For many years, U.S. Taxpayers were able to stay below the radar and not have to worry about the United States discovering their foreign accounts. Although US taxpayers have always been required to report their worldwide income and disclose their foreign accounts, the Internal Revenue Service rarely enforced the law.

Golding & Golding – U.S. and International Tax Lawyers

In more recent years and with the globalization of the US economy, it is common for individuals and businesses to maintain accounts in multiple different countries – whether or not they are a U.S. citizen or Legal Permanent Resident. Moreover, since both US citizens and Legal Permanent Residents are required to report their worldwide income on their tax return, after awhile the United States realized it was missing out on a substantial amount of income – namely interest income from foreign bank accounts.

With the implementation of FATCA and FBAR reporting standards, the failure to report these accounts can ignite a downward spiral for US Taxpayers caught in the web of international tax compliance. This may result in significant penalties which can reach 100% hundred percent of the account value, as well as outstanding tax liability and possible criminal prosecution depending on the facts and circumstances of the case.

                                   

How do the Foreign Banks and IRS Discover You?

Example: Peter is a US legal permanent resident who is originally from Brazil. Peter has numerous accounts in Brazil but never updated the Brazilian bank that he is a legal permanent resident. Thus, the foreign bank has not been reporting Peter’s earnings to the United States.

  • Recently, with the enactment of FATCA, foreign banks have been sending “FATCA Letters” to US citizens, US legal permanent residents, and pretty much any bank customer that has a US address. These letters request affirmation from the account holder that he or she is either a legal permanent resident or US citizen.
  • If the account holder is either a US citizen or legal permanent resident, then he or she must also acknowledge that they have been in compliance with IRS FATCA reporting requirements.

If Peter does not hightail into either the OVDP or IRS Streamlined Programs and he is reported to the IRS, he can be in trouble. That is because of the IRS determines that Peter is not in compliance than they could penalize and significant amounts of money reaching upwards of 100% of the account value in addition to other taxes and penalties.

  1. Compliance: Since Peter’s has significant amounts of money overseas and has not filed a Schedule B, 8938 or FBAR, he could have substantial penalties on the highest values in these accounts.
  2. Taxes: Peter’s accounts earn substantial interest income overseas and Peter has not been reporting this interest income on his tax return. Thus, depending on the facts and circumstances of his case, his failure to comply could be considered tax evasion and tax fraud.

                                     

FBAR Penalties

Whether or not the taxpayer will be liable for penalties would depend on a whole host of different factors, including whether the accounts earned income, how long the accounts went unreported, and the particular revenue agent that is auditing the return/FBAR (since the revenue agent has a range of penalties that he or she can issue).

The following is a breakdown of different penalty structures depending on the nature of the failure to report:

No Unreported Foreign Income

If a taxpayer does not have unreported foreign income,  they will be in the best position to try to fight any penalties being issued for the failure to file the FBAR. The FBAR is an informational form which discloses the individual’s highest account balances for each individual tax year. When this form is not been filed, it generally means that the taxpayer has not provided the Internal Revenue Service with the account values.

  • If the taxpayer’s onlymistake was not filing form, but the taxpayer did report the income on the schedule B, 1040, and any other accompanying form then the taxpayer may be able to avoid the penalty on the FBAR. Even according to IRS notices and guidelines, the revenue agent should consider issuing a warning letter instead of penalty when the taxpayers only mistake was noncompliance in filing the form (as long as all foreign income – no matter how small of an amount – has been reported).

                                     

Unreported Foreign Income (Non-Willful)

If a taxpayer’s failure to file the FBAR was non-willful, then chances are the taxpayer may be in a  position to have a reduction or elimination of penalties. If the taxpayer was non-willful, then that means the taxpayer did have any intent, malice or fraud in failing to comply with FBAR filing requirements — rather, the taxpayer is simply unaware of the requirement to file the FBAR.

Presuming that there was additional income from overseas that the taxpayer did not report and the taxpayer was under examination before the taxpayer had an opportunity to enter the IRS streamlined program, there are four levels of penalties that the IRS could issue:

No Penalty

The IRS has the authority to waive penalties and instead issue a warning letter.

$10,000 Penalty

The IRS has the authority to issue one $10,000 penalty for all the accounts for the entire audit period.

$10,000 Annual Penalty

The IRS has the ability to issue a $10,000 penalty for each year that the taxpayer did not file and FBAR. For example, if the audit period is three years, then the IRS could issue penalties in the amount of $30,000.

$10,000 per account/per year

If the IRS agent wants to – even though the taxpayer was non-willful – if the circumstances require it the IRS agent can penalize the taxpayer $10,000 per account, per year for the entire audit period.

**This is one of the key reasons why it is important that a taxpayer does not speak directly with the Internal Revenue Service regarding these types of international tax issues and retains an experience international tax lawyer.

                                      

Unreported Foreign Income (Willful) 

If a person’s failure to file the FBAR was willful, which generally means intentional, then the stakes are much higher and the penalties much more severe. If a person intentionally failed to file their FBAR, it generally means they also intentionally failed to report their offshore income – which is a form of tax evasion and tax fraud.

The United States taxes individuals on their worldwide income; that means the United States does not care where you earned your income at, you must pay tax on it. For example, if you reside in the United States and earn $10,000 overseas in interest income (even if it was earned in a country that does not tax passive income) you are still required to pay tax on that money in the United States. Although, if you already paid tax in a foreign country already you may be entitled to a foreign tax credit.

In addition, if you sold the home in a foreign country and earn long-term capital gain or short-term capital gain, even if you do not have to pay capital gains enough for country, you have to report it on your US tax return as well. The intentional failure to report can have very serious consequences.

                                       

Why Enter either OVDP or the Modified Streamlined Program?

Individuals and businesses who are looking for a way to avoid the very steep penalties 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, 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.

*Please note, the IRS is not known to be sympathetic and if the IRS does not believe you and audits you anyway then you are disqualified from entering either the OVDP or streamlined program AND the IRS is have more of your overseas/foreign financial information you would like probably like.

Moreover, if the taxpayer improperly submits the forms to the IRS it can be considered “silent disclosure” or “quiet disclosure,” in which if detected by the IRS, the IRS will penalize you heavily as well as probably initiate criminal proceedings against you. In this scenario, not only with the IRS seek to take all of your money and assets through the implementation of penalties and levies, but chances are you will also 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)

OVDP stands for the Offshore Voluntary Disclosure Program, which came into effect in 2009 and was modified again in 2011, 2012 and 2014.

Before the implementation of the modified streamlined program (which is strictly for individuals who were non-willful in their failure to report their overseas assets and income) the penalty structure was generally (and continues to be for willful participants) 27.5% of the highest years annual aggregate total and 50% ifany of your money was held in one of the identified “bad banks.”

In other words, if you have foreign accounts that were unreported to the IRS and Department of Treasury, then to determine your penalty structure you would need to total up all of your unreported overseas and accounts for each year, for the last eight years, and then take the highest year’s highest balance and multiply it by 27.5% to arrive at the penalty amount due. (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, no penalty on the value of foreign real estate that was not previously disclosed, and the 27.5% penalty was reduced all the way 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 in any number of different countries 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 enter the streamlined program if you do not qualify; in other words, suck it up and pay the penalty. Why? Because 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 in March 2015. Essentially, 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 not only are you subject to criminal prosecution – but now you’ve already disclosed all the foreign financial information and thus you’re in a pretty difficult position to defend yourself. The IRS has let it be known that they will enforce criminal tax prosecution laws in these types of situations.

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.