US Policy on Offshore Assets: Disclose or Else
The IRS estimates that it loses over $200 billion in tax revenue per year on unreported offshore assets of over $30 trillion. With those numbers in mind (whether or not they reflect reality), it’s no wonder the IRS is just a tad paranoid about US citizens with assets offshore. This paranoia is evident in that the IRS:
- requires US citizens to report non-US bank accounts, interests in foreign corporations and trusts, and even the receipt of gifts from non-US persons;
- imposes hefty penalties (typically $10,000 per year) even for an inadvertent failure to file the proper disclosure forms; and
- coerces non-US financial institutions into providing information about US account holders under the Foreign Account Tax Compliance Act (“FATCA”).
For example, a US citizen with more than $10,000 in non-US accounts who fails to file the Foreign Bank Account Report (also called the “FBAR”) for 5 years will rack up total penalties of $50,000. And that’s assuming the failure to file was inadvertent—the penalty would be much higher if the IRS finds that the failure was willful.
A Warm Welcome Back
Thankfully, however, these hefty penalties are also accompanied by broad-based and easy-to-use amnesty programs. Any American who fails to file the proper forms can use one of these amnesty programs to either eliminate or substantially reduce their penalty exposure.
Incidentally, these amnesty programs are one reason why it’s awesome to practice tax law—if you walk into my office with a problem, you will walk out with a solution. Lawyers who practice, say, criminal defense don’t have it quite so easy—some bells you can’t unring.
Prerequisite for Participation in an Amnesty Program
Each of these programs has different requirements and different target audiences, but one prerequisite holds true for all of them: they only work if you make the first move. Once the IRS has contacted you about a delinquency, you’re toast—you have to deal with the IRS under the audit procedures instead of going through an amnesty program.
The remainder of this article describes each of the amnesty programs. We’ll go in order from (i) those that are easiest to use and provide for the least penalties to (ii) the more difficult programs to participate in with higher penalties.
1. The Delinquent Submission Procedures
If you failed to file the FBAR or one of the many information returns related to offshore assets (e.g., IRS Form 5471), and you don’t have any unpaid tax liability, then you can simply file the delinquent FBAR or information return and the IRS will waive the penalty. For information returns, you also need to include a “reasonable cause statement,” which is a letter that provides all pertinent facts and background to show the IRS that your failure to file on time was due to reasonable cause and was not the result of your willful neglect of a known legal duty.
The key to this program is that you must have no unpaid tax liability. This may not be so easy to determine-you can have income in sneaky ways that you may not consider unreported (even though the IRS does). For example, if you own at least 51% of the stock of a foreign corporation, you’re generally required to pay tax on any passive income earned by the corporation, even if the corporation doesn’t distribute any amount to you. Also, if you formed a non-US trust, you’re generally treated as directly earning any income earned by the trust.
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2. The Streamlined Filing Compliance Procedures
This is the most often used program (and the way many of my clients get caught up without having to actually pay anything). Under this program, a taxpayer who hasn’t filed tax returns or FBARS can get back into compliance and avoid the hefty penalties discussed above simply by filing 3 years of back tax returns and 6 years of back FBARs. A taxpayer who has filed returns during such period but hasn’t reported offshore assets can use this program to file amended returns that include the previously unreported income from offshore assets.
Taxpayers who live outside the US are only required to pay any back taxes plus interest. Taxpayers who live in the US have to pay back taxes and interest plus a penalty equal to 5% of the highest value of the taxpayer’s offshore assets during the prior 6 years. If a taxpayer has been outside the US for at least 330 days during any of the past three tax years, then the taxpayer qualifies for the version of the program for those who live outside the US (i.e., no 5% penalty).
The key to eligibility for this program is that your failure to file tax returns and/or report offshore assets must not have been “willful.” A key part of participation in this program is an examination of all the facts by a qualified and experienced tax attorney who can tell you how the IRS will view your particular situation—i.e., whether you look like a person the IRS will think acted “willfully” or not.
3. The Offshore Voluntary Disclosure Program
This is the big Kahuna of the amnesty programs—the program for those who “willfully” failed to report offshore assets and the income therefrom. Participating in this program requires full disclosure and full payment. You have to file original or amended tax returns for the previous 8 years, file FBARs for the previous 6 years, pay back taxes plus interest and certain penalties, and pay a penalty equal to 27.5% of the highest value of the offshore assets for the previous 8 years.
That may sound like a big pill to swallow, but the taxpayers who participate in this program are risking far higher civil penalties and potential criminal penalties by not disclosing their offshore activity. Additionally, this program has many more ins and outs than the Streamlined procedures—it’s not a one-size-fits-all proposition.
A Word on “Quiet Disclosure”
Instead of using one of the above amnesty programs, certain taxpayers try to simply start filing tax returns and/or information returns, hoping that they can slip back into the system without the IRS noticing. The IRS calls this a “quiet disclosure,” and they really frown on it.
I hate to say it, but the IRS is right on this one—a quiet disclosure is almost always an extremely bad idea. A taxpayer who goes this route is giving the IRS all the information it needs to audit—they are serving themselves up on a silver platter. Going this route may have made some sense in the past for certain taxpayers, but the hefty penalties now imposed for failing to disclose offshore assets simply makes a quiet disclosure too risky.
The FATCA Clock is Ticking
Non-US financial institutions are generally required by FATCA to report their US accountholders to the IRS. These reports give the IRS all the information they need to begin an audit, which will disallow a taxpayer from participating in one of the above amnesty programs.
Therefore, if you have a delinquent tax return or you’ve failed to file the FBAR or other offshore disclosure form, the clock is ticking. You should begin participating in an amnesty program as soon as possible to insure that your paperwork arrives in the IRS’s inbox before a FATCA report does.
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