IRS is limited to trying to go overseas to collect taxes and penalties. Rather, the IRS can place a levy, lien, and/or seize a U.S. person’s United States property and bank accounts. In addition, the IRS may be able to go overseas to try to enforce tax liabilities and penalties by way of various double tax treaties and FATCA agreements between the United States and foreign countries — but it is usually easier for the Internal Revenue Service to instead issue a Notice of Federal Tax Lien or Levy against US properties or assets.
Writ Ne Exeat Republica
While the Internal Revenue Service has many different options available when it comes to seeking enforcement of unpaid tax and penalty liabilities, the Writ Ne Exeat Republica is one of the least common and most lethal — if for no other reason than its ability to stun and immobilize a taxpayer. Unlike an IRS levy or lien, which focuses on the accounts and assets of the taxpayer, the Writ Ne Exeat Republica focuses on the taxpayer himself. More specifically, it may prevent the taxpayer from leaving the jurisdiction until a tax liability has been resolved.
Immigration Impact of Foreign Reporting Non-Compliance
Recently, many taxpayers have received CP-508C notices regarding the failure to pay outstanding tax and penalty liabilities for prior years. The CP-508C notice is a very dangerous IRS tool because it allows the IRS to weaponize a taxpayer’s immigration status. More specifically, if a taxpayer receives a CP-508C Notice, then they risk either losing the ability to renew their passport or possibly having their passport revoked. The threshold for receiving a CP-508C notice is not extraordinarily high, and it begins at $50,000 (annually adjusted for inflation). These penalties may include international reporting penalties as well, although they do not include FBAR penalties.