Offshore Tax Havens (2018) – IRS Dangers of Foreign Income & Accounts
Offshore Tax Havens (2018) – IRS Dangers of Foreign Income & Accounts
Just because you invest overseas into offshore accounts, assets, etc. does not mean you have committed any wrongdoing.
There is a major difference between intentionally investing money into an Offshore Tax Haven in order to illegally avoid U.S. Tax, as opposed to legitimately investing into the global marketplace.
Offshore Tax Haven
A distinction must be made between an offshore tax haven, and moving money offshore.
While when most people think of the term offshore, they conjure up visions of sipping Pina Coladas in the British Virgin Islands, Caymans or the Bahamas, the IRS sees it differently. The IRS likes to use the general phrase “offshore” for money that is located out of the United States borders – even when it is completely legitimate.
In other words, simply moving money offshore is not the same as investing in offshore tax havens, and we will take an opportunity to explain the difference – and hopefully you can breathe a sigh of relief. If not, and believe your are about to hyperventilate — take a deep breath and contact us for a Reduced Fee Offshore Voluntary Disclosure Initial Consultation.
Moving Money Offshore
If you reside in the United States and you have money outside of the United States, the IRS would likely categorize your money as offshore. Therefore, if you happen to be originally from China or Taiwan and amassed a bit of a fortune before relocating to the United States, from the IRS’ perspective you have offshore money in Taiwan.
In reality, you are a citizen of a foreign country who now resides in the United States but did not sell your foreign assets or cash out the bank accounts. The point being, that just because something is considered offshore — does not mean it is bad.
Let’s take a very common example for our typical client from Hong Kong:
Example of Legal Money Sitting Offshore
David is originally from Hong Kong. He operated multiple businesses when he lived in Hong Kong, and two of them are used to hold investments and collect dividends. In order to provide a layer of anonymity, when he initially opened his Hong Kong PVT Limited, it was owned by a BVI. A BVI is a common structure involving the British Virgin Islands, and the reason why it was so popular, was because until 2009 it was very easy to own shares that were unregistered to any individual name in particular (aka “Anonymous”)
David Relocates to the U.S.
David is now a Legal Permanent Resident of the United States. Since there was no reason to get rid of the BVI, or sell the assets (they are profitable), David continued operating his Hong Kong investment company through the BVI.
David is Audited by the IRS
David is audited by the IRS and they begin to delve deeper into his asset planning and tax structuring trying to corner David, and make him believe he did something improper – aka owning his foreign company through a BVI.
In reality, David had this business set up long before he ever stepped foot in the United States. He only relocated to the United States because his children are attending college and they are planning to work in the United States thereafter.
This is not an example of moving money to an offshore tax haven. This is an example of an astute foreign investor owning his foreign business under a legitimate foreign holding structure, which was put in place long before he came to the United States.
Scott’s Offshore Tax Haven Investment
Scott is originally from the Austria. Scott now resides permanently in the United States, and has a sizable investments (including a pension) from his time working in Austria. Scott doesn’t want the United States to get any crack at any of the money of which he will soon begin taking distributions from the foreign pension.
Therefore, Scott purposely moves his money into a foreign retirement scheme in Malta, which if Scott was not a US person would grow tax free — along with tax-free distributions. The company sells Scott on the fact that they would not be reporting Scott to the United States.
Two Main Concerns for Scott
FATCA is the Foreign Account Tax Compliance Act. In accordance with FATCA, more than 110 countries have entered into agreements with United States to provide account holder information to the IRS. Moreover, more than 300,000 foreign financial institutions have also agreed to report information to the IRS.
Therefore, while the particular investment fund may not report Scott, in order to get the money from Austria to Malta, it has to pass certain avenues, and at any one of those potential stops, the money could be reported by either the initial bank or facilitator bank used to transfer the money, or any other hands that touch the money (investment advisors, financial planners, etc.)
Scott may never know he was reported. This is a major issue for individuals who may become subject to a Reverse Eggshell Audit, and/or anyone who was fleeced by inexperienced OVDP Attorney and submitted to the Streamlined Program when they were willful.
Offshore Tax Fraud
Each year, the IRS publishes a dirty dozen list and offshore tax havens are a mainstay. The IRS is pursuing offshore tax evasion and tax fraud intensely. That is because the IRS has the authority to issue monstrous size penalties against individuals if they are not properly in international tax compliance.
By purposely investing in offshore tax haven in order to avoid detection by the IRS, if the IRS was to become wise to the investment, not only are they able to pursue willfulness penalties that may reach 100% value of the accounts, but they may consider referring the matter for a criminal investigation to the IRS special agents.
Already out of U.S. Offshore Tax Compliance?
If you already out of compliance for either having not reported foreign/offshore accounts and/or intentionally invested in something you believe was a tax haven to avoid offshore reporting, you may consider voluntarily getting into compliance to one of the approved IRS offshore voluntary disclosure programs.
IRS’ New International Tax Enforcement Group
In order to try to hedge its bets and put itself in the best position to try to collect as much money as possible, the IRS is focusing in large part on international tax – and specifically on penalizing individuals through tax enforcement.
Welcome to the IRS’s new International Tax Enforcement Group program.
New International Tax Program
Prior to 2014 and the enforcement of FATCA (Foreign Account Tax Compliance Act), the IRS has less resources to obtain information regarding your offshore, or foreign accounts. Many foreign financial institutions were simply not reporting US account holder information to the IRS – and why would they? It’s not as if the Foreign Financial Institutions care about what the IRS thinks….until the introduction of FATCA.
Under FATCA more than 110 foreign countries (50 more countries than the US entered into income tax treaties with) have entered into IGA (intergovernmental agreements) with the IRS to promote reciprocal reporting of account holder information. Primarily, it means your Foreign Financial Institution will probably be reporting your account information to the IRS.
Likewise, more than 300,000 Foreign Financial Institutions have agreed to proactively report this information to the IRS. In fact, even financial institutions in countries that have not signed IGAs are apparently reporting as well (in order to stay in the IRS good graces).
OVDP & Streamlined – Running Out of Time
Since the IRS has many more resources to obtain information than individuals voluntarily complying through one of the approved IRS offshore voluntary disclosure programs. This is primarily due to the fact that the IRS has a limited and finite amount of resources and believes those resources are better allocated to specific enforcement group that can focus exclusively on these issues.
As the IRS has provided, this will be an elite group of agents. We don’t know what that means, but we can at least presume that the agents will have some additional and specialized training in offshore reporting matters.
In fact, the IRS is touting these new agents as experts in the field of international tax law. These are agents who have the experience and the knowledge to properly investigate these types of intricate and complicated international tax matters.
What Should You Do?
Even though IRS offshore voluntary disclosure is all we presently handle at our law firm, we never want a client to ever feel pressured or prematurely enter into the disclosure program.
With that said, it does appear that the time for entering the program may be limited or cut short without much forewarning. Therefore, if you are already out of compliance for your offshore and foreign accounts, assets, investments, and income and want to get into compliance-now may be the best time to do it.
Offshore Disclosure 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 experienced mentioned above) flubbed their submission and made numerous mistakes in the submission process.
Golding & Golding, A PLC
At Golding & Golding, we have successfully handled numerous OVDP (Offshore Voluntary Disclosure Program) and IRS Streamlined Program applications for individuals and businesses around the globe with outstanding unreported foreign accounts ranging from $50,000.00 to nearly $40,000,000.00 in a single disclosure.
We Take OVDP Representation Very Seriously
We are passionate about representing individuals in offshore voluntary disclosure matters, and feel horrible when a client calls us after having hired an inexperienced Attorney or CPA who either did a sloppy job, charged them more money than they agreed upon, and/or is overall not providing the level of representation a person deserves.
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.
5 IRS Methods for Offshore Compliance
- Streamlined Domestic Offshore Procedures
- Streamlined Foreign Offshore Procedures
- Reasonable Cause
- Quiet Disclosure (Illegal)
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.
4. Reasonable Cause
Reasonable Cause is different than the above referenced programs. Reasonable Cause is not a “program.” Rather, it is an alternative to traditional Offshore Voluntary Disclosure, which should be considered on a case by case basis, taking the specific facts and circumstances into consideration.
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