Just Learned your Foreign Spouse has Offshore Accounts, Income or Investments?
- 0.1 Typical Example
- 0.2 IRS Tax Returns
- 0.3 Streamlined Program or Reasonable Cause?
- 0.4 Reasonable Cause – Viable Option
- 0.5 Reasonable Cause – Process
- 0.6 Benefits of Reasonable Cause
- 0.7 Detriments of Reasonable Cause
- 0.8 Common Questions to Consider – Reasonable Cause
- 1 STREAMLINED PROGRAM OPTIONS
- 1.1 What is the Non-Compliance of Foreign Accounts?
- 1.2 Two Types of Streamlined Programs
- 1.3 Streamlined Domestic Offshore Procedures
- 1.4 Domestic Streamlined Basic Requirements
- 1.5 Streamlined Foreign Offshore Procedures
- 1.6 IRC 911 (Physical Presence Test vs. Bona-Fide Resident Test)
Have you recently learned that your foreign spouse has bank accounts, investment accounts, or retirement accounts in another country? If so, you are not alone – this is a very common occurrence amongst many of our clients.
Oftentimes, when a person marries an individual from a foreign country, the foreign spouse may have had significant earnings prior to coming to the United States.
Depending on the facts and circumstances of the marriage, the spouses may not have discussed prior finances in great detail. Why? Because depending on the culture of the spouse, it may be considered intrusive.
Moreover, if that money is not being used on a day-to-day existence, then it just may not be a topic of conversation that either spouse ever thought about talking about.
David met Michelle when they were both 55 years old. Michelle is originally from Hong Kong and had a very successful advertising career long before she met David. Michelle has a significant amount of money in Hong Kong, which she does not use for daily expenses, but rather allows her parents to use back in Hong Kong. As such, David and Michelle never discussed the $3 million that Michelle accumulated prior to their marriage.
IRS Tax Returns
David and Michelle file joint tax returns. When the CPA sends the questionnaire to David, he continues filling out the form the same way he did prior to Marriage. It is just by happenstance that Michelle is speaking with another individual from overseas, when she learns that she should have been reporting the foreign accounts on a U.S. Tax Return.
When Michelle tells David the requirements, David’s first reaction is to do some research online. After several hours (and Rabbit holes later) David is convinced he and Michelle are going to jail (read: Scare Mongering websites). While they are no going to be going to jail — at least for this reason — David is now completely freaked out, and Michelle feels horrible.
Streamlined Program or Reasonable Cause?
Depending on the facts and circumstances of the case, David and Michelle have two options-either the streamlined program or making a reasonable cost mission. David and Michelle will presumably not have to enter OVDP since they were non-willful.
The following is a summary of the difference between the streamlined program and reasonable cause:
When a person has undisclosed foreign accounts that they have not reported on their annual FBAR (Report of Foreign Bank and Financial Account) and/or filed a requisite 8938, 3520, 3520-A, 5471, 5472, 8621 or any other number of IRS forms geared toward foreign property, account, income and asset reporting – it is important to get into compliance, and fast!
If your failure to disclose foreign accounts was non-willful (in other words, you were unaware of the requirement to file the form), you generally have two different options available in order to get compliant. The first option is submitting a Reasonable Cause Statement and the second option is to submit to the Streamlined Offshore Disclosure Program.
Each method has its own pros and cons, and oftentimes it will boil down to the specific facts and circumstances of the non-disclosure, coupled by the risk assessment on the part of the account-holder.
*If your only failure was to file certain forms, but your tax returns were accurate, you may qualify for delinquency procedures and simply have to file certain forms. Note: If you failed to report foreign income and you paid foreign tax on the income (even if you do not owe any U.S. Tax), then you will not qualify for the simple delinquency procedures — although Reasonable Cause may be a viable alternative.
The following is a summary of the distinction between the two different options:
Reasonable Cause Examples
If you were completely non-willful in your failure to disclosure and were unaware that there was any reporting requirement, then the thought of paying any penalty may sound absurd. Here are three examples in which paying any penalty for your undisclosed foreign accounts may seem unfair.
Example 1: 80-year-old Michael travels worldwide and has 3 accounts in different countries. He only uses the foreign money when he is in the foreign country at issue, he never transfers the money to the US, and there is usually a relatively small amounts of money in each account. The only issue for Michael was that at one point, Michael thought about purchasing a home overseas and left the money in the foreign account for a significant period of time (including 12/31). Foreign taxes were fully paid on the money deposited into the account and foreign taxes were paid on the income the account generated. His only mistake was that he did not report the account and/or the foreign income on his U.S. Tax Return.
Example 2: Michelle, a widow who had never been in trouble with the law, moved to the United States over 30 years ago but has a $1 million USD foreign pension from a private employer through the early 1970s. She has never accessed the account nor has she contributed (or anyone else contributed) since arriving in the United States. The account/earnings are not taxed in the US until distributed, there have been no distributions, and Michelle never reported the account on an FBAR or 8938.
Example 3: David has a foreign account, which he received as an inheritance. He never touched the money, and even though the account earns minimal annual income, there is no tax for passive income in this particular country. He has no other ties to the country and has not used any of the money. David’s son has special needs and he needs to access a large chunk of the money in a short period of time. He has not reported the account on an FBAR or 8938.
Reasonable Cause – Viable Option
As you can see from the aforementioned examples, none of these individuals had any intent whatsoever to perform tax evasion. Moreover, the amount of income earned is relatively minor compared to the outstanding amount in the foreign accounts. In addition, in the case of Michelle, the majority of her money is in a foreign pension account, which is not even taxed by the US under Treaty Rules (unless distributions are made from the Pension). Thus, even under the streamlined program she would be paying $50,000 in penalties for an account in which all of the money was earned and reported timely in her foreign country and all foreign taxes were paid on the contributions.
Reasonable Cause – Process
An individual should never attempt offshore disclosure without the assistance of a qualified attorney. With that said, it is even more important to ensure that if you are pursuing a reasonable cause submission, that you do so only with the help of an attorney. That is because only with an attorney do you receive the benefit of the attorney-client privilege.
Unlike the Streamlined Program or OVDP where there are strict procedures to be followed, a reasonable cause submission is different. It should be noted that a person can submit a reasonable cause application for any number of different reasons; it is not limited only to offshore money and reporting foreign accounts.
With a reasonable cause submission the attorney will carefully evaluate and analyze the facts and circumstances of your case in detail. He or she should sit down with you either person or via teleconference if you are non-local and assess the pros and cons of the potential submission in order to determine what the benefits and detriments may be to a reasonable cause disclosure. Thereafter the attorney will amend the returns, prepare the necessary forms, and draft a persuasive Reasonable Cause Letter.
At Golding & Golding, we are Tax Attorneys (with Masters of Tax Law) and Enrolled Agents credentialed by the IRS (Highest Credential awarded by the IRS), so we handle your entire submission in-house, for a flat-fee.
Benefits of Reasonable Cause
The main benefit of reasonable cause is that if it is accepted by the Internal Revenue Service then there is a good chance that penalties will be waived. As a result, when you report your foreign accounts and you can show that your failure to report them prior was due to reasonable cause, you will not be penalized for un-filed forms, including:
- FBARs (FinCEN 114) – Report of Foreign Bank and Financial Accounts
- FATCA Form 8938 – Statement Of Specified Foreign Assets
- 5471 – US Ownership of Foreign Companies.
- 8621 – US Ownership of Passive Foreign Investment Companies
- 3520 – Foreign Trust Beneficiary
- 3520-A – Foreign Trust Ownership
This may result in a significant savings versus offshore disclosure – especially when you have significant unreported accounts and assets overseas, but minimal foreign income (or substantial foreign income and you have paid foreign taxes in the country you earned the foreign income).
Detriments of Reasonable Cause
Reasonable cause does not come without its risks. If the reasonable cause statement is rejected, then you may be subject to extremely high fines and penalties. Many of these forms listed above carry significant fines and penalties that may reach as high as 100% value of your foreign accounts if your reasonable cause application is rejected and you are held to be willful.
Nevertheless, if penalties are issued, then you are entitled to appeal the penalties and thereafter file with the US Tax Court if you are still unsatisfied with the appeals process. Of course, this may take a lot of time and effort – not to mention attorneys fees depending on the seriousness of the fines and the facts of your case – which is counterintuitive.
Common Questions to Consider – Reasonable Cause
Before convincing yourself that you should be spared any penalty, it’s important to look at the facts and circumstances of your case in the most objective light as possible.
Here’s a list of questions you may consider before making your decision:
- How many forms did you fail to report?
- How much unreported foreign income did you have?
- For how long did you fail to report these forms?
- Did you work with a Tax Accountant or CPA to prepare your returns?
- Did the Tax Accountant or CPA ask you about your foreign accounts?
- Did the Tax Accountant or CPA ask you about your foreign Income?
- Have you otherwise filed your U.S. tax returns timely?
- Did you pay Foreign Tax on the Foreign Earnings or was the Income Exempt?
- Are you originally from the United States?
- How long have you lived in the U.S. and what is your U.S. Status?
- How much unreported foreign income do you have?
- Did you receive a FATCA Letter asking you to Certify U.S. Status
- Are you ready to appeal the matter or even bring it the Tax Court if it is rejected?
STREAMLINED PROGRAM OPTIONS
We represent is individuals in the streamlined program with disclosures as high as almost $40 million for a single disclosure. We actively represent clients around the world from our home base in the exclusive area of (Fashion Island) Newport Beach, California, and represented clients in nearly 45 different countries.
That does not mean we limit ourselves to only high dollar matters. we also handle numerous streamlined filing compliance procedure matters for individuals with significantly less unreported money.
What is the Non-Compliance of Foreign Accounts?
Specifically, when a person is out of compliance with FATCA (Foreign Account Tax Compliance Act), for not reporting Foreign Income, or failing to file timely FBAR reports (Report of Foreign Bank and Financial Accounts), they may be subject to extremely high penalties, fines, and interest payments.
*In fact, even if a person is non-willful (unintentional) and audited by the IRS, they can be subject to a penalty of $10,000 per year, per account.
Two Types of Streamlined Programs
There are two different Streamlined Programs: Streamlined Domestic Offshore Procedures and Streamlined Foreign Offshore Procedures. Both programs involve the disclosure of Foreign (and even U.S.) Accounts. The difference between the two programs refers to whether the applicant is a Domestic Resident or U.S. Resident.
Streamlined Domestic Offshore Procedures
The Streamlined Domestic Program is for individuals who are considered residents of the United States under the strict definition of the term Residence for “Streamlined Compliance” purposes. In other words, they is not foreign residence requirement. The word “domestic” can be deceiving, because it still refers to foreign accounts and foreign asset (although a person can also report unreported U.S. Income as long as they also have unreported foreign income).
Rather, the domestic portion of the phrase refers to the residence of the applicant. Thus, if the applicant resides in the United States or did not reside outside of the United States for at least 330 days in any tax year for the last three years then they must enter the domestic program – as long as they were not willful.
IRC 911 “Bona-Fide Resident Rules” are in applicable – any reference to IRC 911 is regarding the term “Abode” only. See a Golding & Golding Article on the distinction by Clicking Here.
Domestic Streamlined Basic Requirements
The Streamlined Domestic Program requires the applicant to amend and pay outstanding tax liability for the last three (3) years to include unreported foreign income that was not previously reported. It also requires six (6) years of FBARs (FinCEN 114) forms to be filed and the applicant to pay a penalty, which equals 5% of the highest year end value for any given year.
In other words, the applicant will tally the unreported accounts and undisclosed accounts for each year going back six (6) years as to what the value of these unreported accounts were on the last day of the year. Whichever year has the annual aggregate total that is the highest is then multiplied by 5% and that is the penalty amount.
*Even though the streamlined instructions are ambiguous we have confirmed in speaking with the IRS several times that the penalty only applies to the unreported accounts.
To Summarize the Domestic Program
- Amend the last 3 years of Tax Returns
- File required forms such as 3520, 3520-A, 5471, 8621
- File 6 Years of FBAR (FinCEN 114) – Report of Foreign Bank and Financial Accounts
- Take a “snapshot” of the aggregate offshore unreported balances on 12/31
- Pick the highest year’s 12/31 annual aggregate value
- Multiply the value by 5%
- Pay the outstanding Tax, Interest on Taxes due and 5% percent.
The streamlined foreign program has a foreign residence requirement – which is why it is referred to as the foreign program. The foreign portion of the phrase refers to the residence of the applicant. Thus, if the applicant has resided outside of the United States (does not need to be in just one country) for at least 330 days in any tax year for the last three tax years then the applicant qualifies for a penalty waiver. That means the applicant will not have to pay any penalty and will only be responsible for outstanding taxes that are due for the last three years.
It also requires six (6) years of FBARs (FinCEN 114) forms to be filed but the FBAR Penalty is waived.
IRC 911 (Physical Presence Test vs. Bona-Fide Resident Test)
It should be noted that in the frequently asked questions the streamlined foreign program, the IRS is clear that the applicant must meet the 330 day rule. This should be distinguished from Internal Revenue Code section 911 which is used by taxpayers trying to claim the foreign earned income exclusion by showing they qualify for either the physical presence test (330 days) or the bona fide residence test. Thus, even though a person could qualify as a bona fide resident under IRC 911 for the foreign earned income exclusion, it does not mean that they qualify for the streamlined foreign program.
As provided by the IRS: The discussion of the non-residency requirement for eligibility for the Streamlined Foreign Offshore Procedures refers to IRC § 911 and its regulations. Does that mean that anyone who is non-resident under IRC § 911 and its regulations is non-resident for purposes of the Streamlined Foreign Offshore Procedures?
*The reference to IRC § 911 and its regulations is only to the parts of those authorities that define “abode,” which are found in IRC § 911(d)(3) and Treas. Reg. § 1.911-2(b). Non-residency for purposes of the Streamlined Foreign Offshore Procedures is defined in those procedures, and not in IRC § 911 and its regulations.
To Summarize the Foreign Program
- Amend the last 3 years of Tax Returns
- File required forms such as 3520, 3520-A, 5471, 8621
- File 6 Years of FBAR (FinCEN 114) – Report of Foreign Bank and Financial Accounts
- Pay the outstanding Tax and Interest on Taxes due.
- The 5% penalty is waived
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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.)
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