Form 14654 – Understanding the IRS Streamlined Offshore Disclosure Penalty
Form 14654 is the main form required when a person submits an IRS Streamlined Domestic Offshore Disclosure.
When the modified Streamlined Offshore Disclosure Program was introduced back in July 2014, it was a sigh of relief for many individuals who have foreign accounts, assets or income that they were not aware they were required to report — and were non-willful.
Unlike traditional OVDP (Offshore Voluntary Disclosure Program), the Streamlined Program has very reduced penalties, along with a “streamlined” version of the Foreign Tax, Accounts, Income and Investment reporting requirements.
For example, a person only has to amend tax returns for three (3) years and report FBARs for the last six (6) years. This is different than OVDP, in which a person has to amend or file original returns for eight (8) years, and report eight (8) years worth of FBARs.
Of course, the greatest benefit to the streamlined program is the penalty reduction and/or penalty waiver if a person qualifies as a “Foreign Resident.”
Under traditional OVDP, there are multiple penalties that a person would have to pay. The worst penalty of them all is the FBAR/8938 penalty. For OVDP, the penalty is calculated by determining each unreported account’s maximum balance for each year within the eight year compliance. Then, a person must aggregate all the unreported account maximum balances for each year in the compliance period, to determine which year has the “highest penalty base.”
For example, if your foreign account was artificially high for a few days because of a large asset sale or transfer, that money would be included in the penalty base (while avoiding duplicate counting). Thus, if your account generally has $250,000 in it, but for a few weeks (following a real estate sale) it had $2.5 Million in it, the taxpayer must multiply the $2.5 Million by either 27.5% or 50% (depending if any of the money was located in a bad bank).
Under the Streamlined Program, these harsh rules were relaxed. If a person was non-willful and meets the other threshold requirements for filing under the Streamlined Program, the calculations are performed differently.
First, the Tax Filing period is only three (3) years in instead of eight (8) years. Moreover, the FBAR reporting period is only six (6) years instead of eight (8) years.
Second, the penalty based on the highest year-end value – not the highest account value. For example, if Michelle had one account with $300,000 in it on December 31, but at some point during the year (due to the large transfer she was going to use to purchase foreign property) the account had $2.4 million in it, the penalty would be based on $300,000 (For OVDP, the penalty would be based on $2.4 million)
Thus, Michelle’s penalty drops from either $1.2 million (50%) or $660,000 (27.5%) All the way down to $15,000 ($300,000 x 5%). While $15,000 is a lot of money to pay for a penalty, it is a much smaller burden to shoulder in order to get into compliance than it would be in relation to one of the larger penalties.
Unlike OVDP, there is no annual penalty on the outstanding tax liability that is due for each year in which foreign income was earned but no U.S. tax was paid.
The main aspect of the Streamlined Penalty is that the applicant must certify under penalty of perjury that he or she was non-willful. As the Streamlined Program has matured, The IRS stepped up the requirements necessary to show a person was non-willful.
While a person is not required to write a novel explaining the facts and circumstances of their non-compliance, they are required to provide substantial information sufficient to show they were non-willful. Unfortunately, many individuals attempt this alone and often times will make statements or omissions that may allude to them being willful (but really, really sorry about it) — as opposed to non-willful.
It is recommended that applicants use an attorney whenever making an affirmative representation to the IRS. Especially in this type of situation, wherein if you submit without an attorney, you will have no buffer between you and the IRS. Therefore, you will have to answer questions directly, versus having an attorney who will be there with you by your side (and who signed the certification along with you).
Want to learn more about the Streamlined Procedures?
The following is a reproduction of our very popular Streamlined FAQ (Frequently Asked Questions) from the trenches.
Streamlined Offshore Disclosure Program FAQ
For many individuals who are considering whether or not they should “come clean” and enter one of the IRS offshore disclosure programs, they have several questions which are not explained or detailed by the IRS.
In addition, it is hard for individuals without a tax background to distinguish what is reality, and what is just overly-aggressive sales and fear tactics used by many unscrupulous Law Firms, CPAs, and Enrolled Agents.
The following is a list of FAQs (Frequently Asked Questions), Pitfalls, and Tips from the experienced Voluntary Disclosure Lawyers at Golding & Golding.
Our firm is one of the only boutique tax law firms worldwide that is focused exclusively on International Offshore Disclosure Tax Law. We have handled a diverse range of streamlined program applications ranging from under $100,000 to nearly $40,000,000 in a single disclosure.
This is a summary of common Streamlined Program Questions we receive often. It does NOT constitute legal advice that can be relied upon as legal advice for your particular situation, since each person’s circumstances are unique and may impact the determination of whether he/she qualifies for the program.
How do I know if I Was Willful?
In reality, there is no concrete definition of the term Willful or Non-Willful. It is essentially a ‘Totality of the Circumstances’ Test based on whether or not your specific facts and circumstances reflect that you knew, or should have known that you were required to disclose and report your foreign accounts and offshore income — and made the decision not to disclose.
It is really that simple and for most people, if they were unaware that there was a foreign account/foreign income/foreign asset reporting requirement, they could not have possibly known that they were required to report the accounts/income — and would therefore fall into the “non-willful” category.
I Knew I Should have Filed Tax Returns, but Did not Know About FATCA or FBAR?
The IRS is not one for mincing words or arguing semantics. In other words, if you knew you were supposed to file a tax return (or “do something”) to meet the obligation of reporting your foreign accounts and/or foreign income, then the mere fact that you were not fully informed of every measure you needed to take in order to get into compliance…is probably a situation in which the IRS would find you willful.
In these types of circumstances, it is important to speak with an experienced offshore disclosure lawyer – but keep in mind that the fact that you knew you had a reporting requirement and/or tax filing requirement but intentionally failed to meet that requirement is probably sufficient to place you in the willful category (under IRS standards).
What if the IRS disagrees with Me and Believes I was Willful?
If the IRS disagrees with your representation of the facts, then they will reject your Streamlined Application, and either Audit you and/or refer the case to the IRS Special Agents for Criminal Investigation.
Without sounding like a salesperson, this is why you retain an experienced international tax lawyer to represent you throughout the application process. Yes, CPAs, Enrolled Agents and general practitioners will try to sell you that they can do it for “cheaper” and that you are “low-risk”, but once the IRS starts auditing individuals who are in the program, you will be a much better position (mentally and physically) to know you are being represented by an experienced International Tax Attorney (covered by the attorney-client privilege).
Is there an Attorney-Client Privilege with a Non-Attorney?
No, there is not. If you are being represented by a non-attorney, then there is simply no attorney client privilege. There is a very limited privilege with a CPA or Enrolled Agent, but if it turns out the IRS believes you were willful and wants to pursue a criminal investigation against you, the CPA or enrolled agent can be forced to submit to an examination by the IRS (unless the CPA or Enrolled Agent is also an attorney). Please Click Here for an Article on Attorney-Client privilege.
In other words, the information you tell your CPA may be subject to discovery by the IRS.
My CPA told me there is a Privilege?
There is a limited privilege you maintain with a CPA, but it does not cover more extensive criminal and quasi criminal investigations. In this type of situation (Streamlined Disclosure), in which the IRS does not provide concrete guidelines regarding willful versus non-willful, it is important to understand that the IRS could follow-up with you and/or your representative.
While you may believe the facts and circumstances of your situation are clearly non-willful, the IRS may disagree. To that end, this is not the type of matter in which you want your CPA or other non-attorney tax representative to be subject to having to disclose information you believed you told the representative in confidentiality.
Which Three (3) Years of Tax Returns do I have to Amend?
Generally, it has to be the last three years of tax returns that were filed. So for example, in November of 2016 you decide you want to enter the program, you would amend your tax returns for tax year 2015, tax year 2014, tax year 2013. Please Click Here to Learn More about Amending Tax Returns under the Streamlined Program.
Is it True I can still be Audited for the Prior 3 years of Tax Returns?
Whether or not you enter the Streamlined Program (which requires you to amend the most recent 3 years of tax returns), if you have more than $5000 of unreported foreign income, the IRS can expand the Statute of Limitations to audit you from 3 years to 6 years.
For example, if you enter the Streamlined Program in 2016, and amended 2013, 2014, and 2015, the IRS could still audit you for the three prior years (2010-2012) – but that is true whether or not you enter the streamlined program, and by entering the Streamlined Program you may reduce the chances of having those years audited. Please Click Here for an Article regarding the Streamlined Program and the 6-year foreign income audit.
On my Original Schedule B I Indicated I had no Foreign Accounts?
This is where many people start to “ride the line” between willful and non-willful. The fact of the matter is, there are many reasons that we have come across in our practice as to why a non-willful person would indicate they did not have foreign accounts on the Schedule B when in fact they did have foreign account – and would still be considered non-willful. Thus, if the only reason you believe you were willful is because of how you or your CPA/Accountant responded on schedule B, it may be in your best interest to contact an experienced streamlined disclosure lawyer to discuss the possibilities of qualifying for the Streamlined Program
So if I marked No on Schedule B, I may still Qualify for Streamlined?
Yes. For more information, you can click here to read what the IRS has to say about Schedule B and Non-Willful (See IRS FAQ 13).
I received a FATCA Letter, now what?
When you receive a FATCA Letter (Foreign Account Tax Compliance Act), it is important to realize that the clock has already started ticking. It means that the foreign financial institution/foreign bank is probably going to report your information to the United States, and when the IRS learns that you have outstanding foreign accounts that have not been reported on your tax return, it could lead to an audit or examination which may prevent your ability to enter the program.
What if I Do Not Respond to the FATCA Letter?
If you do not respond to the FATCA Letter, chances are the Foreign Bank will submit your information to the IRS, which in turn may lead to an IRS Audit or Examination — and make you ineligible for the Streamlined Disclosure Program. Click Here to learn about not responding to a FATCA Letter.
What if I have an Unreported Foreign Gift (Form 3520)?
If you failed to report a gift from a foreign person, foreign business or trust distribution, it may be subject to a penalty unless you properly disclose it in accordance with amending your tax returns under OVDP. For more information about Foreign Gifts, please Click Here.
What if I Failed to Report a Foreign Trust (Form 3520-A)?
The U.S. Tax Code is stacked against Foreign Trusts. In other words, the failure to properly report your foreign trust on a form 3520-A can lead to significant fines and penalties (as the U.S. Government may see it as your attempt to shelter money offshore in a Foreign Trust). To learn more about Foreign Trust Reporting, Please Click Here.
What if I Never Reported my Foreign Business Interest (Form 5471)
In order to avoid the problem of U.S. Taxpayers sheltering money offshore in a foreign business (and not reporting the earnings), the IRS takes a hardline against individuals with unreported Foreign Business Interest. For individuals required to file form 5471, the failure to filing the form can lead to penalties upwards of $50,000+ and the returns are due annually. To learn more about reporting your Interest in a Foreign Business, please Click Here.
I have a PFIC and/or Foreign Mutual Fund that I never Reported (Form 8621)?
The IRS reserves the most complicated and complex tax computation for the infamous “PFIC aka Passive Foreign Investment Company.” Moreover, the IRS has essentially deemed that all Foreign Mutual Funds fall under the PFIC umbrella. Therefore, that Foreign Mutual Fund you purchased offshore that is accruing and/or distributing Interest or Dividends may be subject to a monster tax analysis — especially if it qualifies as issuing an “Excess Distribution.” For a comprehensive analysis of PFIC 8621 reporting, please Click Here.
I Cannot Locate All of my Account Information
If you are unable to find all of your account information, the most important information to obtain is the year-end balances. That is because it is the year-end balances that are utilized by the IRS to determine what your penalty will be (unless you qualify for a penalty abatement). Thus, while many foreign countries do not hold account information for more than three years and/or charge ridiculous fees for you to obtain the information — you can usually obtain the year-end information.
I do not Have to Pay Tax on These Accounts Overseas?
Welcome to the United States. If you are entering the streamlined program it is because you learned you are required to file your taxes as if you were a US citizen and the IRS taxes you on your Worldwide Income.
Thus, as a US citizen, Legal Permanent Resident, or Foreign National otherwise subject to US income tax on a 1040 you are required to file a US tax return and report all of your foreign earnings. Just because you are not taxed on passive income in the country in which the accounts were held does not mean the income is tax-free in the United States.
In fact, foreign income (paid or accrued) is usually taxable under IRS Tax Law — but if you have already paid foreign tax you may qualify for the foreign tax credit. Click Here to learn more about the Foreign Tax Credit.
I already Paid Taxes on These Earnings Overseas?
Even if you have already paid tax on the foreign earnings overseas you still must report the information and disclose the earnings on your US tax return. But, when you disclose the account information you also claim what is referred to as an FTC (Foreign Tax Credit). In other words, while you are required to disclose the information regarding your foreign taxes, it does not mean you are subject to double taxation – you get a ‘Foreign Tax Credit’ for taxes you already paid.
Are There Penalties on the Outstanding Tax Liability?
No. Unlike the Offshore Voluntary Disclosure Program (OVDP) in which you have to amend your tax returns for eight (8) years as well as pay a 20% penalty on the total outstanding tax liability, under the streamlined program there is no additional penalty for the taxes; rather, there is a 5% penalty on the year-end account balances.
How is the 5% Penalty Calculated?
The penalties calculated as follows: a person will total their year-end balances for unreported accounts, for each year going back six years. If you are in the streamlined program this does not include the value of unreported foreign real estate which generates real estate income.
Once you have totaled the annual aggregate total of your foreign accounts for each year in the last six years, you pick ONY the highest year-end total, multiply it by .05 (5%) and that will be your penalty. In addition to this penalty, you also have to pay any additional tax liability for the last three years (if you have taxes due for unreported income) which result from amending the tax return (if there is any taxes due) as well as interest on the taxes.
I live Overseas, Do I Qualify for the IRS Penalty Waiver?
The IRS Streamlined Program carved out a very small niche for applicants who meet very specific residence requirements. In other words, if you reside overseas for at least 330 days in any one of the last three tax years in which you are filing an amended tax return, then you may qualify to have your 5% penalty abated. It is important to understand that this is not the same as the Foreign Earned Income Exclusion Test and the FEIF Bona-Fide Residence Exception under IRC 2555 does not apply.
Is my Foreign Real Estate Calculated into the Equation?
This can become a very complicated discussion, but keeping it simple it goes like this: if you as an Individual own foreign real estate that generated income and you qualify for the streamlined program, the value of the real estate is not included in the penalty competition. In OVDP the value of foreign real estate that generates income is included in the penalty computation.
To complicate matters, if you own foreign real estate within an investment such as a foreign mutual fund or possibly a foreign self-directed IRA, then the value of the account will include all the investments held in the mutual fund and if that includes foreign real estate then you may indirectly be subject to a penalty on that foreign real estate.
*If you are in this type of situation, you should consider speaking when experienced international tax lawyer before making any submission.
What Type of Accounts Must be Reported?
Generally, all foreign accounts must be reported. For example, Foreign Account reporting would generally include: Foreign Bank Accounts, Foreign Savings Accounts, Foreign Investment Accounts, Foreign Securities Accounts, Foreign Mutual Funds, Foreign Trusts, Foreign Retirement Plans, Foreign Business and/or Corporate Accounts, Insurance Policies (including some Life Insurance), Foreign Accounts held in a CFC (Controlled Foreign Corporation), and Foreign Accounts held in a PFIC (Passive Foreign Investment Company)
Must Foreign Insurance Policies be Reported?
If there is a surrender value, then generally insurance policy must be reported. Foreign life insurance and life assurance policies generally have an investment mechanism to them, which provides monthly, quarterly or annual interest/bonus payments – as well as a surrender value – and if so, the policy must be reported.
What if I am Under IRS Audit or Examination?
If you are currently under IRS audit or examination, than you generally will be disqualified from the program. The idea is that the streamlined program and OVDP are voluntary programs and once you are under audit you are no longer acting “voluntarily.”
Of course, not every IRS agent is fully aware of the parameters of the program and once you receive the notice of audit letter from the IRS it may not hurt you to try to submit to the program but it can cause a major issue depending on whether the audit has anything to do with for accounts and other very personal and confidential information.
What is a Reasonable Cause Statement?
As an alternative to the streamlined program, some individuals opt to just submitting all of the prior documentation that was not previously disclosed or reported, along with a statement detailing why they have reasonable cause for failing to do so.
This is could be a risky move, because by doing so the person is disclosing all of their financial information to the Internal Revenue Service without any guarantee of non-prosecution. Since the penalties for failing to file and FBAR are exorbitant and even the non-willful person can be subject to a $10,000 per account penalty per year the applicant must be careful.
In other situations, the Reasonable Cause submission is a very viable option – you should discuss the facts in detail with an experienced Offshore Disclosure Lawyer.
But I have no tax liability?
The threshold requirement is not whether you owe tax based on foreign earnings and foreign accounts, but whether you properly disclosed your foreign accounts and income. In other words, if you have foreign income from your bank but there also bank fees and other deductions, which reduces your foreign interest income to zero, that does not mean do not have to report the account and income information.
Moreover, the failure to report the account and the “money” that was generated from the account is the problem and would still require disclosure. It also will not exempt you from tax and account reporting requirements.
What is Quiet Disclosure/Silent Disclosure
Honestly, it is a horrible idea to submit documents to the IRS via a Quiet Disclosure or Silent Disclosure. These types of disclosures occur when a person simply goes back and sneak reports/discloses the accounts without entering any program or submitting a reasonable cause statement. If a person does this, than they may be subject to criminal prosecution.
But if you have already done so (without understanding the ramifications of your actions) you can still get right by the IRS and submit under the streamlined program if your actions were non-willful (there are some people who inadvertently filed a quiet disclosure or silent disclosure because they were did not know they were required to even submit to a program or pay a penalty)
Does my Foreign Inheritance Count Toward the Penalty?
Yes. A distinction must be made between estate tax, income tax and reporting requirements. When a person has a foreign inheritance there may not be any estate tax on receiving the money, but if the account generates income then there is income tax. In addition, if the account value exceeds $10,000 (or the annual aggregate total of all the foreign accounts exceeds $10,000) the person must still report the information and therefore the value of the account will go towards the penalty.
Do I Receive Criminal Protection under the Streamlined Program?
No. While a person is almost guaranteed protection against prosecution under OVDP, there is no criminal protection under the streamlined program. Although, when a person is non-willful, criminal protection is generally not necessary.
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.)