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Quiet Disclosure vs. Streamlined | Turning Non-Willful into a Willful Tax Crime

Quiet Disclosure vs. Streamlined | Turning Non-Willful into a Willful Tax Crime

Quiet Disclosure vs. Streamlined | Turning Non-Willful into a Willful Tax Crime

Quiet Disclosure vs. Streamlined Compliance Procedures (aka Streamlined Offshore Disclosure) — what are the Risks?

Making a Quiet Disclosure to the IRS in an attempt to “sneak amend” your tax returns and submit previously unreported FBAR (aka FinCEN 114) and/or FATCA Form 8938s, 3520s, 5471s, or 8621 Forms is a big mistake.

Quiet Disclosures are illegal and may result in you being subject to extremely high fines and penalties, as well as a criminal investigation.

**Click the following link to Read an in-depth Case Study Golding & Golding Prepared on Quiet Disclosure (“From Quiet Disclosure to IRS Audit…to Jail“)

Be Careful What You Read

There is a lot of misinformation online regarding OVDP (Offshore Voluntary Disclosure Program), Streamlined Filing Compliance Procedures, FBAR Penalties (Report of Foreign Bank and Financial Accounts) and Individual FATCA Reporting Requirements (Foreign Account Tax Compliance Act).

One of the biggest misconceptions regarding foreign account compliance are the ramifications for submitting a FBAR Quiet Disclosure of Foreign Accounts and Tax Information.

Quiet Disclosure vs. Streamlined Disclosure

When a person first learns they have unreported Foreign Accounts, Foreign Income, Foreign Assets, Foreign Retirement, etc. it can be devastating. Why? Because the internet is filled with fear mongering articles which are at best inaccurate, and at worst designed to scare you into believing your non-willful (unintentional) non-compliance will result in a prison sentence; it just isn’t true.

But, by time you come to this realization, you may have already been taken for tens, if not hundreds of thousands of dollars by unscrupulous Tax Attorneys, CPAs, EA, Tax Accountants and Financial Advisors. Moreover, if after learning about your foreign reporting requirements you (either by yourself or through representation) then take action to quietly (aka “Silently” or “Secretly”) submit your amended tax returns and/or FBARs to the IRS — you may have just committed a crime (aka knowingly falsifying your tax returns and/or FBARs).

Therefore, before you take any action, it is important you get educated. Golding & Golding focuses their entire practice on Offshore Disclosure matters and we have extensive resources for you to read in order to gain a basic understanding of IRS reporting requirements, and the ramifications for falling out of compliance.

This article will focus on “Quiet Disclosure” – aka secretly amending your returns and FBARs without following the proper channels.

Streamlined Program – Basics

If you are out of Tax and FBAR reporting compliance, it is important to get back into compliance. If your non-compliance was due to inadvertence (non-willful or unintentional) then you may qualify for the “Streamlined Program.”

In the Streamlined Program, the Taxpayer will generally file amended tax returns for three (3) years, and report their account balances for six (6) years on an FBAR (FinCEN 114) which is a Report of Foreign Bank and Financial Accounts Form; they may also have to file a Form 8938 (varies from the FBAR based on type of Assets, marital filing status and country of residence) and/or 3520, 3520-A, 5471, 5472, 8621, 8865 — or various other international business or investment reporting forms.

Streamlined Penalty Calculation

Next, the Taxpayer will have to calculate the Streamlined Penalty, or determine if they can establish Foreign Residence in order to qualify for a Penalty Waiver.

To do this, the taxpayer will total all of their December 31st values (of unreported account balances only) for each of the last 6 years. For example, if a person was seeking compliance in 2016, they would prepare annual summaries for 2010, 2011, 2012, 2013, 2014 and 2015. (2016 is not due until 2017, so they are not out-of-compliance for 2016 yet).

Then, the applicant will select the single year that has the highest year-end (12/31) aggregate total of the unreported foreign accounts, and multiply it by 5% (unless they qualify for the Streamlined Foreign Offshore Procedures with a penalty waiver).

We understand that for many people, the above-referenced equation is unfair: For example, if you have $500,000 overseas that you either received by inheritance, or earned through years of hard work, and already paid foreign income tax and/or estate tax — paying a $25,000 penalty for simply not including it on your U.S. Tax Return seems exorbitant.

With that said, some people attempt quiet disclosure, which is a horrible idea.

Streamlined Program – Common Example

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.

In any of the above-referenced scenarios, a penalty may seem unwarranted. If you fall into one of these categories and want to avoid the penalty, you may consider submitting a Reasonable Cause Exception Statement, which is not the same as Quiet Disclosure.

                           

Quiet Disclosure

In a quiet disclosure, the person does not enter the Streamlined Program, or identify the issues in a “Reasonable Cause Statement.” Rather, the person simply amends their tax returns to include the unreported foreign income (Schedule B), report the foreign accounts (8938 forms; related forms) and files FBAR Statements with the Department of the Treasury.

Here’s the problem: If you were originally non-willful (in that you were unaware of the requirement to file an FBAR) but now you have gone ahead and willfully failed to pay the penalty, you may have bootstrapped your non-willful submission into full-blown tax fraud and tax evasion.

Why? Because you have now willfully evaded reporting foreign accounts and/or paying outstanding U.S. Tax, Interest and Penalties by knowingly filing an untimely FBAR or Amended Tax Return without paying the penalty (or going for a Reasonable Cause Penalty Waiver) for money you know you earned in the past, but had not paid any US tax on (or paid foreign tax on but did not properly disclose to the U.S. and/or claim the IRS form 1116 Foreign Tax Credit)

There may be Hope

No two submissions are identical. You may have perfectly legitimate reasons for having done a quiet disclosure – not the least being receiving bad advice from a CPA or Attorney. With FATCA compliance on the rise and tens of thousands of Foreign Financial Institutions reporting U.S. foreign account holder information to the IRS, you should consider speaking with an experienced international tax lawyer to assess your situation and determine the best strategy for moving forward at avoiding even stiffer penalties and possible criminal investigation.

Streamlined Disclosure

Prior to 2014, and before the introduction of the modified Streamlined Domestic Offshore Procedures or Streamlined Domestic Offshore Procedures (aka “Streamlined Compliance Filing Procedures”) getting into compliance was very overburdensome for non-willful violations, since they would have enter traditional OVDP (Offshore Voluntary Disclosure Program) and submit 8 Years of Tax Returns, 8 Years of Penalties, and pay astronomical penalties unless they risked an “Opt-Out.”

In 2014, The IRS has introduced a new modified version of the “Streamlined” program to assist non-willful U.S. Taxpayers who are out of Foreign Tax Compliance.

The purpose of the Streamlined Program is to assist U.S. Account Holders with getting into compliance, without the overburdensome requirements of traditional OVDP (Offshore Voluntary Disclosure Program).  The Streamlined Procedures make IRS Tax and FBAR reporting compliance easier for individuals who unintentionally (aka non-willful) failed to report their foreign accounts and/or foreign income.

           

Golding & Golding

If you have unreported foreign accounts and are non-willful, you may qualify for the Streamlined Domestic Offshore Procedures. Whether it is because you received a FATCA Letter, learned about it from friends or family, or happened upon it by accident — Foreign Account compliance is important.

Under new U.S. Tax and Offshore Reporting Rules and Regulations, it is important to remain in IRS Tax and FBAR reporting compliance.  

                   

Streamlined Domestic Offshore Procedures

In order to qualify for Streamlined Domestic Offshore Procedures, you must meet two major requirements:

  • Qualify as Non-Willful; and
  • Filed all Necessary Prior Year Tax Returns.

Streamlined Foreign Offshore Procedures

In order to qualify for Streamlined Foreign Offshore Procedures, you must meet three major requirements:

How to Qualify as a Foreign Resident?

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 (3) tax years or do not meet the Substantial Presence Test in one of the last three (3) tax years) you may obtain a waiver of all FBAR and FATCA penalties.

IRC 911 (Physical Presence Test vs. Bona-Fide Resident Test)

The Streamlined Foreign “330-day rule,” is a hard and fast rule — there are no exceptions.

Thus, the Streamlined Foreign “330-day rule” 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.

           

What does Non-Willful Mean?

Qualifying as Non-Willful is by far the most difficult aspect of Streamlined Offshore Disclosure.

You are willful if you knew you were supposed to report and disclose your foreign income and assets but choose not to — as such, you will be required to submit to OVDP instead of the Streamlined Program. In other words, if you knew you had a duty to report the information on an FBAR (Report of Foreign Bank and Financial Accounts)  Form 8938  (Statement of Specified Foreign Assets), or any other number of different IRS forms, but intentionally do not report your accounts, then you act “willfully.”

You are non-willful if you acted unintentionally, and did not know you were required to either report or disclose your foreign income, accounts, or other specified assets.

If you are Non-Willful…

And you filed all necessary prior year tax returns, you should qualify for the Streamlined Offshore Procedures.

The process for getting into compliance is as follows:

Streamlined Basic Requirements

The Streamlined Program requires the applicant to amend and pay outstanding tax liability for the last three (3) years to include unreported foreign income and unreported foreign accounts that were not previously reported on a U.S Tax Return. It also requires the applicant to file six (6) years of FBARs (FinCEN 114) and pay a (relatively) small penalty which equals 5% of the highest year end value for any given year.

To Summarize the Streamlined 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, along with the 5% percent penalty

What Forms Must be Reported?

The following is a list of common forms which many people were never aware they had to report, but which the failure to report may lead to extensive fines and penalties:

Reporting Foreign Accounts (FBAR)

There is a lot of information online regarding the FBAR (Report of Foreign Bank and Financial Account Form) due to the extremely high penalties involved with this form. We have written countless articles, which you can find in our International Tax Library, by clicking here.

If you are a U.S. Person, it does not matter whether or not you have to file a US tax return to determine if you have to file an FBAR. The threshold question is whether you have an annual aggregate total of foreign/offshore bank accounts, financial accounts, retirement accounts, etc. that when combined, exceed $10,000. If so, you are required to file the FBAR Form and report all of the accounts.

It does not matter if the money is all in one account, or in 15 different accounts. It also does not matter if the majority of the money is in one account, with minimal amounts of money in the remaining accounts – rather, once you meet the threshold requirements, you have to report all the accounts.

Penalty: 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.

Golding & Golding Resources: FBAR FAQ; FBAR Penalties

FATCA Form (8938)

FATCA is the Foreign Account Tax Compliance Act. For individuals, it requires reporting of financial accounts and certain specified foreign assets (ownership in businesses, life insurance, etc.). There are different threshold requirements, depending on whether a person is Married Filing Jointly (MFJ) or Married Filing Separate (MFS)/Single, and whether a person resides in the United States or outside of the United States.

Penalty: 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.

Golding & Golding Resources: Form 8938 FAQ; Form 8938 Penalties

Foreign Gift Form (3520)

If you receive a gift or inheritance from a foreign person that exceeds $100,000 either in a single transaction, or a series of transactions over a year, you are required to report the gift on this form. You have the file this form, even if you are not required to file a tax return (although it is normally filed at the same time as your tax return).

Penalty: 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.

Golding & Golding Resources: Form 3520 Penalties

Foreign Corporation or Foreign Partnership (5471 or 8865)

The rules are somewhat different for these two forms, but essentially the same (with the 5471 being much more commonplace for U.S. investors). If you own at least 10% ownership in either type of business, you required to report the information on either a form 5471 or 8865. Both of these forms require comprehensive disclosure requirements, involving balance statements, liabilities, assets, etc. Moreover, the forms need to be filed annually, even if a person does not have to otherwise file a tax return

Penalty: 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.

Golding & Golding Resources: Form 5471 Penalties

Passive Foreign Investment Company (PFIC)

One of the most vilified type of financial assets/investments (from the U.S. Government’s perspective) is the infamous PFIC. A PFIC is a Passive Foreign Investment Company. The reason the United States penalized this type of investment is because it cannot oversee the growth of the investment and income it generates. In other words, if a U.S. person invests overseas in a Foreign Mutual Fund or Foreign Holding Company — the assets grows and generates income outside of IRS and U.S. Government income rules and regulations.

As a result, the IRS requires annual disclosure of anyone with even a fractional interest in a PFIC (unless you meet very strict exclusionary rules)

Penalty: The Penalties for not filing an 8621 run concurrent with the 8938 penalties (see above).

Golding & Golding Resources: Form 8621 Penalties; PFIC Form 8621 Excess Distribution Calculation

Foreign Trust (3520-A)

A Foreign Trust is another type of Foreign Investment that is frowned upon by the IRS. From the IRS’ perspective, the only purpose behind a Foreign Trust is to illegally avoid US reporting and income tax requirements by moving money offshore. While there are many people who may operate illegally in this fashion, there are various legitimate reasons why you would be a trustee or beneficiary of a Foreign Trust (Your cool grandma really loves you and placed $5 million in trust for you overseas). Form 3520-A is a relatively complex form, which must be filed annually by anybody that owns a foreign trust.

Penalty: 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.

Golding & Golding Resources: Form 3520-A Foreign Trust Penalties 

Foreign Real Estate Income

Even if you are earning rental income from property that is located outside of the United States, you still must report the income on your U.S. taxes (even it is exempt from tax in the foreign country). Remember, United States taxes individuals on their worldwide income. Therefore, the income you are earning from your rental property(s) must also be included on your US tax return.

A few nice benefits of reporting the income is that the United States allows depreciation of the structure – which many foreign countries do not allow. Moreover, you can take the same types of deductions and expenses that you otherwise take the property was located in the United States.

Penalty: Varies, depending on the Nature and Extent of the non-disclosure.

Golding & Golding Resources: Foreign Real Estate Income FAQ