Foreign Account & Income Reporting
At some point in the recent past you learned (for the first time) that you are out of compliance with reporting and disclosing foreign income and foreign accounts.
You are on extension for your 2017 tax return, and assessing what your best strategy may be in moving forward with your tax filings and offshore and foreign account reporting.
You have not yet made any intentional or reckless statements or omissions to the IRS on this issue — so you still have a chance to avoid willfulness related fines and penalties.
Is a very crucial period in your tax lifetime; a fork in the IRS road.
The IRS wants to believe that everybody is willful (Read: Scare Tactics). The IRS wants you to believe that nobody inadvertently fails to stay in tax compliance. This is despite the fact that the IRS provides little to no resources for either non-US persons or US persons with foreign income and a foreign income or account/investment tax reporting requirement.
In fact, the US government has even lowered the threshold requirements for willfulness. It does not even require intent — just reckless disregard, and really, what does that mean?
Isn’t Everybody a Little Reckless Sometimes…
Moreover, even though the penalties for willfulness are considered criminal in nature (upwards of 100% value of your foreign accounts in a multi-year audit), the government does not even need to meet the burden of proof requirements that would otherwise be required in a criminal setting.
In other words, the IRS can pursue criminal-like penalties against you in a civil forum, and they are not required to meet the burden requirements that the Government would otherwise be required if it was a criminal case (read: much worse for taxpayers).
You May Not Be Willful Yet…
This is important. Let’s say in January, 2017 you learned for the first time that you are required to report your foreign accounts and investments, along with all the income you earn abroad – even though it is either tax-free in the country of origin, or taxes were already withheld abroad from source.
You scour the tax websites and expat forums and come to the conclusion that while many people will skate by unscathed, some people will not – and for them the penalties can be brutal.
In life, you are somewhat risk-averse but at the same time cautious about delving into disclosing all of your foreign accounts and income to the IRS. In fact, your only a few years away from retirement or for any other reason your strategy in the upcoming years is to move back to your foreign country.
What do you do?
IRS Offshore Disclose – Non-Willful
If you properly disclose your foreign income, accounts, and investments using one of the approved IRS Offshore Voluntary Disclosure Programs such as OVDP, Streamlined or Reasonable Cause, then you can safely get into compliance. Depending on which program you choose you may have a stiff penalty, a less than stiff penalty, or possible even a penalty waiver.
You would be recommended to contact experienced Offshore Disclosure Counsel (there is no attorney client privilege with a CPA or accountant) and properly prepare the documents necessary to get yourself into compliance.
While you may have to pay a penalty, in the end you will be firmly in compliance with the Internal Revenue Service and should be able to avoid any additional fines or penalties for these related issues.
Non-Disclosure – Willful
On the other hand, you just don’t see yourself getting into compliance. Maybe you have a foreign pension, PPF, Superannuation or other fund that may be subject to penalty that is worth millions, and that money is not even available to you now — so even a 5% penalty seems high. Moreover, you are so risk-averse that the idea of making a reasonable cause statement with the potential of being penalized heavily down the line is too much to bear.
Instead, you roll the dice and don’t properly disclose.
You’re taking a big risk, here’s why:
Potential Penalties for Non-Disclosure
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Underpayment & Fraud Penalties
Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.
Even Criminal Charges are Possible…
Possible criminal charges related to tax matters include tax evasion (IRC § 7201), filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.