- 1 IRS Offshore Compliance Enforcement
- 2 Typical Example Where TurboTax Fails
- 3 Schedule B
- 4 FBAR
- 5 Form 8938
- 6 TurboTax Leads to a False Sense of Security
- 7 IRS Form 3520 – Receipt of Gift From Foreign Person
- 8 Form 5471 – Foreign Corporations
- 9 Form 8865 – Foreign Partnership
- 10 Other Forms Missing from TurboTax
- 11 Golding & Golding, A PLC
While TurboTax may be good for individuals who only have FBAR or 8938 filing requirements, for anything more complicated — the program is woefully deficient for individuals with Offshore and Foreign Reporting, such as IRS Forms 3520, 3520-A, 5471, 8621 or 8865.
IRS Offshore Compliance Enforcement
Ever since the Internal Revenue Service has made the enforcement of Offshore Compliance a key priority, it has become more and more important each year to make sure you are in IRS tax compliance.
The reason for being in IRS compliance is to avoid the extremely high fines and penalties that can be issued against you for non-compliance.
Depending on the facts and circumstances of your situation, you could be penalized upwards of 100% value of all of your foreign accounts, assets and investments – which does not include the additional penalties for underreporting income, fraud, etc.
These penalties can also lead to bank levies, seizures and even passport revocation.
This is not intended to scare you, rather it is to ensure that you understand that by using programs such as “TurboTax” it may lead to a false sense of security. And, if you are taking the steps to try to file your Tax Returns accurately, it is not fair to be blindsided down the line.
The problem with Turbotax itself does not include various forms which you may need in moving forward with your offshore compliance.
Typical Example Where TurboTax Fails
David is a Legal Permanent Resident (aka Green-Card Holder). He has been residing in United States for about 10 years. About three (3) years ago he inherited a 15% share of a foreign business that is owned 60% by US persons. In addition, when his mother passed away, and each he and his brother each inherited an apartment building, with David inheriting 55% since he was the older brother and will oversee the administration of the building.
David has three foreign accounts valued in total at $900,000, as well as some stock ownership.
By using TurboTax, David will be able to access Schedule B. Schedule B will inform David that since he has ownership or signature authority over foreign accounts that exceed at least $10,000 on any given day, and that he will have to file the FBAR.
The FBAR is the Report of Foreign Bank and Financial Account Form. Since David had ownership, co-ownership, or signature authority over foreign accounts that have an annual aggregate total that exceeds $10,000 on any given day of the year, he will report the accounts on the FBAR. While a person cannot access the FBAR through TurboTax (since it is a distinct form which is not filed directly with the tax return) the TurboTax program provides some instruction on what to do.
Form 8938 is a relatively new form, which came into effect in 2011. It is designed in accordance with FATCA (Foreign Account Tax Compliance Act). The threshold requirements vary, depending on whether a person is a U.S. Resident or Foreign Resident, and whether they are filing married filing joint, or single/separate.
Under either circumstance David would have to file form, since the accounts are in local banks.
The form 8938 is filed directly with the tax return and the forms are included in the TurboTax package.
TurboTax Leads to a False Sense of Security
As a result of filing the 8938 and FBAR, David believes he is in tax compliance because he has completed all the requisite forms required by TurboTax. Unfortunately, this is incorrect, and due to the nature of David’s foreign assets, he could be subject to extensively high fines and penalties for failing to file numerous different forms.
Here’s a list of the forms David may have to file, which he will not be able to access through TurboTax.
IRS Form 3520 – Receipt of Gift From Foreign Person
IRS Form 3520 is used when a person either receives a gift from an individual or business (that meet certain threshold requirements) and/or a trust distribution. Since David received an inheritance a few years back, the inheritance is considered a gift. Moreover, David’s inheritance was from a foreign person who is an individual — and the value of the gift exceeds $1.6 million.
As a result, David should have completed form 3520 in the year he received the gift.
Penalties for Not Filing 3520
Section 6677. A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable): 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust. 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution. 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679) for failure by the U.S. person to report the U.S. owner information.
Such U.S. person is subject to an additional separate 5% penalty (or $10,000 if greater), if the foreign trust (a) fails to file a timely Form 3520-A or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c) and the Instructions for Form 3520-A.
Form 5471 – Foreign Corporations
David never filed an IRS Form 5471 reflecting the ownership of the foreign corporation and never thought he had to, since he had not received any income from the Foreign Corporation.
The IRS takes this form very seriously and is known to issue penalties for failing to file the form. Form 5471 is a very complex form that requires at least a basic understanding or knowledge of accounting and tax laws. In addition, aside from the year he acquired interest, since it is a Controlled Foreign Corporation, David would have an ongoing requirement to file this form while he still maintained the interest in the business.
Penalties for Not Filing 5471
Failure to file information required by section 6038(a) (Form 5471 and Schedule M). A $10,000 penalty is imposed for each annual accounting period of each foreign corporation for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign corporation) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired.
The additional penalty is limited to a maximum of $50,000 for each failure. Any person who fails to file or report all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901, 902, and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure to the U.S. person, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038(c) (2) for limits on the amount of this penalty.
Failure to file information required by section 6046 and the related regulations (Form 5471 and Schedule O). Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction. If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period or fraction thereof during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000.
Criminal penalties. Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file the information required by sections 6038 and 6046
Form 8865 – Foreign Partnership
David owns the apartment building abroad with his brother and therefore must file a Form 8865 at least in the year of acquisition. Since the partnership is considered a Controlled Foreign Partnership, David may also have an ongoing reporting requirement. First, David would have to file in the year he received the interest in the partnership.
Second, because it is controlled, David would also the file the form each additional year detailing his ownership along with some other schedules that are required when filing a form 8865 one 5471.
Penalties for Not Filing 8865
A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.
Any person who fails to furnish all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901, 902, and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038 (and the underlying regulations) for the maximum reduction, the exception due to reasonable cause, and for limits on the amount of these penalties.
Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information.
Other Forms Missing from TurboTax
These are just some of many International Tax Forms you will not be able to access through TurboTax. For Example, if you have a PFIC and need to file form 8621, or Transfer Property into a Foreign Business – you may need to file other forms as well, which you cannot access through TurboTax.
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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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.