PFIC Tax Lawyers – Reasonable Cause May Limit Scope of IRS Audit
With the enforcement of FATCA (Foreign account tax compliance act) and FBAR (Report Of Foreign Bank And Financial Accounts) taking center stage in the world of international tax compliance, there is a new contender for what may become one of the harshest rules in international tax compliance.
Form 8621 – PFIC
To keep the article simple, the most important thing to know about form 8621 is that chances are if you have a foreign investment in a foreign corporation or foreign trusts that serve as a profit generating business type formation, you may be subject to the PFIC (Passive Foreign Investment Company).
While most of the articles you will read about online involving 8621 and PFICs deal with the different PFIC elections such as a Qualifying Electing Fund (QEF), Market-to-Market election (MTM) or the 1291 default position (which has a brutal tax outcome), there is a new problem to contend with. That is, the failure to file a form 8621 – which is a form that many tax practitioners have no idea about, and that has recently updated reporting laws – can result in keeping your tax return open indefinitely.
Unfiled 8621 – No Statute of Limitations
The general rule is that a tax return has a three-year statute of limitations (subject to a possible six-year statute of limitations when more than 25% of income has not been reported or an artificially increased basis of 25% reduced the tax liability by more than 25%). Moreover, if the IRS can prove fraud then there is no statute of limitations.
Otherwise, once a tax return is filed, the IRS has three (3) years to audit you. If you file your tax returns before April 15, the statue of limitations does not begin to run until April 15. If you file a tax returns after April 15, then the statue of limitations does not begin to run until that time.
If you filed your tax returns timely, included your FBARs but were unaware of the requirement to file an 8621 (which were only recently updated to include reporting PFICs even if no distribution has taken place), then there is a distinct possibility that the statute of limitations for auditing your tax return has not yet begin to run.
But I filed my Tax Returns?
Yes, but you did not fire tax returns…completely. In other words, the IRS’s position is that even though you filed all of your other forms, until you have filed your 8621 form the entire tax return remains open and the statue limitations has not begin to run. Thus, even if you did not receive any distributions from your PFIC (which by definition includes nearly all foreign mutual funds and foreign trusts), the mere fact that you did not file what amounts to an informational report, may leave your tax return in limbo.
The Reasonable Cause Exception
Even though you may not have filed your PFIC 8621 form timely, if you can show that the failure to do so was reasonable, then you may be able to avoid the entire tax return remaining open, and limit the IRS audit the only issues involving the 8621.
Keep in mind that if the IRS wants to audit you, you will generally be at their mercy and why would they want to issue a reasonable cause exception to someone with their intent is to audit them for their entire tax return?
If you have not properly filed your 8621 forms starting in tax year 2013, you may consider speaking with an experienced international tax lawyer to evaluate and assess your tax situation.
Beyond the 8621, if you have foreign accounts that have an annual aggregate total that exceeds $10,000 it is very important that you file your annual FBAR statements to avoid FBAR penalties that can reach 100% value of the account balances.
The following is a summary of FBAR laws:
Golding & Golding are experienced U.S. and International FBAR Lawyers who represent clients worldwide with FBAR (Report of Foreign Bank and Financial Account) reporting compliance before the IRS (Internal Revenue Service), DOT (Department of Treasury), and DOJ (Department of Justice)
As Tax Lawyers and Enrolled Agents (Highest Credential awarded by the IRS), we are able to both analyze your tax situation as well as provide you, your officers and your business sound legal advice.
Our clients are located throughout California, as well as nationwide and around the world. We have represented clients with unreported accounts exceeding $15,000,000 and with accounts and assets over 35 countries.
The United States takes FBAR reporting and compliance very seriously, and if not handled carefully a person may find themselves, their trust, or their business subject to significant taxes, fines, penalties, interest and possible criminal investigation.
When do I File an FBAR?
If you, your family, your business, your foreign trust, and/or PFIC (Passive Foreign Investment Company) have more than $10,000 (in annual aggregate total at any time) overseas in foreign accounts and either have ownership or signatory authority over the account, it is important that you have an understanding of what you must do to maintain FBAR (Report of Foreign Bank and Financial Accounts) compliance. There are very strict FBAR filing guidelines and requirements in accordance with general IRS tax law, Department of Treasury (DOT) filing initiatives, and FATCA (Foreign Account Tax Compliance Act).
What Accounts are Reported on an FBAR?
Filing FBARs and ensuring compliance with IRS International Tax Laws, Rules, and Regulations is extremely important for anyone, or any business that maintains:
- 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
- Insurance Policies (including some Life Insurance)
- Foreign Accounts held in a CFC (Controlled Foreign Corporation); or
- Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
Golding & Golding provides Foreign Account Reporting (FBAR) strategies for clients around the globe in order to report Foreign Bank Accounts and become FBAR compliant. We also defense clients who are under FBAR Audit by the IRS and DOT.
What is an FBAR?
In accordance with international tax law compliance, taxpayers who meet the threshold requirements are required to file an FBAR.
An FBAR is a “Report of Foreign Bank and Financial Accounts” form. It is a form that is filed online directly with the Department of Treasury. Unlike the tax return, the FBAR form must be filed by June 30th of the tax year and there are no extensions available for filing it late. If you attempt to file it late, there can be serious repercussions, including fines and penalties – since it is considered Quiet Disclosure or Silent Disclosure in an attempt to circumvent the OVDP or Streamlined Program rules and regulations and filing an untimely FBAR.
**UPDATE: Starting in 2016 for Tax Year 2015 – filing of your 2015 FBAR will be in accordance with the same time periods to file your tax returns, which is by April, 2016 unless you receive an extension of time to file.
FBAR filings can be overwhelming, especially if you have never filed one before. If this is the case, our experienced international FBAR Lawyers can assist you in ensuring you are compliant with IRS FBAR Law and FATCA requirements.
Who is Required to File an FBAR?
Not everyone who has foreign accounts is required to file an FBAR. Rather, it is required to be filed by all U.S. Taxpayers (whether they reside in the U.S. or overseas) with foreign accounts that have an “annual aggregate total” exceeding $10,000 at any time during the year. Thus, if a U.S. Taxpayer (including Legal Permanent Residents “aka Green Card Holders”) maintains foreign accounts, including banks accounts, financial accounts, or insurance policies that have a combined value of more than $10,000 (or has indirect ownership of the account or signature authority), then that person is required to file an FBAR statement.
What if None of My Accounts Exceed $10,000?
It does not matter. It is important to remember that the threshold is the Annual Aggregate Total value at any given time during the year. This means if you have 11 bank accounts with $1000 each at any given time during the year, you are STILL required to file the FBAR and list all the accounts on it, even if none of the accounts exceed $10,000. In other words, you are required to report the total value of all your foreign accounts located in any foreign country on your FBAR once you exceed the $10,000 annual aggregate total threshold on any given day during the year.
There are various accounts and other assets (insurance policies) which may or may not be included in your FBAR analysis. Please contact one of our experienced FBAR Lawyers for further assistance regarding specific account disclosures.
What if I did Not File an FBAR Statement?
If a person fails to file the FBAR, there is still hope. Depending on whether the person also had unreported foreign income (income that was earned overseas and not reported on the U.S. tax return – even if it was reported in a foreign country and foreign tax was paid), the IRS and DOT will determine if a penalty will be issued; usually the taxpayer will be penalized but the amount of the penalty will vary.
What are the Penalties for Failing to File an FBAR?
Recently, the Internal Revenue Service issued a memorandum which details how the IRS “believes” the agents should penalize individuals in accordance with their authority. Essentially, there are two sets of penalty structures and they are based on whether the taxpayer was willful or non-willful.
FBAR – Willful
Willful is determined by a “totality of the circumstances” analysis. Somebody is considered to have acted willfully if they intentionally evaded the payment of taxes or disclosure of foreign accounts. In other words, they willfully or knowingly “knew” about the requirement to disclose and report overseas assets, accounts, and income but chose not to. In these situations, the Internal Revenue Service has the authority to penalize the taxpayer upwards of 50% of the value of the assets per audit year for failing to file the FBAR (in addition to a slew of several other non-FBAR penalties), but no more than 100% value of the account over an audit period.
Generally, audits last three years and the Internal Revenue Service has made it known that they will not penalize the individual beyond the value of the accounts for the audit periods at issue. Thus, if you had $1 million in your foreign bank account and you knowingly did not report this information to the IRS and they audit you for three years, they can take all of your $1 million.
FBAR – Non-Willful
When a person is non-willful, it generally means they were unaware of the requirement to file an FBAR. In this situation, the IRS takes some mercy – but nowhere near as much mercy as you can imagine certain people deserve (example: individuals who relocated from overseas and have foreign accounts that they simply did not use or earn much income on, or individuals who inherit money from overseas relatives.)
In these situations, the IRS has four (4) main options in terms of penalizing the taxpayer:
- The IRS agent can simply issue a warning letter instead of a monetary penalty to the taxpayer. This will rarely happen (although Golding and Golding has achieved this result on multiple occasions for individuals who have been audited and did not file FBAR statements and/or otherwise do not qualify for one of the IRS offshore voluntary disclosure programs, but were non-willful).
- The IRS agent could penalize the taxpayer a total of $10,000 for all of the years that the taxpayer did not file FBAR statements. For example, if the taxpayer is audited for three years and did not file FBARs for those three years, the IRS may penalize the taxpayer $10,000 for the total amount of the audit.
- The IRS agent could penalize the taxpayer $10,000 for each year that the FBAR was not filed. So using the example above, if the taxpayer is audited three years and did not file an FBAR for three years, then the IRS could penalize the taxpayer $30,000 – and usually not beyond the value of the account.
- The IRS agent could penalize the taxpayer $10,000 per account per year. In other words, if the taxpayer had four different bank accounts and was audited for three years – the IRS could penalize taxpayer $120,000.
One very important thing to remember is that the penalty scheme listed above is for non-willful taxpayers. In other words, even though the IRS knows the taxpayer did not intentionally attempt to evade tax, the IRS has the power to still issue tens, if not hundreds, of thousands of dollars in penalties in a non-willful situation.
Whether a person is willful or non-willful is a complex evaluation which requires a comprehensive factual analysis by an experienced FBAR lawyer to ensure the taxpayer is informed before making any representation to the IRS.
Why is it Important to File an FBAR?
Prior to the recent changes in the law, taxpayers were able to fly below the radar and could probably last most of their lifetime without having to file international tax forms disclosing their foreign income and overseas assets. The problem is that under the new FATCA (Foreign Account Tax Compliance Act) laws, foreign countries and the United States are entering into intergovernmental agreements (IGA) with foreign countries.
IGAs are “reciprocity agreements.” In other words, while foreign countries are going to report account information of US taxpayers (U.S. Citizens, Legal Permanent Residents, and Foreign Nationals Subject to U.S. Tax), the United States is going to do the same and report account information to the foreign countries. Thus, there is a benefit to both parties in entering these IGA Agreements.
FBAR compliance is very important for any taxpayer subject to IRS tax reporting requirements. The failure to file a timely FBAR and remain in IRS tax compliance can lead to significant fines, penalties, and other possible consequences.
What can I do to get FBAR Compliant?
There are various safe harbor programs in place, which if a person meets the requirements, then they can have their penalty reduced if not eliminated. The two main programs are the Offshore Voluntary Disclosure Program (OVDP) and Modified Streamlined Program. These safe-harbor programs can be eliminated by the IRS at anytime.
We have gone into great detail on our website explaining the difference between the Offshore Voluntary Disclosure Program (OVDP) and Modified Streamlined Program. Essentially, Offshore Voluntary Disclosure Program (OVDP) is a program intended for those who were willful. In other words, if you knowingly defrauded the IRS by not reporting your foreign assets and you “knew” you were supposed to report the information, then the OVDP is the proper program for you.
In this program, the penalty is relatively high compared to the other program, but you walk away with the satisfaction of knowing you only have to pay a financial penalty and you will probably not end up in prison doing a 20-year prison stint with real criminals.
Alternatively, if your only mistake was that you were unaware of the requirement to file FBAR statements, then you can enter the Modified Streamlined Program. Unlike OVDP, the Modified Streamlined Program does not provide you criminal protection but if you are non-willful then you do not require criminal protection. Under the streamlined program, the penalty structure is reduced significantly and the filing requirements are much more limited.
Nevertheless, it is absolutely crucial that you do not enter the streamlined program or file FBAR Reasonable Cause Statements if you were willful – because if you are detected by the IRS and they find that you were clearly willful but you were just simply trying to get a penalty reduction, then the IRS will see this as tax fraud and tax evasion and they will prosecute to the fullest extent of the law.
**In addition, the current reduced penalty rate will often increase with each new year, and most importantly, if you find yourself under audit, then you are disqualified from entering these programs.
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.)