Santa is not the only person checking its list this time of year. The IRS also has announced recently that it is indeed checking its list for taxpayers that have not filed various required disclosure forms for reporting foreign interests and assets. Several provisons incorporated in the U.S. tax code and the Bank Secrecy Act impose additional filing obligations upon individuals and entities that either own or have signature authority over foreign assets. These filing obligations can be duplicative at times, but once studied, then become easy to administer going forward. However, many U.S. individuals (including Green Card holders) either are unaware of the obligation and many tax preparers never asked the questions necessary to determine whether any additional filing obligation applies. As a consequence, many individuals have not satisified the filing obligation and may also owe additional tax, interest, and penalty associated with the non-compliance. A draconian penalty regime applies to the non-compliance. In some cases, the non-filing coupled with a failure to report income may rise to the level of a criminal matter. The good news is that the IRS wants taxpayers to resolve their obligations and provided an incentive to resolve them through various voluntary disclosure programs. The bad news is that Congress has conferred additional power upon the IRS to discover those tax filers that have not shown the initiative to become compliant. It is not too late.
Owning assets in foreign accounts is not by its very nature a bad thing, but failing to disclose the interest on the appropriate form has become a lighting rod for controversy upon IRS examination of individual and corporate tax returns. Many individuals accumulate foreign assets by any number of means, e.g., a devise from a relative’s estate, living in a foreign jurisdiction, investment decision, etc. The IRS has a catalog of forms, including four primary forms, that it expects taxpayers to attach to their individual tax return as appropriate or file separately.
- Statement of Specified Foreign Financial Assets (Form 8938)--Report Financial accounts held at foreign financial institution
- Report of Financial Bank Account and Financial Accounts (“FBAR” and "FinCen Form 114")--Report financial accounts held at foreign branch of US and foreign financial institution
- Annual Information Return of Foreign Trust With a U.S. Owner (Form 3520-A)-- Report foreign trust with a U.S. owner required to file form. U.S. owner ultimately responsible to ensure such filing completed.
- Information Return of U.S. Persons With Respect To Certain Foreign Corporations (Form 5471)--Report of certain U.S. citizens and residents who are officers, directors, or large (25% or more) shareholders in certain foreign corporations.
Please note the IRS has many other forms. Please consult with a tax professional for a full analysis appropriate to your tax filing facts. The penalties for non-filing are rather severe and may go as high as 50% of the highest account balance when the violation is deemed "willful" in nature. In addition, criminal penalties may apply.
The asset reporting threshold for many of these forms is not substantial, and can be as little as $10,000 in the case of FBAR. However, the penalty for non-filing might be large in relation to the actual balance. No penalties will be imposed to the extent a taxpayer can demonstrate the non-filing or failure to comply resulted from reasonable cause, not willful neglect. The courts have sided with the IRS on many cases seeking to define and apply this standard. Nonetheless, the IRS has offered a number of programs that differentiate taxpayers and provide relief, including complete relief in some cases, i.e., no penalty. These programs commonly referred to as Offshore Voluntary Disclosure Program (“OVDP”). The OVDP offers several tracks which provide different levels of penalty relief for non-filing of the FBAR and Form 8938 which differentiates between different groups and the enumerated relief. The following factors determine what program a non-compliant taxpayer may enter into and receive the designated relief:
· State of mind – willful or non-willful
· Outstanding tax liability – yes or no
· U.S. resident or non-U.S. resident (in any of the 3 prior tax years)
The OVDP tracks typically require the taxpayer to declare any outstanding tax liabilities and amend certain income tax filings for a series of years, generally 3 years. The taxpayer also needs to disclose fully the facts for the non-filing when there is an outstanding tax liability and generally provide 6 years of the outstanding FBARs or other required filing.
The IRS has begun to focus more of its enforcement budget and resources on non-compliant taxpayers, especially non-filers of the above forms, and has developed additional tools to risk assess individuals and identify potential targets, including:
· Whistleblower Program (persons with knowledge of non-filer’s assets)
· Tax Information Exchanges with Foreign Taxing Authorities
· Tax Information Exchanges with Foreign Financial Institutions
· Selection for IRS Examination
To avoid falling into the IRS enforcement net and minimize potential penalty assessments, taxpayers should actively pursue and verify that their worldwide income has been properly reported on their U.S. returns and ensure that their U.S. return properly reports any non-US assets. If there is a problem, then the time to resolve the issue is before the IRS gathers the information from an information exchange with a foreign institution, or other means, and begins an audit or sends a notice asking why the information was omitted from a FBAR prior filing. A discussion with an attornery or certified public accountant to determine eligibility for participation in the OVDP should be also pursued. The ultimate goal is to return to the compliant list and off the IRS' "non-compliant list." Otherwise, the IRS will confer something much worse than coal on the taxpayer.