Offshore Voluntary Disclosure Program (2017) – Beyond Bank Accounts
Offshore Voluntary Disclosure Program
The IRS Voluntary Disclosure Programs are offshore reporting programs designed to bring individuals who have offshore accounts, foreign income, or other money abroad into compliance with a reduced penalty structure.
Oftentimes, when people think of offshore voluntary disclosure, the first thing they think of is their Foreign bank accounts and usually the FBAR (Report of Foreign Bank and Financial Accounts)
Although the majority of individuals stuck in this mess will have unreported foreign bank accounts, and presumably will have a FBAR reporting requirement, unfortunately it is just the tip of the iceberg.
Offshore Voluntary Disclosure is a comprehensive process that involves a diverse range of reporting and compliance issues that if not handled properly, can lead to bigger problems.
Offshore Disclosure Assets and Investments
When a person is required to file a 1040 (whether or not they meet the threshold requirement for actually having to file), there is a laundry list of issues they must contend with involving international tax. Specifically, there are numerous assets that need to be reported — even if a person is not required to file an actual tax return.
What Must be Reported to the IRS
A starting point should be that everything you have abroad may have to be filed. Then you take a step back and look at some of the nuances determine your actual reporting requirements.
Some examples of assets that must be reported include:
- Foreign Bank Accounts
- Foreign Savings Accounts
- Foreign Investment Accounts
- Foreign Securities Accounts
- Foreign Mutual Funds
- Foreign Trusts
- Foreign Retirement Plans
- Foreign Business and/or Corporate Accounts
- Foreign Insurance Policies with Surrender Values
- Foreign Life Assurance Policies
- Foreign Accounts held in a CFC (Controlled Foreign Corporation); or
- Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
Exceptions & Exclusions Often Do Apply
The following are a few exceptions many of our clients have to contend with:
A PFIC is a passive foreign investment company. It is a highly complicated tax analysis that most software programs do not provide any analysis for (Read: Turbotax is of no help to you). While a PFIC will often have to be reported on a form 8621, if you meet certain exclusions, you may be able to avoid reporting aside from years in which you have excess distribution (presuming you never made a QEF or MTM election)
Foreign Real Estate
If you own foreign real estate outright, it is not reported on an FBAR or Form 8938. If you own real estate as part of a foreign corporation, then the real estate and value of the real estate is included as an asset to the corporation or partnership and reported on either a form 8938, 8865 or 5471 if applicable. Moreover, if the real estate is owned outright, but it generates rental income, then the income must be reported to the IRS.
This is a very complex subject. That is because United States does not treat foreign retirement accounts the same. For example, if you have a CPF, TPF, EPF or other provident fund account, chances are you will have to report the accrued but not distributed income.
When it comes to an Australian superannuation fund, it will often depend on the ratio of employee contributions versus employer contributions, as well as whether the individual is considered a highly compensated employee.
Alternatively, when comes to the UK, issues involving citizenship, residency, and type of pension will determine whether the pension is taxable or not (prior to actual distributions).
What if the Money is Exempt overseas?
The IRS does not really care if the income you earn abroad is not taxable in the foreign country (unless treaty or similar rules apply). For example, if you earn interest income in Hong Kong or Singapore that is being generated tax-free, you still must report it, and pay US tax on the earnings.
If you own foreign real estate in various countries such as South Africa (which has a threshold requirement for tax), the IRS does not exempt the income the same way South Africa might. In other words, even if the earnings are below the threshold requirements for a foreign country, it still must be reported on a US tax return.
The reason why is so important is because the IRS has taken to issuing gargantuan penalties against individuals whose issues seem relatively minor (Read: is the world going to explode because Marty didn’t report his foreign account?)
When it comes to penalties, the IRS has extreme leeway. On the one hand, if a person can show reasonable cause then often times penalties will be waived. On the other hand, the IRS has the right to issue penalties which can reach 100% value of the foreign account in a multiyear audits scenario (noting, that up until recently the IRS issued 300% penalties for unreported FBARs, when a person was found to be willful).
The following is a summary of penalties as published by the IRS:
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.
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.
Underpayment & Fraud Penalties
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.
Even Criminal Charges are Possible…
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 is subject to a prison term of up to five years and a fine of up to $250,000. 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.