If you frequently read articles in the The Guardian, The New York Times, or press releases from the Department of Justice, you know that the scope of U.S. international tax enforcement continues to increase and there are plenty of fish in the sea that will eventually be caught. For the biggest fish — willful offenders with unreported or hidden offshore accounts and assets — the Offshore Voluntary Disclosure Program (“OVDP”) is likely the best option to address outstanding non-compliance; however, new initiatives from the Internal Revenue Service (“IRS”) may turn the tide for so-called non-willful minnows. While the particular facts and circumstances must be carefully considered before addressing past non-compliance, if you have unreported foreign accounts or assets and you answer yes to any of the following questions (i.e., you are potentially considered non-willful) and feel like a fish out of water when it comes to your options, then you may want to consider participating in theStreamlined Filing Compliance Procedures (“Streamlined Procedures”), Delinquent FBAR Submission Procedures (“Delinquent FBAR Procedures”), or the Delinquent International Information Return Submission Procedures (“Delinquent Information Return Procedures”), which are described in some detail below.
Yes No Question
Did you recently learn that you owned or had signatory authority over a foreign account?
Did you recently learn of FBARs (Report of Foreign Bank and Financial Accounts) and/or the requirement to report offshore accounts where the aggregate value exceeded $10,000?
Did you rely on a tax professional who failed to instruct you that many foreign accounts and/or assets must be reported on U.S. tax returns and FBARs, despite providing all requested information to the tax professional?
Did you recently learn that you were a U.S. citizen or that you were required to report and pay U.S. income tax on your worldwide income?
If you held foreign mutual funds, did you incorrectly treat sales or dividends received as capital gains or qualified dividends on your tax returns (i.e., not pursuant to the Passive Foreign Investment Company rules)?
Have you failed to file FBARs and/or information returns, such as Form 8938 (Statement of Specified Foreign Financial Assets), Form 8621 (Information Return by a Shareholder of a Passive Foreign Investment Company), Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations), Form 8891 (U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans), Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts), or Form 8865 (Return of U.S. Persons with Respect to Certain Foreign Partnerships)?
Before the Streamlined Procedures. From 2009 to 2012, taxpayers who were unaware of certain foreign tax and information reporting and payment requirements were, in essence, forced to enter the OVDP to make amends. Otherwise, they risked significant civil and criminal penalties for unreported foreign accounts and assets. Under the terms of the OVDP, taxpayers were (and are) required to file the last eight (8) years of tax returns and FBARs and pay any outstanding tax, interest, and penalties (either failure to file and failure to pay or accuracy-related) for these years. In addition, taxpayers in the OVDP were required to pay a miscellaneous offshore penalty of up to 27.5% of the total value of non-compliant foreign accounts or assets. In return, taxpayers accepted into the OVDP could avoid criminal prosecution and astronomical FBAR penalties.
As there was no clear alternative to the OVDP, a significant amount of non-willful violators — including dual citizens, individuals without a Social Security number, and individuals with foreign accounts that they were unaware of — were treated the same as the most egregious willful violators of U.S. tax laws. For example, a U.S. citizen who lived his entire life abroad and maintained benign retirement accounts in his country of residence, but was unaware of the foreign reporting requirements imposed by the U.S., might face a stiffer penalty than a U.S. resident who ferreted money away in a Swiss bank account to avoid payment of U.S. tax (and detection). While there were some exceptions to the standard penalty rate in the OVDP — which was between 20% to 27.5% of the value of non-compliant foreign assets, depending upon when taxpayers entered the OVDP — many individuals either did not qualify for the lower penalty rate or revenue agents were reluctant to apply those exceptions in all but rare circumstances.
If taxpayers could not swallow the penalty structure of the OVDP but still wanted to address non-compliance, they could “opt out” of the OVDP or they could avoid the OVDP altogether by making a “quiet disclosure.” An “opt out” occurred where taxpayers initially entered the OVDP and then elected to withdraw and subject themselves to a standard civil examination, without the OVDP penalty framework. A “quiet disclosure” occurred where taxpayers filed amended tax returns and FBARs through the normal channels, subjecting themselves to potential civil examination but not putting the IRS on notice of the disclosure — the opposite of a “noisy” disclosure through the OVDP.
In either scenario, taxpayers were left with enormous uncertainty as to the assessment of FBAR penalties and, in some cases, could face penalties in a civil examination that exceeded the value of the unreported foreign accounts. Aside from tax, interest, and penalties on unreported income, a non-willful failure to report a foreign account could result in a penalty of up to $10,000 per account per year. 31 U.S.C. § 5321(a)(5)(B). Willful failures to report foreign accounts could result in a penalty of up to 50% of the highest balance in the foreign account, per account per year. 31 U.S.C. § 5321(a)(5)(C). Still other taxpayers struggled with the potential assessment of information return penalties, which could also significantly exceed any potential tax due. See I.R.C. §§ 6038 through 6039F. For example, a $10,000 penalty may be assessed for certain failures to provide information regarding certain foreign corporations, partnerships, or other specified assets. Failures to furnish information regarding certain trust transfers and foreign gifts may result in penalties that are calculated as a percentage of the unreported amount. Making matters worse, in some cases, a failure to provide foreign information returns will provide the IRS with an unlimited period to assess additional tax and penalties. I.R.C. § 6501(c)(8)(A).
First Version of the Streamlined Procedures. In response to these issues, the Streamlined Procedures were first announced by the IRS on September 1, 2012. The Streamlined Procedures were directed to address complaints and concerns from many U.S. taxpayers who sought to address their tax non-compliance and felt like they were minnows trapped in the same IRS net as the sharks the OVDP was designed for. In other words, the Streamlined Procedures were crafted to encourage compliance by taxpayers who did not fit the mold of the OVDP.
The first version of the Streamlined Procedures, which has since been replaced, focused on the amount of tax resulting from the unreported foreign accounts and assets as well as a slew of risk factors identified by the IRS. Taxpayers were categorically eligible for the Streamlined Procedures if they resided outside of the U.S. for the last three years, did not file a U.S. tax return during that period, were not currently under a tax investigation, and were considered to be a “low risk.” “Low risk” was ill-defined, but generally existed only where the following questions were answered in the negative:
- Do any of the tax returns filed pursuant to the Streamlined Procedures claim a refund or show more than $1,500 in tax due?
- Do you have “material economic activity” in the United States?
- Were any FBAR penalties previously assessed or have you been issued an FBAR warning letter?
- Do you have any U.S. source income?
- Do you have any financial interest in an entity or account outside of your country of residence?
- Did you fail to declare any income in your country of residence?
Although participants in the first version of the Streamlined Procedures did not receive certain assurances available in the OVDP (e.g., closing agreement, no future examination, no referral for prosecution, defined penalty structure), this program gave a distinct subset of taxpayers the opportunity to come into tax compliance without the sticker shock of the OVDP. In this version of the Streamlined Procedures, taxpayers could become compliant by filing the most recent three (3) years of tax returns and six (6) years of FBARs and paying the associated tax and interest. These taxpayers would face no tax or FBAR penalties. While the IRS’ initial efforts were laudable, few taxpayers actually qualified for this treatment. As a result, many individuals still opted out of the OVDP, made quiet disclosures, or did nothing at all in light of the potentially crippling penalties that could apply.
Current Version of the Streamlined Procedures. In light of even more feedback from taxpayers and practitioners, the IRS announced the current version of the Streamlined Procedures in June 2014. The adoption of the current version of the Streamlined Procedures coincided with parallel changes to the OVDP and the announcement of other compliance initiatives, such as the Delinquent FBAR Procedures and Delinquent Information Return Procedures. Importantly, the current version of the Streamlined Procedures did away with the tax threshold and risk factors found in the prior version. It also created a different penalty structure for those non-willful violators who were considered domestic and foreign. The current version provides much more guidance on eligibility and, as a result, many more taxpayers have taken advantage of the Streamlined Procedures. Filings pursuant to the current Streamlined Procedures are still subject to potential examination and may result in the assessment of additional civil or criminal penalties if it is determined that taxpayers are not eligible (i.e., they are willful) or if income and/or assets are not properly reported.
Taxpayers still need to file the past three (3) years of tax returns and corresponding information returns (e.g., Forms 5471, Forms 3520, Forms 8938, etc.), file six (6) years of FBARs, and pay any outstanding tax and interest with all tax returns filed. While foreign taxpayers (i.e., non-U.S. residents) pay no FBAR penalties (or tax penalties), domestic taxpayers are required to pay a 5% miscellaneous penalty, based on the value of non-compliant foreign assets and accounts, to address non-compliance within the Streamlined Procedures. The biggest (and most helpful) change is the elimination of the risk assessment required for eligibility determinations. Instead, the Streamlined Procedures require taxpayers to certify, under penalties of perjury, that non-compliance was “non-willful” and a description of the non-compliance must be provided. “Non-willful” conduct includes “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”
While this certification (either on Form 14653 or Form 14654, depending upon the residence of the taxpayer) is straightforward in nature, taxpayers must keep in mind that willfulness is a legal question that requires careful analysis of the surrounding facts and circumstances. If the Internal Revenue Service determines that a taxpayer does not qualify as “non-willful” and, therefore, does not qualify for treatment under the Streamlined Procedures, the taxpayer is subject to all applicable civil and criminal penalties. Furthermore, since the Streamlined Procedures preclude later application for the OVDP, an incorrect or invalid application for the Streamlined Procedures can have severe consequences.
Evaluating the Options. While the Streamlined Procedures are not the most appropriate compliance mechanism for all taxpayers — the OVDP is likely still the best option for those who willfully failed to comply with foreign tax reporting obligations or those for which “non-willfulness” is unclear — it is the preferred option for many with unreported foreign income or accounts.
For non-willful taxpayers eligible for the foreign version of the Streamlined Procedures, there is little downside to coming into compliance. Though compliance costs and the tax due may not be insignificant, non-resident taxpayers can use the Streamlined Procedures to avoid the real hammer — FBAR penalties. Non-resident, non-filers may also receive beneficial treatment with respect to certain retirement or savings plans where deferral has not been properly elected. (Note: Recent relief for certain Canadian Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) is not available to many non-filers under Rev. Proc. 2014-55, 2014-44 I.R.B. 753.) Even where non-willful non-compliance relates to domestic taxpayers (i.e., residence in the U.S. during the last three years), the Streamlined Procedures are often the best path for compliance as the 5% penalty mitigates significant exposure and provides some peace of mind to taxpayers.
Taxpayers who reported all items of foreign income on their U.S. tax returns but did not file FBARs or certain information returns may consider the Delinquent FBAR Procedures and Delinquent Information Return Procedures as alternatives. These compliance programs, which may be used by taxpayers who have information reporting deficiencies and have not already been contacted by the Internal Revenue Service, require taxpayers to file delinquent returns or FBARs with “reasonable cause” statements. Again, it is important to note that “reasonable cause” is a legal question that requires careful analysis of the surrounding facts and circumstances. As with the Streamlined Procedures, failure to properly establish reasonable cause can expose taxpayers to all applicable civil and criminal penalties. Still, assuming this condition is satisfied, taxpayers can use these programs to reduce or eliminate potentially significant penalties and these measures may be preferable to inaction or other methods.
While the Offshore Voluntary Disclosure Program still provides an appropriate resolution for those with egregious or willful non-compliance, the Streamlined Procedures, Delinquent FBAR Procedures, and Delinquent Information Return Procedures deserve consideration for many non-willful minnows that could soon become easy bait for the Internal Revenue Service.
These descriptions are intended for informational purposes only. If you have unreported foreign income, assets, or financial accounts, you should consult a tax professional. Each of the compliance initiatives described above have specific eligibility and procedural requirements that require strict adherence. Failure to comply with these requirements may result in dire civil and criminal consequences.
Please contact Brandon Mourges at 410.951.1149 firstname.lastname@example.org for a free consultation.