- 1 Preliminary Issue: Asset and Account Reporting vs. Income
- 2 U.S. Persons Living Overseas
- 3 FBAR – Ownership, Interest or Signature Authority
- 4 8938 – Statement of Specified Foreign Assets
- 5 Foreign Trust
- 6 3520-A
- 7 3520
- 8 Foreign Gift
- 9 Foreign Partnership
- 10 Foreign Corporation
- 11 PFIC (Passive Foreign Investment Company)
- 12 REIC
- 13 Real Estate Ownership by an Individual
- 14 Real Estate Ownership in a Corporation/Trust
- 15 Gift and Estate Tax
- 16 Common International IRS and DOT Forms
- 17 Streamlined vs. OVDP
- 18 Why Comply with IRS Foreign Disclosure Laws?
Golding & Golding is an international tax law firm comprised of tax attorneys and enrolled agents. Unlike other firms that like to “advertise” they handle international tax, international tax law is all we do. Moreover we have developed a niche practice in representing individuals and businesses worldwide offshore disclosure.
Offshore Disclosure is more than just “OVDP” or the “IRS Streamlined Program.” It is the comprehensive and detailed practice of bringing U.S. Taxpayers into Tax Compliance involving numerous different issues and hurdles. Issues involving Fraud, Evasion, Unreported Earned Income, Unreported Foreign Assets must all be taken into consideration when evaluating a person’s compliance initiatives.
Many of our clients are located overseas and abroad. Whether a person is a U.S. citizen turned expat living in a foreign country or foreign national linked to the United States because he or she is a former or current green card holder (or qualifies for the substantial presence test) there are still US tax compliance responsibilities.
Under new guidelines such as FATCA (Foreign Account Tax Compliance Act) individuals who have US tax compliance/reporting requirements must make sure they stay in compliance in order to avoid extremely high fines and penalties. The U.S. government has become so serious about enforcement, that they have been utilizing new tools to facilitate enforcement, including: passport revocations and custom holds.
There are a large number of reporting responsibilities, depending on the facts and circumstances of your situation. With that said, we are going to provide you a summary of the various key reporting requirements we have found are most common with taxpayers living abroad or overseas in a foreign country.
Please click the link to be taken to a page with a much more comprehensive summary
Preliminary Issue: Asset and Account Reporting vs. Income
This is a very convoluted topic, but it is important for us to explain it before getting into the specific details of IRS Tax requirements.
When a person has interest or ownership over various foreign accounts and foreign assets, this interest must be reported to the IRS if applicable rules apply. It does not matter whether the asset generated any income and/or if any distribution was made. Rather, what is being reported is the ownership/interest in the asset or account.
The United States taxes US taxpayers on their worldwide income. It does not matter where you resided when you earn income (excluding FEIE rules), and it does not matter whether the foreign country taxes that category of income. If you earned income overseas, that income must be reported on your US tax return even if you do not have any interest in the asset. For example, foreign income could include foreign employment or high dividends being paid from an asset that does not meet the FBAR or 8938 threshold requirements for reporting.
U.S. Persons Living Overseas
For reference, there are few distinctions between terms that you should be aware.
- U.S. Citizen: A US citizen is considered a US citizen no matter where he or she lives. A person does not lose that status simply because they reside overseas.
- Green Card Holder: A Green Card Holder/Legal Permanent Resident has obtained formal status from the United States. If a person resides overseas for a significant period of time, they may have been considered to have abandoned their green card. This does not mean they can avoid tax reporting requirements, because they may not have met the formal requirements for relinquishing a green card.
- Long-Term U.S. Resident: if a person has a green card or was a long-term US resident, they may have continuing reporting requirements at least for a period of time. When they leave the United States and may be considered a covered expatriate in the US can go after them for taxes and penalties (this prevents an individual and collective wealth in the United States and then hightailing it out of there with no tax liability)
- Substantial Presence Test: A person who needs to US residents requirements solely under the substantial presence test, will general lose this status ones they no longer meet the test.
FBAR – Ownership, Interest or Signature Authority
Whether a person has ownership, interest or signature authority over a foreign account, they are still required to file an annual FBAR (Report of Foreign bank and financial accounts) form directly with the Department of treasury online if they meet the minimum threshold reporting requirements. The requirements are simply does the person have more than $10,000 in annual aggregate total of ownership, interest, or signatory authority over foreign accounts
8938 – Statement of Specified Foreign Assets
The 8938 form is a bit different than the FBAR. It is file directly with your tax return and submitted to the Internal Revenue Service along with your tax return. The threshold requirements for having to file this form are much higher than for the FBAR. Whether or not you have the file the form will be determined by your marital status and if you are considered a foreign resident. The form is similar to the FBAR with key distinctions such as direct ownership of partnership interests or stock ownership would be identified on the 8938 but not the FBAR. Conversely, if a person does not have an interest in the account, they may not be required to file the form – as opposed to the FBAR, in which a person with mere signature authority must still file the form.
Just because you reside overseas does not mean you can avoid foreign trust and foreign gift reporting requirements if you receive trust distributions or gifts from foreign persons.
Depending on what your estate planning or asset ownership is in a foreign country will help determine whether you have a foreign trust or not. Moreover, the definition of a foreign trust is very broad for US tax purposes and even if you do not believe your force structure is a foreign trust, chances are it may be. When it comes to foreign trusts, there are two main forms that need to be submitted to the IRS — and the failure to do so may result in extremely high fines and penalties.
This is a form that is filed when you have ownership over the foreign trust. This is a much more comprehensive form and will usually require the assistance of the trust administrator if you are using a foreign trust company
This form is used by any beneficiary of a foreign trust. This form is also used by individuals who receive foreign gifts from either a foreign individual or foreign business. The gift can be either cash or have a fair market value and whether or not you have to report the gift will depend on who issued the gift. In other words, the threshold requirements for having to report a gift very depending on whether the gift was issued by a person or a foreign company.
As with form 3520 for trust distributions, the recipient of a gift from a foreign person also must file form 3520. The failure to file this form timely can have serious financial consequences, including penalties upwards of 25% of the value of the gift (35% in other circumstances)
Interest in a foreign partnership must be reported. Which forms a person must file to get into IRS and US government compliance will depend on the value of the interest of the foreign partnership. Nevertheless, ownership interest in a foreign partnership is included on an 8938 form – statement specified foreign assets. This reporting is required, even if there is no income or distribution, since what is being reported is the ownership interest and not necessarily whether or not a distribution was made.
Interest in a foreign corporation must be reported. Which forms a person must file to get into IRS and US government compliance will depend on the value of the interest of the foreign corporation. Nevertheless, ownership interest in a foreign corporation is included on an 8938 form – statement specified foreign assets. This reporting is required, even if there is no income or distribution, since what is being reported is the ownership interest and not necessarily whether or not a distribution was made.
PFIC (Passive Foreign Investment Company)
As you may or may not be aware, the US government hates Passive Foreign Investment Companies. The reason why is because individuals often use these companies to shelter investments that would otherwise be earning interest, dividends or receiving distributions and thus currently taxable under US law. For example, a US mutual fund generally has to distribute 90% of its earnings to avoid a second layer of tax. Conversely, a foreign mutual fund can do whatever it wants, and often times it will suspend income that would otherwise be distributed and thus allowing the investor to avoid any immediate tax liability.
The reporting requirements of the PFIC (especially if there was an excess distribution) is very complex. Moreover, there is no minimum threshold requirement for reporting interest in the PFIC and therefore any interest in a PFIC must be reported. To further complicate matters, the definition of PFIC for IRS purposes is overbroad and includes investments you probably never thought or intended on qualifying for PFIC such as a foreign mutual fund.
An REIC is a real estate investment company. Is a company that is designed to facilitate real estate investments. There are various aspects to an REIC, with the main concept being that investments in various real estate projects are aggregated or pooled together and then managed by a fund. Generally, ownership in an REIC as ownership of a corporation. This, depending on the value of the ownership of the REIC a person would have to report the interest on an 8938 and 8621.
Moreover, when income is being generated from the REIC — even if the income and property is all sourced from overseas/abroad — the income must be reported on a US tax return. If taxes were already paid in a foreign country, then individual may be able to apply and utilize a foreign tax credit so that he or she is not paying double tax.
Real Estate Ownership by an Individual
There are various facets to real estate that is owned by an individual. First, if the real estate does not generate any income and is not owned by foreign entity commenting generally it does not need to be reported. If there is foreign real estate that is being used to generate rental income, then there are some additional issues to contend with. First, while the real estate itself does not need to be reported, the income being generated does need to be reported on a US tax return. This is true, even if taxes do not need to be paid in the foreign country because it does not meet the threshold requirements for reporting in that country.
Moreover, if there are foreign accounts associated with the property, even if the accounts and merely being used for expense purposes-they must be reported as well, presuming threshold requirements are met.
Real Estate Ownership in a Corporation/Trust
When foreign property is held in a corporation or other entity, the rules are much more complicated. That is because the real estate is not parsed out from the rest of the assets. Therefore even though the actual piece of property may not be reported, the value update is included as part of the value of the Corporation or is it. Moreover, since you have to report your percentage value of ownership of the foreign entity in essence, you are reporting a real estate.
The reason this is important, just because of the US government finds you are out of compliance and is going to penalize you, then the value of your interest can be penalized and thus you are being penalized on the unreported value of the real estate as well
Gift and Estate Tax
Gift and estate tax can get very complicated. For purposes of the summary, we will keep it very brief. If you are a US citizen, legal permanent residents considered a tax resident for gift and estate tax purposes you get the full benefit of the gift and estate tax exclusion.
This is a very simplified version of the Rule.
Each person gets $5.45 worth of gift and estate tax exclusion. That means, a person can even get or pass away with $5.45 million worth of money/assets and the recipients will not be taxed on the receipt of the money or assets. In addition, a person can also get $14,000 a year to anybody they want and that $14,000 is not subtracted from a person’s lifetime $5.45 million exemption.
For married couples for US citizens they can get $28,000 together to anybody they want. Thus, if one spouse has $28,000 to get but the others spouse is not then spouses for US citizens can get it together so that the one spouse with money can double up their gift without impacting their $5.45 million exemption amount.
Just because a US person resides overseas does not mean they lose their $5.45 million exemption amount (read: Expats). Conversely, just because a person was a foreign national who resided in the United States previously as a US person for taxes does not mean they may still get the benefit of the $5.45 million after they leave the United States.
For individuals for non-US persons and foreign residents, their exemption amount is limited to $60,000; thus, is important to fully and carefully evaluate and analyze your tax situation at the time you are considering planning your estate – especially when you reside overseas.
Common International IRS and DOT Forms
The following is a list of forms that are commonly used by individuals who reside overseas and are still subject US tax and reporting requirements
(Add Links and Other Forms)
- FBAR Form – Report of Foreign Bank and Financial Accounts
- Form 8938 – Statement of Specified Foreign Assets
- Form 3520 – Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
- Form 3520-A – Annual Information Return of Foreign. Trust With a U.S. Owner.
- Form 5471 – Information Return of U.S. Persons With Respect. To Certain Foreign Corporations
- Form 5472 – Information Return of a 25% Foreign-Owned U.S. Corporation or a Corporation Engaged in a U.S. Trade or Business
- Form 8621 – Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund
- Form 8805 – Foreign Partner’s Information Statement of Section 1446 Withholding Tax
- Form 8813 – Partnership Withholding Tax Payment (Section 1446)
- Form 8833 – Treaty-Based Return Position Disclosure
- Form 8840 – Closer Connection Exception Statement
- Form 8843- Statement for Exempt Individuals and Individuals With a Medical Condition
- Form 8854 – Initial and Annual Expatriation Statement
- Form 8865 – Return of U.S. Persons With Respect to. Certain Foreign Partnerships
- Form 8898 – Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession
Streamlined vs. OVDP
If you are out-of-compliance, the two main programs to get you back into Compliance is OVDP (Offshore Voluntary Disclosure Program) and Streamlined Compliance Procedures.
A summary of the two programs is provided for you below:
At Golding & Golding, we have successfully handled numerous OVDP (Offshore Voluntary Disclosure Program) and IRS Streamlined Program applications for individuals and businesses around the globe with outstanding unreported foreign accounts ranging from $50,000.00 to over $35,000,000.00
Click Here to learn about some of our more recent OVDP and Streamlined accomplishments.
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.
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.)