Much has been written in the press about “U.S. persons” who have a bank account in a foreign country. This has led to many misconceptions, including, in many instances, that the ownership of foreign bank accounts by U.S. persons is either illegal, immoral, or both.
The truth is that the ownership of foreign bank accounts by a U.S. persons is legal, provided that the income from such accounts is reported on their U.S. income tax returns and that, if certain thresholds are met, the U.S. person timely files certain U.S. Internal Revenue Service (“IRS”) and U.S. Treasury reports to disclose the existence of such accounts, even if they do not earn income.
Potential penalties if not compliant
Problems arise if the U.S. person does not comply with the U.S. income tax and U.S. Treasury laws. Failure to report the income on a U.S. income tax return can subject the individual to IRS’s “failure to file and failure to pay” penalties, which can equal 25% of the yearly tax due. In large cases, the U.S. person could be subject to a Civil Fraud penalty of 75% of each year’s tax deficiency and criminal penalties as well.
Failure to file certain Treasury forms that report the existence of foreign bank accounts can generate a non-willful $10,000 per year penalty or, if deemed willful, can lead to a penalty of the greater of $100,000 or 50% of the balance in the account for each year.
So, what can a U.S. taxpayer who has not complied with the rules described above do? The answer is painful, as the taxpayer is left with only three options, all of which are unfavorable.
One option is to submit delinquent Foreign Bank Account Reports (“FBARs”) and amended tax returns without entering into the IRS voluntary compliance program. This type of submission is commonly referred to as a “quiet disclosure.” The IRS is aware of U.S. taxpayers making this quiet disclosure and has blocked the processing of these returns and flagged these taxpayers for further investigation. You should expect that the IRS will use such conduct to show “willfulness” by the taxpayer and to justify the maximum punishment. If you have already quietly disclosed, you should seriously consider participating in the IRS’ 2014 OVDP. Once the IRS contacts you, you cannot get into this program and you would be subject to the maximum penalties (civil and criminal) under the tax law.
A second option is to use the IRS Streamlined Disclosure process. This process is available to all U.S. taxpayers whose failure to file or pay tax was “non-willful,” with lighter compliance requirements and with a minimal penalty, if any.
Back in June of 2014, the IRS announced significant changes to its voluntary compliance programs for taxpayers who have failed to report income generated by offshore accounts or who failed to report the existence of those accounts. The changes reflect a recognition that the current Offshore Voluntary Disclosure Program (“OVDP”) was too burdensome, costly, and onerous for the many U.S. taxpayers who, for lack of knowledge or due to an innocent mistake, have failed to file all offshore disclosures. Consequently, new streamlined procedures were put in place.
A significant element of these streamlined procedures may involve a potential penalty. Eligible taxpayers residing outside the U.S. will not be liable for any penalty, but those inside the U.S. will be subject to a 5% “miscellaneous offshore penalty” on the foreign assets that gave rise to the noncompliance.
The third option is for taxpayers who do not qualify for the Streamlined Disclosure program to come forward as quickly as possible through the 2014 OVDP. As with the prior OVDP, risk of criminal prosecution will be eliminated when the taxpayer successfully concludes the 2014 OVDP. However, if the taxpayer delays too long to enter the 2014 OVDP, he or she risks higher penalties within the program or may become ineligible.
The IRS and the U.S. Department of Justice have joined forces to investigate foreign financial institutions that may have assisted U.S. taxpayers in setting up foreign entities and accounts to avoid their U.S. tax obligations. U.S. taxpayers in this situation risk criminal prosecution and heavy fines unless they come forward.
If one of the taxpayer’s foreign financial institutions or facilitators who helped organize the offshore arrangement has been publicly identified as being under investigation or acting in cooperation with the government before the taxpayer enters the 2014 OVDP, the penalty for failure to report any and all foreign accounts rises from 27.5% to 50%.
The penalty is assessed on all of the taxpayer’s offshore holdings that are related to the non-compliance, not just those at the bank under investigation.
The 2014 OVDP Update presents new opportunities mixed with new penalties – consult with an experienced professional to handle your situation properly, before the IRS knocks on your door.
This article was originally published in NJBIZ
F. Wayne Holton is a tax partner at Citrin Cooperman & Company, LLP and has been helping clients in the international tax arena for more than four decades. Anand Madhusudanan is also a partner at the firm and provides international tax planning and quality control services for his clients. They can be reached at 973-218-0500 or via email at firstname.lastname@example.org and email@example.com respectively.