Taxpayers’ ability to maintain hidden foreign assets and accounts undetected from the Internal Revenue Service (“IRS”) is becoming increasingly more difficult. The IRS’ greatest weapon, the Foreign Account Tax Compliance Act (“FATCA”) was launched on July 1, 2014. FATCA requires foreign financial institutions to disclose information regarding their U.S. clients or otherwise face harsh penalties in the form of a 30% withholding tax on U.S. source payments. The U.S. also adopted an intergovernmental approach to FATCA by entering into bilateral intergovernmental agreements (“IGA”) with partnering FATCA countries to facilitate the automatic exchange of U.S. taxpayer data.
In addition to FATCA, the IRS has taken several other measures to seek out U.S. taxpayers with undisclosed foreign bank accounts, such as IRS whistleblower programs, increased enforcement and criminal prosecutions, information gathering under IRS’ amnesty programs, use of “john doe” summons, and tax treaty requests.
U.S. taxpayers with undeclared foreign accounts should seriously consider their disclosure options, as the IRS continues to receive quantities of U.S. taxpayer data from foreign banks and foreign country taxing authorities in compliance with its FATCA initiative. U.S. taxpayers who do come forward under one of the IRS amnesty programs may mitigate the potential civil and criminal penalties they would otherwise face in the case of an audit. To be eligible, U.S. taxpayers must come forward before being audited or subject to investigation, and before the IRS obtains any third-party information about their delinquencies (i.e., taxpayer data received from foreign banks under FATCA).
FinCen 114 – Report of Foreign Bank and Financial Accounts (“FBAR”) – What triggers an FBAR reporting obligation?
U.S. citizens and residents who have a direct or indirect financial interest, or signature authority or other control over, foreign financial accounts, the aggregate value of which exceeds $10,000 at any point during the year, are required to file Form FinCen 114, Report of Foreign Bank and Financial Accounts (the “FBAR”). Foreign financial accounts include foreign banking, brokerage, securities, checking, deposit, life insurance policies with a cash surrender value, or any other type of account held at a foreign financial institution. Signatory authority is the right of an individual to control the disposition of the assets by direct written communication to the financial institution. Indirect ownership of offshore corporate accounts by certain U.S. shareholders of foreign corporations may also trigger an FBAR reporting obligation.
Unless excused by reasonable cause, the penalty for failure to file a complete FBAR is up to $10,000 per omission per year for negligent, non-willful failure, or the greater of $100,000 or 50% of the account balance per omission per year for willful failure. Criminal penalties may also apply for willful failures to file the FBAR, including a fine of not more than $500,000 or up to 10 years of imprisonment.
What are my disclosure options?
1 – The 2012 Offshore Voluntary Disclosure Program (“OVDP”)
Currently, the IRS has a special program called the 2012 OVDP available for non-compliant taxpayers with undeclared foreign income, assets and/or accounts. Eligible OVDP participants must pay back taxes and interest for up to eight years, as well as a 20% accuracy-related penalty on the full amount of underpayments of tax for all years. In addition, participants will be subject to a fixed OVDP penalty of 27.5% (or 50% if the undeclared account is held with a foreign financial institution identified as being under investigation or as cooperating with the IRS) applied to the highest aggregate balance of foreign bank accounts or value of foreign income producing assets during the OVDP disclosure period. The OVDP program remains the most expensive program in terms of penalties and compliance costs, and generally is best suited for U.S. taxpayers presenting willfulness issues and potentially subject to severe civil and criminal penalties. The OVDP currently remains open indefinitely and the IRS may change its terms. The IRS has increased the fixed OVDP penalty several times since the initial inception of the program (2009 OVDP 20%; 2011 OVDP 25%; 2012 OVDP 27.5% to 50% depending on the case). As the IRS closes down on foreign banks through its FATCA initiative, it can be expected the terms of the OVDP will become stricter, and the program could be discontinued all together.
2- Streamline Domestic Offshore Procedures (“SDOP”)
Taxpayers residing in the U.S. who do not present any willful violations should consider the SDOP. Under the SDOP option, U.S. taxpayers must certify (under penalties of perjury) their failure to report foreign financial assets and pay all tax due on income related to those assets was not the result of willful conduct. The IRS defines non-willful conduct as 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. If eligible, taxpayers must prepare a non-willfulness certification statement, and file complete and accurate amended tax and information returns for the most recent three years, and accurate FBARs for the most recent six years. In addition, a fixed SDOP penalty of 5% will apply to the highest aggregate yearend balance of all non-compliant foreign accounts during the SDOP reporting period. Eligible participants also will be required to pay back taxes, plus interest.
3- Streamline Foreign Offshore Procedures (“SFOP”)
This options applies only to U.S. taxpayers residing outside the U.S. and who do not present any willful violations. To be eligible, U.S. taxpayers must demonstrate they are nonresident U.S. taxpayers. Similar to the SDOP, eligible participants must submit a non-willful certification statement and be subject to the same three and six year reporting period for filing complete and accurate amended tax returns and FBARs. Participants will be required to pay back taxes, plus interest. No further penalties (fixed or otherwise) should apply to the extent the participants are eligible and compliant with all terms of the SFOP.
It is important to note, the OVDP and SDOP fixed penalties are in lieu of potential FBAR and other delinquent informational return penalties, which depending on the case, may result in a much more favorable outcome in contrast to civil penalties which may be imposed under IRS audit. Further, other non-program disclosure options (not discussed in this article) may be better suited in your case, especially if the OVDP and SDOP options result in a high and unfair penalty assessment.
The decision to enter any of these voluntary disclosure programs should not be taken lightly. The determination of non-willful vs. willful conduct depends on the unique facts and circumstances of each case, and should be undertaken by a competent tax attorney who can protect your rights and discuss the best disclosure options, while preserving full confidentiality under the attorney-client privilege.
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