Foreign Income Tax Avoidance (2018) – IRS Penalties Can Be Severe
The IRS and DOJ are continuing to increase enforcement of fines and penalties against individuals who have unreported or undisclosed foreign interests.
There are several new risk factors, which increases the chances of your accounts, assets, investments, and income being discovered, including:
- FATCA Reporting by more than 110 Countries
- Offshore Reporting by more than 300,000 FFIs
- New International Tax Enforcement Groups
- Renewed interest in FBAR Penalties
OVDP Ends on 9/28/2018
In addition, the IRS is closing the OVDP “Program” on September 28, 2018, which means if you were willful (or otherwise prefer OVDP to Streamlined), than you will have no other outlet at this time for making a voluntary disclosure, short of contacting the CI (Criminal Investigation) Department of the IRS and making a direct “Attorney Proffer” which is far different than submitting under the gentler OVDP.
Foreign Accounts/Income & Risk of Exposure
You may be wondering how the IRS would even be able to find your offshore money, in order to penalize you.
The following is a brief example about how the IRS goes about uncovering your “secret” foreign money.
Offshore Money Case Study Example: Brad
Brad is originally from Taiwan. He relocated to the United States back in 2012 and is now a Legal Permanent Resident “Green Card Holder” seeking naturalization in the United States. He has a sizable nest egg in Taiwan, which earns interest income each year.
Brad files his U.S. tax returns timely each year using TurboTax.
U.S. Based Income
Brad has his own company in the United States, and makes a solid living. The company is a consulting company, and therefore does not have significant expenses — other than Brad’s business, travel and entertainment expenses.
Overall, Brad’s tax return is not too complex.
Taiwan Income and Accounts
Brad also has accounts and income from Taiwan. In any given year, the accounts have about $5 million combined, and generate about $200,000 year. The first year or two in in preparing his tax returns, Brad did not understand whether he was supposed to report his foreign accounts, since he was on temporary visa status.
Fast-forward to 2015, and Brad is now aware that he will have to report both the foreign accounts and the income on his US Tax Return. Brad decided that he would prefer not to report his Taiwanese Accounts/Income, since Taiwan had not actually signed the FATCA Agreement yet, and he never received any notice from his bank. He also never updated them as to his U.S. Status, but he did place his mom on the account to obtain any necessary information (and in order to not provide his U.S. address).
He just presumed he would just take care of it later…
In 2017 Brad’s mom back in Taiwan informed Brad that she received a FATCA letter for him.
Brad never thought he would receive a FATCA letter because he never updated his foreign bank that he was residing in the United States and/or requested any mail sent to the US.
Unfortunately, recently Brad had to apply for credit for his U.S. business, since he is seeking to expand. The loan company ran a credit check on Brad and then contacted some of the banks for references.
When Brad completed the loan application, he obviously used his U.S. address since he is a U.S. person seeking a U.S. loan for his U.S. company.
Brad is Audited by the IRS
Before Brad has the opportunity to even respond to the FATCA Letter (and presumably get himself further into trouble), he receives an IRS Audit Notice. The Audit has nothing to with the foreign accounts. Rather, Brad waffled back and forth between using the cash method accrual method for his U.S. business, and never fixed the issue.
This resulted in a significant disparity of income from the first year started the business to the present.
Major Concerns for Brad
Brad is No Longer Eligible for Offshore Disclosure
Since Brad has received Notice of an IRS Audit or Examination from the IRS, he is now ineligible to enter any of the approved IRS Offshore Voluntary Disclosure Program.
Does the IRS Know About the Foreign Accounts?
It is impossible to know whether the IRS is already aware of Brad’s foreign account(s) and income. This puts Brad into an impossible position, because on the one hand he is supposed to completely come clean during the audit, and if the IRS agent asks about unreported foreign or domestic income, he is supposed to disclose.
On the flipside, the audit is a civil audit and Brad has a right against self-incrimination. This is called an Eggshell Audit/Reverse Eggshell Audit.
IRS Offshore Penalty List
A Penalty for failing to file FBARs
United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
FATCA Form 8938
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A Penalty for failing to file Form 3520
Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A Penalty for failing to file Form 3520-A
Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
A Penalty for failing to file Form 5471
Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A Penalty for failing to file Form 5472
Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
A Penalty for failing to file Form 926
Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
A Penalty for failing to file Form 8865
Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Fraud penalties imposed under IRC §§ 6651(f) or 6663
Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
A Penalty for failing to file a tax return imposed under IRC § 6651(a)(1)
Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
A Penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2)
If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
An Accuracy-Related Penalty on underpayments imposed under IRC § 6662
Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty
Possible Criminal Charges related to tax matters include tax evasion (IRC § 7201)
Filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
A person convicted of tax evasion
Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
What Brad Could have Done
Once Brad realized he had made some mistakes with his tax return, he could’ve easily gotten into compliance. That is because at that time he had not acted intentionally, and therefore would presumably qualify for the streamlined program.
Moreover, depending on when he learned about the reporting requirement, he may have qualified for the Streamlined Foreign Offshore Procedures, and avoided all fines and penalties.
Unfortunately, by knowingly, willfully or recklessly continuing to file tax returns improperly and intentionally not including the foreign accounts and income on his tax returns, Brad is now willful, and may suffer extensive fines and penalties.
What Should You Do?
Everyone makes mistakes. If at some point that you should have been reporting your foreign income, accounts, assets or investments the prudent and least costly (but most effective) method for getting compliance is through one of the approved IRS offshore voluntary disclosure program.
Summary of IRS Offshore Voluntary 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 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.
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.
Contact us Today, We can Help You!