Preventable IRS Offshore Voluntary Disclosure Program Errors – Golding & Golding
For many people, IRS Offshore Voluntary Disclosure is an integral part of getting into tax compliance for prior years, in which the individual (Estate or Business) did not report foreign money,
For the majority of individuals who submit to traditional IRS Offshore Voluntary Disclosure, it is because they were either willful, willfully blind, or had reckless disregard when it came to reporting their foreign money, including: Offshore bank accounts, Offshore investment accounts, offshore businesses, offshore investments, offshore life insurance policies and/or pensions (including Superannuation, PPF, CPF EPF, etc.)
Not everybody who failed to properly report their offshore money is required to enter traditional IRS Offshore Voluntary Disclosure (OVDP) – it is mainly reserved for three classes of applicants:
- Individuals who were willful (or unsure that they were non-willful)
- Businesses (since businesses cannot “go streamlined”)
- Individuals seeking a Mark-to-Market election for PFICs.
Mistakes in IRS Offshore Disclosure
Everybody makes mistakes. But, there are many unscrupulous tax attorneys, non-tax attorneys, CPAs and accountants who unwittingly thrust individuals into IRS Offshore Disclosure (namely OVDP), to make a quick buck. They do this by unnecessarily scaring individuals, that if they do not enter traditional OVDP, they will end up in prison — this is rarely if ever the case.
**It should be noted, that if you are willful or fall into one of the other categories, traditional OVDP may be your only option but it is important that you have vetted this information out with experienced offshore disclosure counsel.
Schedule B – Question 7 is not Per se
Just because you marked off no to question seven on schedule B does not mean that you have to go OVDP. Even the IRS understands this, and if your attorney or CPA is telling you that you have to go OVDP, it’s time to seek new counsel.
– In fact, even the IRS provides its own set of FAQ: “We realize that many taxpayers failed to acknowledge their financial interest in or signature authority over foreign financial accounts on Form 1040, Schedule B. If you (or your return preparer) inadvertently checked “no” on Schedule B, line 7a, simply provide your explanation.”
Real Estate is Not Always Penalized
If a person decides to go the traditional OVDP, then real estate may be part of the penalty computation. In order to be part of the power of the competition it should be income-producing property (unless it was property that was purchased with other money that is otherwise subject to the OVDP penalty, that is beyond the scope of this summary). Just purchasing property for your own use is not subject to penalty.
In addition, if you have a mortgage on the property then you can ordinarily subtract the value of the mortgage as a part of the penalty base for the computation.
Provident Funds are Not Taxable
It is amazing to see tax professionals such as those that tout themselves as CPA/Attorneys or “Experts” counsel their clients into believing that this information is not reportable or taxable. On numerous occasions we have inherited cases in which these so-called “experts” have given this type of advice.
First, employer contributions for a provident fund (CPF, EPF, TPF) are currently taxable to the employee. Moreover, the contributions from the employee into the fund are not currently deductible. Finally, depending on a few other factors the majority of the time you crude but not distributed income within the Provident fund is currently taxable (and it will increase your basis so that you do not double pay the tax at a future date)
Foreign Retirement Accounts Are Reportable
For example, let’s say you have a superannuation fund in Australia. Under Australian laws you are unable to access that money until you reach a certain age or other alternative conditions are met. The United States does not necessarily recognize the tax-deferred treatment of a foreign retirement. While the United States has comprehensive tax treaties with Canada and the United Kingdom, with other countries, foreign retirement is usually summed up in one paragraph of the international tax treaty.
Whether or not you are currently taxed on the income which has not been distributed will be dependent in part on whether there is a tax treaty with the United States or not, and what the tax treaty states or otherwise provides as to income tax (as well as whether you are a Highly Compensated Employee). Nevertheless, the account must be reported.
FATCA Exclusions are Usually for Institutions
On a number of occasions, we will speak with a potential client who tell us that they spoke with a professional who indicated that a certain type of fund does not need to be reported because it is excluded under FATCA. One typical example is a PPF (Public Provident Fund) in India. While the foreign financial institution may be exempt from having to report the account information, that does not exempt the individual from having to report the account information on a FBAR/FATCA Form 8938.
Tax-Free is Not Recognized in the United States
Many different countries have many different investment schemes. In countries such as Ireland and the UK there are various savings accounts and other government subsidized investment tools, which may not ordinarily be taxed by the foreign government. Most countries have some form of tax-free investment.
It is important to understand, that even though the foreign government may not tax the income, that does not exempt the income from taxation under US Tax Law. In other words, the United States will still require you to report the information and income on FBAR, FATCA Form 8938 and Schedule B — as well as pay tax on the earnings unless an exemption/exclusion applies.
There are no 8621 Penalties
This is horrible advice that various clients have relayed to us from prior representation. While there may not be any specific financial penalties (although an argument can be made that 8938 penalties would apply) for failing to file a form 8621, it actually contains one of the worst penalties of all.
That is, that if the form is not filed then the tax return is considered incomplete. Since the tax return is not considered complete, the statue limitations does not begin to run on the tax return. Therefore, instead of the IRS having three years or six years in some limited situations to assess your tax and/or audit you, now the IRS has forever.
Foreign Retirement is not a PFIC
This is also an overreaching, inaccurate statement. Many attorneys and CPAs want your business, but don’t want to do the work. There are not many programs designed to handle issues involving PFICs (especially excess distributions), so some tax counsel/CPAs will provide inaccurate information to try to put your mind at ease – even though it is not true.
One example is foreign retirement and PFIC. It is as simple as this: if your foreign retirement owns foreign mutual funds, then chances are your foreign retirement may be a PFIC. As a PFIC, it is crucial to understand the tax ramifications of whether or not you should make a Mark-to-Market election or not, and what the tax outcome will be for your excess distribution (especially if you never had a distribution prior, and are about to receive a large distribution)
Foreign Earned Income Exclusion/Foreign Tax Credit
It is important to understand that just because a person utilizes the Foreign Earned Income Exclusion, does not mean they are excluded from using the foreign tax credit on the same category of income.
For example, if a person qualifies for the foreign earned income exclusion and earned $95,000 in 2016, the full amount of that money may be excluded for tax purposes by the IRS. In addition, if the person pays taxes in the foreign country on that income, then that person cannot double-dip and use the foreign tax credit on the same income in order to receive a refund.
With that said, if the person earn $150,000 and still utilized the foreign earned income exclusion, they can still use a portion of the foreign tax credit to offset the additional income above and beyond the FEIE Cap. In other words, there is an equation that is used so that the amount of the tax credit that would’ve been used in lieu of the foreign earned income exclusion is reduce and the remaining portion of the tax credit can be used (in part, if not in whole) to further reduce the tax liability.
In addition, the unused portion can be carried forward.
Using Inexperienced Counsel/CPA Because They Are Cheaper
In life, you get what you pay for. When it comes to offshore voluntary disclosure, there are many nuances that can severely impact your case. It is important that you utilize an experienced offshore disclosure attorney in preparing your application.
First, by using a CPA only, you lose the attorney-client privilege and depending on the facts and circumstances of your case, the CPA can be questioned — and if it is a quasi-criminal investigation you will all but lose any confidentiality you may have thought you had with the CPA.
Moreover, when it comes to attorneys, you should try to find an attorney that focuses exclusively on this area of law. Tax laws are complicated and general tax law firms just do not have the experience or focus to dedicate all the time and resources necessary to handle your case.
Want to Learn More About IRS Offshore Voluntary Disclosure?
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
Golding & Golding – Offshore Disclosure
At Golding & Golding, we limit our entire practice to offshore disclosure (IRS Voluntary Disclosure of Foreign and U.S. Assets). The term offshore disclosure is a bit of a misnomer, because the term “offshore” generally connotes visions of hiding money in secret places such as the Cayman Islands, Bahamas, Malta, or any other well-known tax haven jurisdiction – but that is not the case.
In fact, any money that is outside of the United States is considered to be offshore; the term offshore is not a bad word. In other words, merely because a person has money offshore (a.k.a. overseas or in a foreign country) does not mean that money is the result of ill-gotten gains or that the money is being “hidden.” It just means it is not in the United States. Many of our clients have assets and bank accounts in their homeland countries and these are considered offshore assets and offshore bank accounts.
The Devil is in the Details…
If you do have money offshore, then it is very important to ensure that the money has been properly reported to the U.S. government. In addition, it is also very important to ensure that if you are earning any foreign income from that offshore money, that the earnings are being reported on your U.S. tax return.
It does not matter whether your money is in a country that does not tax a particular category of income (for example, many Asian countries do not tax passive income). It also does not matter if you are a dual citizen and/or if that money has already been taxed in the foreign country.
Rather, the default position is that if you are required to file a U.S. tax return and you meet the minimum threshold requirements for filing a U.S. tax return, then you have to include all of your foreign income. If you already paid foreign tax on the income, you may qualify for a Foreign Tax Credit. In addition, if the income is earned income – as opposed to passive income – and you meet either the Bona-Fide Resident Test or Physical-Presence Test, then you may qualify for an exclusion of that income; nevertheless, the money must be included on your tax return.
What if You Never Report the Money?
If you are in the unfortunate position of having foreign money or specified foreign assets that should have been reported to the U.S. government, but which you have not reported — then you are in a bit of a predicament, which you will need to resolve before it is too late.
As we have indicated numerous times on our website, there are very unscrupulous CPAs, Attorneys, Accountants, and Tax Representatives who would like nothing more than to get you to part with all of your money by scaring you into believing you are automatically going to be arrested, jailed, or deported because you have unreported money. While that is most likely not the case (depending on the facts and circumstances of your specific situation), you may be subject to extremely high fines and penalties.
Moreover, if you knowingly or willfully hid your foreign accounts, foreign money, and offshore assets overseas, then you may become subject to even higher fines and penalties…as well as a criminal investigation by the special agents of the IRS and/or DOJ (Department of Justice).
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.
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 (reduced by any outstanding mortgage) 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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