IRS Foreign Investment Reporting

If you have Foreign Investments, chances are you are going to have to report your Foreign Investments to the IRS (Internal Revenue Service) when you are considered a U.S. Person (even if you do not meet the threshold for filing a tax return). When it comes to the U.S. and taxes, it does not matter if your investment is located in the United States or abroad – the IRS wants to know about it.

IRS Foreign Investment Reporting – 5 Important Things to Know by Golding & Golding, APLC

IRS Foreign Investment Reporting – 5 Important Things to Know by Golding & Golding

Foreign Investments

When it comes to foreign investments, oftentimes the investment will be subject to U.S. Tax or Reporting — and even most CPAs and Attorneys are not aware of these tax/reporting requirements.

Moreover, most people are also unaware of the ridiculously steep penalties that can be issued against individuals (and how far the IRS will go to collect the penalties) for not properly reporting or paying tax on foreign investments.

Tax liability will often be determined by whether any passive income was accrued or distributed, and/or any elections were made

Certain Foreign Investments are “Bad”

Depending on the type and nature of the foreign investment, an individual may become subject to US tax immediately, even if it is an investment which has not been distributed yet. This is very common for individuals who have any ownership in a foreign PFIC (Passive Foreign Investment Company) and did not make a proper election such as an MTM or QEF election.

The following is a brief summary of five important things to know about you foreign investments.

You May have an FBAR Filing Requirement

The FBAR (Report of Foreign Bank and Financial Account form) is one of the most important forms to file when you have foreign investments. First, it has a very low threshold requirement, which is an annual aggregate total (of all accounts), of all different types (accounts are not grouped by type) when the threshold requirement of $10,000 is exceeded on any day of the year. It does not matter the type of investment account (if it qualifies), and it does not matter whether the individual owns the account separately, jointly, or merely has signature authority.

For any of these above-referenced scenarios, the IRS wants to know about your account information — and contrary to popular belief reporting goes far beyond mere bank accounts. Chances are, your foreign mutual fund, foreign pension, foreign investment fund, foreign life insurance, and other foreign retirement plans will qualify as an account which must be reported on the FBAR.

The penalties for failing to report this information are as low as a warning letter in lieu of penalty (Form 3800), and all the way up to 100% value of the accounts in a multiyear audit.

You May Also have a Form 8938 Requirement

Form 8938 is a relatively new form that came into existence in 2011. It was developed in accordance with FATCA (Foreign Account Tax Compliance Act) and it is similar to the FBAR. But unlike the FBAR, Form 8938 is filed directly with your taxes. In addition, unlike the FBAR which just reports the maximum balances, Form 8938 requires that you detail (line by line) the type of income you receive (such as dividends, interest, or capital gain) along with the total amount that was received or earned.

In addition, Form 8938 asks much more specific questions such as:

  • Whether the account is owned individually or jointly with a spouse
  • Whether was opened in the year of filing
  • Whether it was closed in the year of filing, and
  • Whether any income was earned on the asset.

Finally, there are some distinctions from the FBAR. For example, on form 8938 a person only reports an asset if he or she has an interest in it (which may be different than reporting it on an FBAR when a person has no interest in the account). Moreover, while it includes certain items such as direct stock ownership (which is not required on the FBAR), it excludes other types reporting is otherwise required on the FBAR.

Year of Acquisition – 10% Ownership

Depending on whether you received more than 10% ownership (and there are some other threshold requirements possibly as well), you may be required to report on a much more complicated form – such as a form 5471 or 8865. These two specific forms are used when a person is required to report a foreign corporation or a foreign partnership. There are various threshold requirements to determine whether a person must report (such as whether the company was a controlled foreign company, or whether the individual controlled the company at any time).

These forms are complicated. They require at least a basic understanding of accounting, and they take a very long time complete. Moreover, the penalties for failing to report these forms timely can lead to penalties reaching six figures.

The IRS (for reasons unknown) takes the filing – or lack thereof – of these forms very seriously, even against individuals who may not be investment savvy but merely inherited or purchased a small stake in a foreign company.

**Often times, after a person files a form 5471 or 8865 in the year of acquisition and may not be required to continue filing it in subsequent years, but presumably will also have to file a form 8938 in lieu of these forms to report the specified foreign asset on a yearly basis. It depends on what “Category of Filer” you qualify as.

The Dreaded Form 8621 – PFIC

A Form 8621 is a dreaded form. It is so dreaded that most tax software programs – whether for non-tax professionals or tax professionals – does not provide any help, assistance, or guidance with the form.

The form is used when an individual has a PFIC (Passive Foreign Investment Company). In recent years, the IRS has expanded the definition of PFIC to include investments most individuals would never conceive to be considered a PFIC. The most common is a foreign mutual fund. The reason is because foreign mutual funds are not accountable to the IRS as a US mutual fund it, and usually does not the strict regulatory requirements of the US mutual fund – resulting in income being accrued, but not distributed and not taxed.

The form must be filed by individuals who meet the threshold requirement for owning PFIC. It is usually when an individual has more than $25,000 or $50,000 if married filing jointly (even in years when no distribution was made). There is no threshold requirement for reporting in years the filer has an excess distribution and typically when an election is made, the owner must file the form — even if there was no movement on the investment.

The direct penalty form 8621 is bad. In years this form was required by the taxpayer(s) but not filed, the tax return is not considered complete. In other words, it is not complete than the statute of limitations does not begin to run on the expiration of the IRS’s ability to audit you for the return.

Moreover, the IRS will argue that the entire tax return remains open during the time the form has not been filed. So feasibly, the IRS will argue that even though you only felt to report this one form, the IRS can audit the entire tax return.

Enforcement Priority & Offshore Disclosure

The Internal Revenue Service has made the enforcement of offshore reporting a key priority. It is one of the main focuses of the IRS, and in fact the IRS has recently developed new enforcement units to try to locate, investigate, and penalize individuals who are not in compliance.

If you are out of compliance, one of the best ways to get back into compliance (or compliance for the first time) is to submit to the IRS offshore voluntary disclosure program.

A summary is provided below

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 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.

1. OVDP 

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).

OVDP Penalties

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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