- 1 IRS Streamlined Program Audit
- 2 3-Year Statute of Limitations
- 3 6-Year Statute of Limitations – +$5,000 Foreign Money
- 4 FATCA Form 8938 (Prior 3 Years)
- 5 How Will the IRS Find Out?
- 6 Watch Out For Inexperienced Counsel
- 7 This is not Uncommon; You are Not Alone
- 8 What are my Offshore Voluntary Disclosure Options?
- 9 1. OVDP
- 10 2. Streamlined Domestic Offshore Disclosure
- 11 3. Streamlined Foreign Offshore Disclosure
IRS Streamlined Program Audit
While the IRS Streamlined Offshore Disclosure Program may be a good option for those individuals who meet the threshold requirements, and are confident in their non-willfulness, there is a danger lurking for some individuals.
Even though these Streamlined Applicants may be non-willful, they could possibly be subject to additional fines and penalties.
How? The danger lies in un-filed Form 8938 (or other International Reporting Forms) that should’ve been filed in the three years prior to the audit. While under many circumstances, three years is the maximum amount of time the IRS may audit you, that is not the only statue limitations.
In fact, when it comes to unreported foreign income or foreign money, the amount of time the IRS has to argue may double – even without having to prove fraud – to six (6) years.
3-Year Statute of Limitations
In a typical audit situation, the IRS has three years to audit you (Note: most international tax matters are not “typical”). The way the statute is applied is a bit confusing:
– It is three years from the date that the tax return is due or later, if filed later. Example, if David files his taxes on February 10, 2015, then the IRS has three years audit and from April 15, 2015. In other words, filing a tax return before the April 15 deadline does not limit the statute of limitations for the IRS.
– If David files the tax return after April 15, 2015, the IRS will still have three years audit him from the date the late return was filed; in other words, the statute is not minimized because David filed a late return (it may also limit David’s ability to apply for a credit, if applicable)
– If David was required to file a form 8621, but didn’t do so, then the stature limitations does not begin to run.
6-Year Statute of Limitations – +$5,000 Foreign Money
When a person has significant amounts of unreported US income, the IRS has an additional three years to audit them. Likewise, there is an exception to the “significant amount of income” will when it involves foreign accounts and foreign money.
There is some ambiguity and how the statute is written, and how the statute is applied, but feasibly, if a person has more than $5000 of unreported foreign “money,” (not just income) the IRS can increase the audit from three years to six years. Specifically, the IRS provides: “Sec. 6501(e)(1)(ii) extends the period to six years for failure to report specified foreign financial assets whose total value exceeds $5,000.”
Some tax practitioners will argue that when the statute is read together as a whole, the $5000 should only refer to $5000 worth of income, but the IRS seems to be enforcing the rule as if it is merely $5000 of unreported money.
FATCA Form 8938 (Prior 3 Years)
When a person submits to the IRS streamlined program, they have to go back and amend the returns for three years. A typical example would be Michelle, who filed incorrect tax returns for 2014 through 2016. Therefore, when Michelle enters the streamlined program, she will have to amend her tax returns for 2014, 2015, in 2016.
Here’s the problem: Michelle also did not file form 8938 for 2011, 2012 and 2013. Therefore, if during the audit the IRS agent has any inclination that Michelle may have had a reporting requirement to disclose foreign money in these three prior years, but did not do so, she could be subject to extremely high fines and penalties the prior years. The penalties for 8938 can reach upwards of $60,000.
How Will the IRS Find Out?
Relatively easily. Why? Because part of the streamlined program a person has to file or amend FBARs for 6 years. Using the same example from above, Michelle would have had to file FBARs for 2011 through 2016 — even though the IRS Streamlined Disclosure Program only requires tax returns to be amended from 2014 through 2016 in her specific case.
Watch Out For Inexperienced Counsel
You have to be careful in speaking with inexperienced counsel. Often times they would try to sell individuals on the streamlined program because it is more inexpensive and they may not have been “willful.” With that said, if the IRS agents on them and go back further, the penalties may far exceed any penalties they would’ve had if they had submitted to traditional OVDP. Had experienced counsel vetted the client out properly, the client and counsel could have discussed the decision in better detail so that the client could have made a fully informed decision.
In addition, sometimes the facts for the prior years may be different than the facts and the most recent three years, which may tip off the IRS that the applicant was not necessarily “non-willful,” and only submitted to the streamlined program to avoid the perceived penalties under OVDP — and now the IRS agent wants to recommend the individual the investigated by the IRS Special Agents.
This is not Uncommon; You are Not Alone
In recent months, we have had an uncharacteristically number of individuals contact us after first speaking with us, and then speaking with less experienced attorneys who sell them on the streamlined program when they should have submitted OVDP.
We recently drafted a blog posts involving the dangers looming for individuals who are tricked by unethical, and experienced counsel to go streamlined when they should have submitted to traditional OVDP.
A Link to this blog post can be found below:
What are my Offshore Voluntary Disclosure Options?
There are multiple different 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.
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 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.
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Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)