When a Person, Estate or Business is out-of-tax compliance for failing to report Foreign Income, Foreign Income and/or Foreign Assets, the applicant has relatively few options for timely and safely getting into tax and foreign reporting compliance — before fines and penalties are issued.
While the most common options include the Offshore Voluntary Disclosure Program or the Streamlined Offshore Disclosure Program, there is another alternative.
It is called making a Reasonable Cause submission.
I Never Knew About Foreign Reporting Requirements
Chances are that if you are reading this article, you have recently learned about certain IRS international tax compliance laws (FBAR, FATCA, 8938, 3520-A, 5471, 8621, etc.) which are causing you to lose sleep. In general, the IRS, DOT, DOJ and U.S. Government in general have made enforcement of Offshore Tax and Reporting requirements a key enforcement priority.
Not only has Offshore Tax Evasion become a mainstay on the IRS Dirty Dozen Tax Scam list, but with the implementation of FATCA (Foreign Account Tax Compliance Act) and other intentional tax compliance programs, the chances of the U.S. Government discovering your foreign accounts has increased exponentially.
I am Scared, What can I Do?
While dealing with the IRS is scary, it is probably nowhere near as bad as some of the scare-mongering articles would like you to believe. Moreover, if you were non-willful in your failure to comply, then much of the fear you are experiencing is unnecessary. Even if you were willful, the traditional OVDP program is designed to get you into compliance without the fear (most of the time) of the IRS/DOJ launching a criminal investigation against you.
The real fear is that even if you never had any intent of being out of tax compliance (aka “non-willful”), you may get caught in the IRS wave of “new and heightened” Offshore Enforcement laws, resulting in significant fines and penalties.
Under the new FATCA (Foreign Account Tax Compliance Act) laws, in which more than 100 countries and tens of thousands of Foreign Financial Institutions such as Foreign Banks and Foreign Investment Firms are proactively reporting U.S. Account Holder information to the U.S. Government, the IRS may already have your information.
As such, it is important get into compliance quickly, before it is too late.
When your actions are considered “non-willful,” your two main alternatives are entering the Streamlined Domestic/Foreign Offshore Procedures or submitting a Reasonable Cause Exception Statement.
The most familiar and common option for individuals and businesses that have unreported foreign accounts or unreported foreign income is to enter offshore disclosure. Offshore Disclosure is a general term to describe various methods for getting back into US government tax and foreign account reporting compliance.
Golding & Golding have written numerous articles and blog posts for our website, as well as widely known journals and books regarding the nuances and intricacies of offshore disclosure. All in all, the biggest (and only) negative to offshore disclosure is the penalty.
Depending on the facts and circumstances of your case, your country of residence, and your risk management – there are two main programs that have various penalty schemes.
Streamlined: Under this program, you are certifying that you are non-willful in your failure to comply, and the traditional penalty (see below) will be reduced to either 5% or a complete penalty waiver if you qualify under the strict definition of foreign residence for the streamlined program.
OVDP: The Offshore Voluntary Disclosure Program is the traditional program, which is often reserved these days for individuals and businesses who were willful (a.k.a. knowingly failed to report their foreign income and/or foreign accounts). There are other reasons for entering OVDP — even if you were non-willful — but that is beyond the scope of this article. There are three penalty alternatives:
- 27.5% Penalty if you go through the program and none of your money is in a “bad bank.”
- 50% Penalty if you go through the program and any of your money was ever in a bad bank during the compliance period.
- Opt-out and try your luck at penalty reduction.
*If you were willful, we do not recommend the Reasonable Cause Alternative.
Reasonable Cause Examples
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.
Reasonable Cause – Viable Option
As you can see from the aforementioned examples, none of these individuals had any intent whatsoever to perform tax evasion. Moreover, the amount of income earned is relatively minor compared to the outstanding amount in the foreign accounts. In addition, in the case of Michelle, the majority of her money is it a pension account which is not even taxed by the US. Thus, even under the streamlined program she would be paying $50,000 in penalties for an account in which all of the money was earned and reported timely in her foreign country and all foreign taxes were paid on the contributions.
Reasonable Cause – Process
An individual should never attempt offshore disclosure without the assistance of a qualified attorney. With that said, it is even more important to ensure that if you are even considering a reasonable cause submission, that you do so only with the help of an attorney. That is because only with an attorney do you receive the benefit of the attorney-client privilege.
Unlike the Streamlined Program or OVDP where there are strict procedures to be followed, a reasonable cause submission is different. It should be noted that a person can submit a reasonable cause application for any number of different reasons; it is not limited only to offshore money and reporting foreign accounts.
With a reasonable cause submission, the attorney will carefully evaluate and analyze the facts and circumstances of your case in detail. He or she should sit down with you either person or via teleconference if you are non-local and assess the pros and cons of the potential submission in order to determine what the benefits and detriments may be to a reasonable cause disclosure. Thereafter the attorney will amend the returns, prepare the necessary forms, and draft a persuasive Reasonable Cause Letter.
At Golding & Golding, we are Tax Attorneys (with Masters of Tax Law) and Enrolled Agents credentialed by the IRS (Highest Credential awarded by the IRS), so we handle your entire submission (Taxes, Legal, and Audit Defense) in-house, for a flat-fee.
Benefits of Reasonable Cause
The main benefit of reasonable cause is that if it is accepted by the Internal Revenue Service then there is a good chance that penalties will be waived. As a result, when you report your foreign accounts and you can show that your failure to report them prior was due to reasonable cause, you will not be penalized for un-filed forms, including:
- FBARs (FinCEN 114) – Report of Foreign Bank and Financial Accounts
- FATCA Form 8938 – Statement Of Specified Foreign Assets
- 5471 – US Ownership of Foreign Companies.
- 8621 – US Ownership of Passive Foreign Investment Companies
- 3520 – Foreign Trust Beneficiary
- 3520-A Foreign Trust Ownership
This may result in a significant savings versus offshore disclosure – especially when you have significant unreported accounts and assets overseas and minimal income.
Detriments of Reasonable Cause
Reasonable cause does not come without its risks. If the reasonable cause statement is rejected, then you may be subject to fines and penalties that are higher than would have been issued under the Streamlined Program.
Nevertheless, if penalties are issued, then you are entitled to appeal the penalties and thereafter file with the US Tax Court if you are still unsatisfied with the appeals process. Of course, this may take a lot of time and effort – not to mention attorneys fees depending on the seriousness of the fines and the facts of your case – which is counterintuitive.
Common Questions to Consider – Reasonable Cause
Before convincing yourself that you should be spared any penalty, it’s important to look at the facts and circumstances of your case in the most objective light as possible.
Here’s a list of questions you may consider before making your decision:
- How many forms did you fail to report?
- How much unreported foreign income did you have?
- For how long did you fail to report these forms?
- Did you work with a CPA, Enrolled Agent, or Tax Accountant and prepare your returns?
- Did the CPA, Enrolled Agent, or Tax Accountant ask you about your foreign accounts or Foreign Income?
- Have you otherwise filed your U.S. tax returns timely?
- Did you pay Foreign Tax on the Foreign Earnings (unless exempt in the Foreign Country)
- Are you originally from the United States and how long have you been in the United States filing tax returns?
- How much unreported foreign income do you have?
- Did a foreign financial institution inform you of your requirement to get FATCA or IRS Tax Compliant?
- Are you prepared to go the distance and appeal the matter or even bring it the Tax Court if it is rejected?
To help you better understand the process, we have also pasted below a popular blog article we authored outlining the difference between OVDP and the IRS Streamlined Program, which is provided for you below:
OVDP vs. Streamlined
In order to assist you better understand the distinction between the two different IRS foreign account disclosure programs, we are providing the following summary for your reference:
If you or your business has unreported or undisclosed foreign accounts, offshore assets, or foreign income, then you may be considering whether you should enter the Offshore Voluntary Disclosure Program (OVDP) or the IRS Streamlined Offshore Disclosure Program, and what the definition of “Willful” is.
Whether or not a person enters Offshore Voluntary Disclosure Program (OVDP) or the IRS Streamlined Offshore Disclosure Program will depend on the facts and circumstances of each taxpayer’s situation. No two tax situations are identical, and the failure to properly submit to the correct program can have serious consequences for the unsuspecting taxpayer.
Why Comply with IRS Foreign Disclosure Laws?
Because if you fail to comply with FATCA (Foreign Account Tax Compliance Act) as well as general IRS Foreign Disclosure Laws, the IRS has the authority to penalize you upwards of 100% of the value of your offshore assets and accounts as well as:
- Collect Taxes for prior tax years
- Collect Interest on outstanding tax liability for prior years
- Penalize you for the failure to report foreign accounts on the tax return (Schedule B and 8938)
- Penalize you for the failure to report foreign gifts (3520)
- Penalize you for the failure to report foreign Trusts (3520 and 3520A)
- Penalize you for the failure to report ownership in Foreign Corporations (5471 and 5472)
- Penalize you for the failure to report ownership in a PFIC (8621)
- Genera Negligence and Fraud Penalties
- Investigate you for Criminal Tax Fraud & Criminal Tax Evasion if you willfully failed to report your assets & foreign income.
The reason why international tax law compliance has taken center stage is because under the new FATCA (Foreign Account Tax Compliance Act) laws, foreign countries are actively reporting the bank and financial accounts of US citizens and US legal permanent residents to the IRS and U.S. Government.
If a foreign country is interested in working with the United States, the foreign country will enter into an “ Intergovernmental Agreement” (IGA) with the United States. These agreements are reciprocity agreements, which means that not only will the foreign country report the information to the IRS, but the IRS will also reciprocate by providing the same information to foreign country tax authorities.
Why Enter either OVDP or the Modified Streamlined Program?
Individuals and businesses who are trying to avoid 100% FBAR penalties and/or Criminal Prosecution may seek to voluntary disclose, pay a penalty (unless abated), and avoid criminal prosecution.
There are the only two approved programs by the Internal Revenue Service that can bring a taxpayer into compliance. Instead of entering the programs, a taxpayer may qualify to directly report under the reasonable cause exception, in which the taxpayer directly submits the forms with a statement explaining why they were not properly filed instead of paying a penalty.
*The IRS is not known to be sympathetic, and if you choose the “Reasonable Cause/Delinquency FBAR Submission” option and the IRS does not believe you, you may be subject to IRS Audit and/or examination, as well as being disqualified from entering either the OVDP or Streamlined Program. Worse yet, the IRS has all of your unreported and undisclosed foreign account and foreign income information – which can lead to serious fines and penalties.
**If the taxpayer submits the forms to the IRS without submitting to the FBAR Delinquency/Reasonable Cause or IRS Disclosure Programs, it can be considered a “silent disclosure” or “quiet disclosure.” If the IRS learns of the Quiet or Silent Disclosure, the IRS will penalize you heavily as well as consider initiating criminal proceedings against you. In this scenario, not only will the IRS seek to take all of your money and assets through the implementation of penalties and levies, but you may be spending the next 2 to 20 years in prison for tax evasion or tax fraud.
What is the Difference between OVDP and the Streamlined Program?
Before making a decision regarding voluntary disclosure, it is important to understand the difference between the two main programs.
OVDP (Offshore Voluntary Disclosure Program Requirements)
In accordance with OVDP filing requirements, The Applicant will then be required to pay the outstanding tax, along with estimated interest, a 20% penalty on the outstanding tax, as well as an “FBAR” 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 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!
When it comes to the Streamlined Program, the penalty is limited to 5% on the highest “year-end” balance for the last 6-years. The reason is that if the person was non-willful, they should not be overly-penalized if there was an artificial increase in the value of the bank accounts – such as from the sale of a home during the tax year.
(A complete breakdown of OVDP requirements can be found on our OVDP Page, by Clicking Here)
OVDP is Unfair for Non-Willful Taxpayers
Before the implementation of the modified streamlined program, it was difficult for individuals who were non-willful (no specific definition, but generally “without intent to deceive or defraud”) to become compliant. Why? Because if you are non-willful, you still had to go through the filing procedures as if you were willful, and then opt out of the penalty structure and open yourself up for audit.
Not such a big deal, except for the fact that you also had to pay 20% penalty on the outstanding taxes that you owed along with a 27.5% penalty on the highest year’s annual aggregate (unless you successfully “opted out” from the penalty structure – which came with a whole other set of headaches). As you can imagine, for individuals who simply inherited some money overseas, had no international dealings, and had no idea that they were required to report foreign passive income (Interest income) in a country that does not tax its own citizens on passive income earnings — providing this information to the IRS was a huge burden.
What is the Modified Streamlined Program?
In order to avoid “non-willful” applicants from having to go through the entire OVDP process before opting out, the IRS and Department of the Treasury modified a small program in existence, called the streamlined program, which was very limited. The IRS expanded the program to basically allow anyone who was non-willful to enter the program.
The program reduced the amount of documentation that applicants were required to file to only three years of amended tax returns and six years of FBAR (Foreign Account Reporting Statements). In addition, there was no penalty on the tax amount that was due and no penalty on the value of income generating foreign real estate that was not previously disclosed. Moreover, the 27.5% penalty was reduced down to 5%, or completely waived if the foreign residence requirements were met.
Penalty Waiver: there is a small facet of the modified streamlined program called the Modified Foreign Offshore Program. If a person qualifies for the modified stream of program (which means they acted non willfully) and they can prove they lived overseas for a total of 330 days out of the tax year in any year within the last three years, then they may qualify to have the penalty waived.
The Streamlined Programs sounds great, right? Well it is, unless you are attempting to wrongfully evade the 27.5% penalty by entering the program when you knew you were willful.
What if you are caught trying to sneak into the Streamlined Program?
I cannot stress to you enough to not try and enter the Streamlined Program if you were willful. If you knowingly enter the streamlined program and it is found that you acted willfully in your failure to disclose and report your overseas and foreign assets and income you will most likely be prosecuted by the IRS.
The IRS made this fact known in a recent public relations statement. From the IRS’ perspective, if you wrongfully enter this program in order to avoid paying the full penalty amount what you have done is stolen 27.5% or 50% of the penalty amount due to the IRS – and this does not make the IRS very happy.
Even worse is that you may be subject to criminal prosecution. And, since you have already disclosed all the foreign financial information in your Streamlined Program application, you will be in a tough position to try and defend yourself.
Why is the Modified Streamlined program in Jeopardy?
Just like in everything in life, a few bad apples spoil the whole bunch. The IRS has learned that several individuals who were willful in their failure to report undisclosed foreign tax and bank information have been caught trying to sneak into the modified streamlined program in order to pay a reduced penalty – or avoid the penalty altogether This contradicts the IRS’ intention which was to modify and expand the Streamlined Offshore Disclosure Program to assist taxpayers who otherwise would be overburdened by having to enter the OVDP and opt out of the penalty structure.
There is No Reason to be Scared of the OVDP or the Streamlined Programs
The goal of this article is not to scare you. Rather, it is to warn you to just be cautious if you are entering into these programs. Way too many inexperienced and unscrupulous attorneys, CPAs and enrolled agents see these programs as a way to scare individuals.
If You are going to enter a Foreign Disclosure Program, use an Attorney
While CPAs and enrolled agents (who are not also attorneys) may charge less than an attorney is important to note that you do not have an attorney client privilege with CPAs and enrolled agents. What that means, is that if it turns out you wrongfully entered the streamlined program and the IRS wants to speak with your representative, unless your representative is an attorney, there is no privilege between a CPA and Taxpayer when a Criminal Matter is at issue.