Handling IRS Targeted Audits, Voluntary Disclosures and Reporting Foreign Assets. Presentation Roadmap

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1 Handling IRS Targeted Audits, Voluntary Disclosures and Reporting Foreign Assets Elizabeth Copeland Farley Katz Joseph Perera Presentation Roadmap Trends in IRS Targeted Audits and Tips for Handling Foreign Bank and Financial Accounts Report (FBAR) IRS Form 8938 Statement of Foreign Financial Assets IRS Foreign Reporting Forms 5471 and 5472 Other Foreign Reporting Forms Offshore Voluntary Disclosure Program Tax Symposium 1

2 Targeted Examinations Undeclared Foreign Source Earnings & Accounts Mortgage Interest Limitations NOL carry forwards Section 1031 Like-kind Exchanges Real Estate Dispositions High Income Non-Filers Cash Intensive Schedule Cs EITC tax preparer due diligence audits Employment Tax and Worker Misclassifications Executive Compensation & Fringe Benefits 3 Targeted Examinations (cont.) S-Corps: asset valuations from C-Corp. conversions. Partnerships: sales of reported interests, distributions of installment notes, debt cancellations, and income/expenses. Estate & Gift: closely held entity valuations and discounts, near death sales, fractional interests, and overfunded bypass trusts. Tax Exempt Organizations: compensation for key employees, conflicts of interest, and abuse of donoradvised funds Tax Symposium 2

3 Tips for Handling Targeted Examinations Obtain relevant account transcripts from wide range of prior years and perform compliance check. Reference applicable sections of IRM: 4.23 Employment Tax 4.24 Excise Tax 4.25 Estate & Gift 4.26 Bank Secrecy Act 4.27 Bankruptcy 4.32 Abusive Transactions 4.25 Partnership & S Corps Oil & Gas Industry 4.42 Insurance Industry 4.43 Retail Industry 4.52 Global High Wealth International Employee Plans Exempt Orgs. 5 Tips for Handling Targeted Examinations (cont.) Review Audit Techniques Guides (ATGs) that IRS examiners use during audits to identify issues and accounting methods unique to specific industries. Consider FOIA request prior to exam if unable to obtain needed information from examiner or supervisor. Prepare concise (fact based) document and transaction summaries followed by analysis of authority to support taxpayer s position Tax Symposium 3

4 Foreign Bank and Financial Accounts Report ( FBARs ) 7 Bank Secrecy Act U.S. citizens, residents or a person in and doing business in the U.S. must file a report with the government if they have an interest in, or signatory authority over, one or more financial accounts in a foreign country with a total value > $10,000 at any time during the calendar year. Must file FinCEN Form 114 electronically by April 15 of each year (for prior calendar year); can request a six month extension. (formerly June 30th with no extensions). Title 31 of U.S. Code (not part of the Internal Revenue Code) Tax Symposium 4

5 New IRS Exam Guidance on FBAR Penalties Issued May 13, Effective for all open FBAR cases. Statute of limitations on FBAR is 6 years. Willful Penalties 50% of the highest account balance limited to one year. Maximum penalty cannot exceed 31 U.S.C. 5321(a)(5)(C) limits 100% of the highest account balance of all unreported foreign financial accounts during the years under examination IRS Counsel approval is required for asserting willful penalties. 9 New IRS Exam Guidance on FBAR Penalties (cont.) Nonwillful Penalties Limited to $10,000 per open year, regardless of number of accounts. Can be reduced to a single $10,000 penalty in appropriate cases. In exceptional cases, the IRS exam agent can recommend $10,000 penalty per account per year. Need Group Manager and FBAR Coordinator approval. IRS Counsel no longer needs to approve the nonwillful amount. Reasonable cause can still be argued to allow for no penalty Tax Symposium 5

6 FBAR Collection Issues Under 31 C.F.R unagreed cases are assessed FBAR penalties giving the taxpayer 30 days to pay or face increased interest charges. Assessments must be made within six years of the violation (e.g. the failure to file on June 30). 31 U.S.C. 5321(b)(1). Government must file suit for collection of the FBAR penalty within two years of assessment. 31 U.S.C. 5321(b)(2). 11 FBAR Collection Issues (cont.) If suit is not filed by the government, the amounts can only be collected from the taxpayer via offsets, and administrative remedies. See 31 C.F.R. 5.4(a)(6). The taxpayer s only remedies for judicially contesting the assessments are to do one of the following in the United States District Court (IRM (18)): Pay and file suit for refund; or Wait for the government to file suit for collection and then challenge the assessment Tax Symposium 6

7 IRS Form 8938, Statement of Foreign Financial Assets Form introduced in 2012 and updated in Dec IRC 6038D 13 IRS Form 8938 Reports ownership interests of specified foreign financial assets if total value > $50,000 on last day of yr. or $75,000 at any time during yr. Thresholds higher for joint filers and individuals living abroad. Form 8938 filed with annual tax return. Following individuals file: U.S. Citizen; A resident alien of the U.S. for any part of the tax year; A resident alien of the U.S. who elects to be treated as a resident of a foreign country under the provisions of a U.S. tax treaty; A nonresident alien who makes an election to be treated as a resident alien for purposes of filing a joint income tax return; Reportable ownership interests and financial assets differ from FBAR Tax Symposium 7

8 Reporting Forms Related to Foreign Entities Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Entities Form 5472, Information Return of a 25% Foreign Owned U.S. Corporation Engaged in U.S. Trade or Business Very complex forms! IRS estimates a total of 122 hrs. for recordkeeping; learning about the law; and preparing form 5471 (w/o schedules), and 24 hrs. for form IRS Form 5471 Filed by U.S. citizens & residents (wherever they reside) who are owners, directors, or officers of foreign corporations. Satisfies reporting requirements of transactions between foreign corporations and U.S. persons under IRC 6038 and Categories of Filers Category 2: Director or officer of a foreign corporation and a U.S. person acquires at least 10% of the stock or acquires an additional 10% of stock. Category 3: U.S. person that acquires 10% of the stock, becomes a U.S. taxpayer and owns at least 10% of the stock, or disposes of enough stock to put them under the 10% stock ownership threshold. Category 4: U.S. person who controls foreign corporation. Owns more than 50% of the total value of the corporation s stock or voting rights. Category 5: U.S. shareholder of U.S. controlled foreign corporation who owned any amount of shares for at least 30 days and owned on last day of year Tax Symposium 8

9 IRS Form 5472 Filed by foreign reporting corporation to disclose information about certain reportable transactions that occur with foreign or domestic related parties. IRC 6038(A) and 6038(C). Reporting Corporation: Either a corporation that is 25% foreign owned, or a foreign corporation that is engaged in business or trade with the U.S. Must have at least one (direct or indirect) foreign shareholder who owns at least 25% of stock and/or voting power. Figuring out who is considered a foreign person is first step to determining whether that person is also a foreign shareholder. Reportable Transaction: Many listed in instructions, such as purchases and sales of stock in trade or tangible property, cost sharing transactions payments made or received, rents or royalties paid or received, and commissions. Related Party: Any direct or indirect 25% foreign shareholder of the reporting corporation and multiple others listed in instructions. 17 IRC 6038 Penalties Automatic penalties for failure to file forms 8938, 5471 and Penalty of $10,000 per failure to furnish required information within time prescribed. Continuation penalty: An additional $10,000 penalty for each 30-day period, or fraction thereof, after the 90-day period has expired. Maximum continuation penalty is $50,000. Penalty may be abated for reasonable cause under IRC 6662 and Reg standards. Requires reasonable cause statement submitted in writing and signed under penalties of perjury. Relief not available for continuation penalty. Appeal rights available if request for abatement denied but collection may continue during appeal Tax Symposium 9

10 Other Foreign Reporting Forms Form 8865 Report by US persons owning a foreign partnership. IRC 6038, 6038B and 6046A Form 926 Report by US persons transferring property to a foreign corporation. IRC 6038B Form 3520 Annual report of transactions with foreign trusts. IRC Report of US persons receiving foreign gifts. IRC 6039F. Form 3520-A Annual report by foreign trusts with a US owner 19 Offshore Voluntary Disclosure Program Tax Symposium 10

11 Voluntary Disclosure Program On January 9, 2012, the IRS announced that the Offshore Voluntary Disclosure Program ( OVDP ) was being extended indefinitely. Taxpayers with undisclosed foreign bank accounts could voluntarily come forward, file late FBARs, and amend returns to pick up previously unreported foreign income and receive reduced penalties. 8 years returns would need to be amended. 8 years FBARs would need to be filed. Must pay 20% Accuracy Related, Failure to File, and Failure to Pay Penalties on tax due. Miscellaneous Penalty of 27.5% on OVDP Assets. Miscellaneous Penalty goes to 50% if any investment was with a banking institution under investigation by the US government. 21 OVDP Assets All of the Taxpayer s offshore holdings that are related in any way to tax noncompliance are subject to the 27.5% [50%] penalty. Includes all assets directly or indirectly held by the Taxpayer that are related to tax noncompliance. Financial accounts holding cash, securities or other custodial assets. Tangible assets such as real estate or works of art. Intangible assets including patents, stock, and other interests in U.S. and foreign business entities Tax Symposium 11

12 Opting Out If a taxpayer enters the OVDP program and disagrees with the suggested penalty, the taxpayer can opt out and fight the penalties. Automatically subject to an IRS examination of all applicable returns. Must prove nonwillfullness to avoid the full FBAR penalty. If still disagree with the result the taxpayer can go to IRS Appeals. 23 New Streamlined Procedures Announced June 2014 and is available to taxpayers residing in the U.S. and residing outside the U.S. Must certify that failure to report all income, pay tax, and file required information returns (including FBARs) was due to non-willful conduct. Not eligible for program if taxpayer is currently under exam. Individuals currently in OVDP but who have not signed closing agreement can choose to be treated under streamlined (with certain modifications). Streamlined disclosures are processed in ordinary course (similar to a quiet disclosure) Tax Symposium 12

13 Non-Willful Conduct 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 25 Streamlined Procedures and U.S. Residents Eligibility Requirements Have resided in U.S. for the previous three years. Have filed tax returns for previous three years. Failed to report income from foreign assets and/or failed to file information returns such as FBAR, Form 8938, Form 5471, Form 3520, etc. Failure was due to non-willful conduct Tax Symposium 13

14 Streamlined Procedures and U.S. Residents (cont.) Participation Requirements File amended returns for the past three years, along with any required information returns (cannot use this program to file delinquent returns). On the top of each return, write Streamlined Domestic Offshore in red. File six years FBARs (Form 114) electronically. In the reason for late filing, choose Other. Type in the following: Streamlined Filing Compliance Procedures. Complete and sign Certification by U.S. Person Residing in the U.S. Pay tax and interest due; not liable for accuracy related penalty or penalties for failure to file information returns. 27 Streamlined Procedures and U.S. Residents (cont.) Participation Requirements Pay miscellaneous 5% penalty. Equal to 5% of the highest aggregate value / balance of the taxpayer s foreign assets during the six-year FBAR period. Balance and asset values are determined by using year-end account and asset value. Asset or account is subject to the penalty if it should have been reported on FBAR or Form 8938.» But not bank accounts subject to signatory authority only. Electronically file FBARs for the previous six years. On cover page, select Other for reason for filing late. In the explanation box, enter Streamlined Filing Compliance Procedure Tax Symposium 14

15 Streamlined Procedures and Taxpayers Residing Outside U.S. Eligibility Requirements If U.S. Citizen or Green Card holder, for any one of the previous three years, has not had a U.S. abode and was physically outside the U.S. for at least 330 days. For non U.S. citizens and Green Card holders, for any one of the previous three years, the person did not meet the substantial presence test. 29 Streamlined Procedures and Taxpayers Residing Outside U.S. (cont.) Procedural Requirements: File three years delinquent or amended tax returns reporting income and tax, and file any required information returns. On top of each return, write Streamlined Foreign Offshore in red. Complete and sign Certification by U.S. Persons Residing Outside the U.S. Pay tax and interest; but not the accuracy related, failure to file, failure to pay, failure to file information returns or FBAR penalties. Electronically file FBARs for the previous six years. On cover page, select Other for reason for filing late. In the explanation box, enter Streamlined Filing Compliance Procedure Tax Symposium 15

16 Disclaimers This document is not intended to provide advice on any specific legal matter or factual situation, and should not be relied upon without consultation with qualified professional advisors. Any tax advice contained in this document and any attachments was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under applicable tax laws, or (ii) promoting, marketing, or recommending to another party any transaction or tax-related matter Tax Symposium 16