IRS Amnesty for Certain US Taxpayers with Offshore Income and Assets. David Neufeld 1

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1 IRS Amnesty for Certain US Taxpayers with Offshore Income and Assets David Neufeld 1 On June 18, 2014 the IRS in IR ( Taxpayers/Streamlined-Filing-Compliance-Procedures) modified its Streamlined program for certain US taxpayers who have failed to properly file tax returns or foreign bank account reports (FinCEN 114, formerly TD F ) (FBARs), offering the closest thing to a total amnesty practitioners could have predicted. Those that qualify could find it very beneficial; most significantly the program permits the potential waiver of most or all penalties. Ultimately the determination of whether it is available to those otherwise qualified is based on whether the IRS decides a taxpayer s past non-compliance was willful. Depending on how one guesses the Service will come out on that tells taxpayers what they should do; if they feel they can make a good case for non-willfulness they should embark on this new program, but if not then they might consider either entering the Offshore Voluntary Disclosure Program (OVDP) program, opting out or doing a quiet disclosure. BACKGROUND For years the Service and Treasury have been on a highly publicized crusade to uncover assets of US taxpayers hidden outside the US, the income from which is not reported, and criminally prosecute those non-compliant taxpayers and those bankers and advisors who accompanied or led them down this path. In this context hidden assets include accounts not reported on FBARs, foreign information returns such as the Form 3520 and, in more recent years, the Form Alongside this stick the Service has dangled a carrot of sorts since Those taxpayers who properly voluntarily offered themselves up could get a virtual get-out-of-jail-free card, shielding themselves from criminal prosecution. But, unlike the game Monopoly, freedom is not free; participation in the OVDP (earlier versions were called the OVDI) cost some taxpayers a major portion of those hidden assets through tax payments, special FBAR penalties (now 27.5% or maybe 50% of certain asset values) and the 20% accuracy related penalty and interest. Such is the cost of the certainty of freedom. This is coupled with the FATCA enforcement efforts directed against the foreign banks that, in effect, deputized hundreds of foreign banks to enforce US tax laws and become informants. 1

2 As practitioners became more familiar with the intricacies and nuances of this program they and their clients have gotten comfortable with alternative strategies, including quiet disclosures and opt outs. Quiet disclosures are an attempt to discretely file late returns and forms without exposure to the OVDP penalties or criminal prosecution. This might slip through the audit web or it might not; the Service has said publicly that they are on the lookout for this and recently got significant public relations mileage out of a case where they (and ultimately a jury) came down particularly hard on a taxpayer out of Florida. 2 Opting out is an alternative that might be considered by a taxpayer who believes he or she is not at risk of criminal sanctions and can withstand a full audit. As it turned out, given the typical fact patterns and relatively low revenues of the opt out cases on the one hand and the increased need for personnel to run these lengthy exams on the other, the Service was committing a disproportionately large amount of resources and, with the exception of cases like Zwerner, not getting anything like the revenues they get from the quicker OVDP cases or the explosive press they get from the criminal prosecutions. The Service has recognized that there are clearly those who fall within the technical definition of non-compliant taxpayers but who, for one reason or another, have found themselves in that position without a willful intent to avoid compliance. Thus, in 2011 they began a Streamlined program to allow non-willfully non-compliant non-resident US taxpayers to come clean with far less exposure than otherwise available. But, given limiting definitions, this class turned out to be so small as to provide no measurable relief to the Service, still overwhelmed by not only the large number of OVDP participants but the even more time consuming opt outs. Clearly a better crafted Streamlined program would absorb many of those otherwise opting out, freeing Service personnel to pursue bigger game. And that is what we got on June 18, THE 2014 STREAMLINED PROGRAM Eligibility Criteria If the OVDP is for willfully non-compliant individuals who now wish protection from criminal prosecution and opting out is for those who, notwithstanding their failure to file returns, are comfortable they are not exposed to criminal prosecution and are willing to roll the dice on a body cavity audit and the potential array of income tax non-compliance penalties to avoid the 27.5% of asset value miscellaneous penalty, the Streamlined Program is for those who know and can certify, if necessary, non-willfulness, have not committed tax fraud and otherwise meet the eligibility requirements. (For a helpful guide through the eligibility requirements see the attached flow chart.) 2

3 The Streamlined Program is actually two programs with a common starting point, the Streamlined Foreign Offshore Procedures for those US taxpayers 3 who are non-residents and fit into the program and the Streamlined Domestic Offshore Procedures for those residents who qualify. For non-residents this can mean no penalties whatsoever; for residents the penalty can be a fraction of that to which they might otherwise find themselves subject. Whether resident or not, each have several eligibility criteria to meet but it all starts with one litmus test: was the non-compliance willful? Lack of willfulness, we are told in the IRS announcement, means negligence, inadvertence or mistake or a good faith misunderstanding of the law. 4 Recent cases have determined that reckless disregard and willful blindness is each an indicator of willfulness. 5 Where the line is drawn between willful and non-willful is not clear. Perhaps a depositor with a bank identified as a criminal actor under FATCA might imply willfulness, certainly where there is evidence in the account record for evasive actions like a promise not to tell the U.S. government about the account. Perhaps an inheritor of a foreign account or one named to a foreign bank account by a parent without his own knowledge will be deemed non-willful. Perhaps one born in the US but resident in a foreign country for the bulk of her life might never even think she has a US filing obligation and might be deemed non-willful. Certainly greyer areas exist. In order to invoke this criterion, the taxpayer must certify under penalties of perjury that [m]y failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct. (A draft of the requisite form for the non-resident is at for the resident it is at Don t be wrong about willfulness or not only will the taxpayer be rejected from the program but OVDP with its criminal protections will no longer be available and there might possibly be an additional charge of perjury. Other criteria include: getting in their door before the Service or Justice Department is knocking on (or in) yours; there cannot be an active civil audit of any issue, not just the offshore issues, and there cannot be an active criminal investigation. A pre-clearance letter is a necessary first step as anything sent to the government during an investigation would be an admission; not being in the OVDP; being in the OVDP or being in the Streamlined Program are mutually exclusive forever. Enter the Streamlined Program and kiss the possibility of OVDP and its shield against criminal prosecution goodbye; enter the OVDP after 3

4 June 30, 2014 and the Streamlined Program is not available. However those in the OVDP before July 1, 2014 and not yet having executed a closing agreement are in a small club, able to test the OVDP waters and then jump to the Streamlined program. What s unclear is if there is or will be any time limit to this choice. But if one does qualify, the benefits can be huge. It is a virtual amnesty from most if not all penalties for past non-willful indiscretions and apparently a cost the government is willing to bear in order to return non-filers back onto the grid where their compliance can be monitored going forward. Benefits for Residents (the Streamlined Domestic Offshore Procedures) In addition to the eligibility criteria, resident individuals (citizens or permanent residents) or estates otherwise meeting the criteria must have filed a Form 1040 or 1041, as the case may be, for each of the three prior years for which a filing deadline (as extended) has indelibly passed and file an amended Form1040/1041 for each of those years along with all international information returns (e.g. Form 3520, Form 5471 and Form 8938) even if such form would otherwise be filed separate from the return. Any retirement income deferral elections can be made retroactively. Also any unfiled FBARs that have not been filed over the prior six years must be filed. Finally any unpaid tax going back three years, interest and a miscellaneous offshore penalty must be paid upon entrance into the program. The calculation of the penalty is different than its cousins in the OVDP. Whereas in the other programs the penalty is based on the highest value and highest account balances of all assets to which the penalty applies over the entire review period (six years or eight depending on which program), the Streamlined Program for residents looks to the highest aggregate year-end balances and account values over the time period for each relevant foreign financial asset. What this seems to mean, but is far from clear, is that it is an asset by asset review. For instance, for each asset that was excluded from an FBAR one would take the highest year-end value of that particular asset over the prior six years and apply a 5% penalty. 6 If an asset was erroneously excluded from a Form 8938 or the gross income from an asset was not reported (even if the asset had been disclosed), then take the highest year-end value of that particular asset over the prior three years and apply a 5% penalty. Then aggregate all such 5% penalties. tably, the calculation base for this penalty is limited to the undeclared assets rather than all of one s foreign financial assets (whether required to be declared or not) that may have been related to the unreported income or assets, as would occur under the OVDP. However you cut it, this will be well below the total of the 20% accuracy related penalty plus the 27.5% penalty otherwise payable within the OVDP; this may even be a better deal than opting out simply from the perspective of costs 4

5 and fees to get through the audit. Speaking of audit, participants in the Streamlined Program are told that they need not worry that participation will necessarily lead to an exam or other penalties. The only caveat is that the returns are subject to audit in the normal return pool as would any other return that is filed that year. That presupposes that entrance in the Program is not an indicator on the DIF score or otherwise a red flag. Also, if the initial return was filed fraudulently or there are independent items on the return that could generate a deficiency or a penalty then those taxes and penalties can be assessed. Benefits for n-residents (the Streamlined Foreign Offshore Procedures) If residents have it good, non-willfully non-complaint non-residents must be dreaming. If one can pass through the non-residency hoop and has non-willfully failed to report the income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR... with respect to the foreign financial asset... (emphasis added) then they have no penalties zip zero nada of any kind for anything that appears on the return. They just need to (1) file any delinquent Form 1040/1041 from the prior three years with any delinquent international information return, (2) file any delinquent FBAR from the prior six years and (3) pay all outstanding taxes and interest for the prior three years even if they have been failed to pay tax for many more years than three. Interestingly, although these programs have always been about unpaid taxes in the end of the day, it has always been bootstrapped by the investigation of the failure to disclose foreign financial accounts on the FBAR. Yet these non-resident Streamlined cases might involve only Form 1040 non-filing and might not have even involved a failure to file the FBAR. As with the Domestic program, audits are not automatic but can happen in the normal course of events and deficiencies and penalties can arise for issues developed by the audit other than from the non-filings covered by the program. Determining n-residency Determination of non-residency is similar to but not precisely lined up with the rules of section 911, the foreign earned income exclusion. A U.S. taxpayer is not a resident of the U.S. if (1) he or she is physically outside the U.S. for 330 full days in any one or more of the most recent three years for which the U.S. tax return due date (as extended) has passed and (2) in that time frame the taxpayer did not have a U.S. abode. 5

6 Physically Outside the US To be physically outside the U.S. seems self explanatory and likely poses no real issues except for those on the cusp of meeting or failing to meet this rule. One might be tempted to look for guidance, nevertheless, to the regulations under section 911, but that section refers to days present in a foreign country or countries. Maybe this is a difference without a distinction, but the rules interpreting days present in a foreign country treat days on the ground different than days flying over, for instance, which would not seem to matter to those concerned only with days outside the U.S. The 330 day rule of section 911 applies to a rolling 365 day period, and is not slavishly tethered to the calendar year. It seems the only way to make the rule work for the Streamlined Program would be to interpret the 330 day rule as 330 days out of a calendar year. However, this is not certain. Abode in the U.S. What appears simple is not always so. Clearly, one with an abode in the U.S. is a resident. The Service directs us to Publication 54, a dog eared copy of which (or the digital equivalent) is in the possession of every U.S. expat, for an explanation of the term abode in this context. 7 Abode has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. Abode has a domestic rather than a vocational meaning and does not mean the same as tax home. The location of your abode often will depend on where you maintain your economic, family, and personal ties. 8 The guidance goes further to clarify that section 911 and its regulations would allow that neither temporary presence of the individual in the United States nor maintenance of a dwelling in the United States by an individual necessarily mean that the individual s abode is in the United States. Invoking the section 911 regulations specifically for this purpose highlights the inapplicability of those regulations to the 330 day rule, above. A note on return filing deadlines Throughout this Program timeframes are defined in terms of the last day (as extended) for filing a return. For the Form 1040, that will be April 15 for some taxpayers and October 15 6

7 for others. Still others will have a June 15 testing date. For the FBAR, that will be June 30. Advisors need to be cognizant of these dates in relation to what they tie to. For instance, for 2013 a taxpayer outside the country qualified to file on June 16, 2014 who satisfies the nonresidency rule for 2010 but not for 2011, 2012 and 2013 (remember, this need be met for only one of the three years) would want to keep the filing date for 2013 from passing as long as possible in order to file for the Foreign Offshore Program using the 2010 non-residency dates. Had June 16, 2014 come and gone for that taxpayer without extension he cannot enter the Foreign Offshore Program. A similar analysis might benefit a taxpayer in the Domestic Offshore Program depending on how his year-end account values look for the relevant years for purposes of determining the penalty; in some cases letting a year pass helps, in others it could be devastating. ***** For the right taxpayer the Service has exhibited unusual generosity by waiving most if not all penalties and limiting the liability for past taxes to three years. But a detailed analysis is required to be certain one is the right taxpayer as a mistake can be terribly costly. 1 Law Office of David Neufeld, 5 Vaughn Drive, Suite 201, Princeton, New Jersey (609) , David@DavidNeufeldLaw.com 2 U.S. v. Carl Zwerner, Civ.. 13-cv (S.D. Florida, May 28, 2014): jury verdict for 150% of account values (50% for each of 3 years). The case settled after trial for a lesser figure. 3 Even non-citizen aliens are included in this group if they have a U.S. tax obligation and fail the substantial presence test for one of the prior three years. 4 See, e.g., Cheek v. U.S., 498 U.S. 192 (1991); Income Tax Reg (c). 5 U.S. v. Williams, 489 Fed.Appx. 655, 2012 WL (C.A.4 (Va.)), 110 A.F.T.R.2d , USTC P 50,475 (4 th Cir. 2012); U.S. v. McBride, 908 F.Supp.2d 1186, 110 A.F.T.R.2d , USTC P 50,666 (D. Utah 2012) 6 Although the penalty is based on year-end values, the FBAR and Form 8938 filing requirements are based on thresholds relative to highest values during each year. An analysis must first look to the entire year to determine if a filing is mandated and then, if so, the year end value for the penalty calculation. 7 This author finds it galling that the Service continues to lazily refer taxpayers to Publications and then take litigating positions that such reliance is improper and the Tax Court buys it no less. See, e.g. Bobrow v. Commissioiner, T.C.Memo (January 28, 2014). 8 Pub. 54, page 12. The concept of abode (or in New York, permanent place of abode ) often comes up in the context of state residency (e.g. those who prefer to be state tax-free in Florida rather than state taxed in New York). See Gaied v. New York State Tax Appeals Tribunal, 22 N.Y.3d 592, 6 N.E.3d 1113, 983 N.Y.S.2d 757, 2014 NY Slip Op (2/18/2014). 7

8 2014 Streamlined Offshore Filing Program Eligibility Individual or Estate Streamlined Foreign Offshore Procedures Consequences: 1 File delinquent 1040s/1041s for prior 3 years and make all available elections for retirement income deferrals*** Failure to report income from a foreign 2 File all delinquent international information financial asset ("FFA") or pay the tax; returns (e.g. 5471, 3520, 8938) failure to file int'l info returns; failure to 3 File delinquent FBARs for prior 6 years file an FBAR with respect to FFA was non willful* 4 Pay all tax and interest upon filing the returns 5 penalties of any kind (failure to file, failure to Willing to certify subject to penalties for pay, accuracy related, FBAR) for anything reported perjury that noncompliance was not on the return**** willful 6 automatic audit**** 7 Participation in OVDP (i.e. criminal shield) not permitted t under civil examination for ANY Ineligible Streamlined Domestic Offshore Procedures reason Consequences: 1 File amended 1040s/1041s for prior 3 years with all delinquent international information returns (e.g. 5471, 3520, 8938) and make all available t under Criminal Investigation elections for retirement income deferrals 2 File FBARs for prior 6 years 3 Pay tax and interest; Penalty = 5% of the highest aggregate g year end balance/value of all subject FFAs over the 3/6 year period 4 automatic audit or other penalties In OVDP 5 Participation in OVDP (i.e. criminal shield) not permitted Entered OVDP before July 1, 2014 prepared by David Neufeld, Esq. David@DavidNeufeldLaw.com Princeton, NJ Have not yet received a Closing 2014 David S. Neufeld Agreement US Citizen, Permanent Resident or estate of same Fails to satisfy the Substantial Presence Test during any 1 of most recent 3 years for which filing due date (as extended) has passed Eligible for Streamlined Foreign Offshore Procedures Physically outside the US for at least 330 full days during any 1 of most recent 3 years for which filing due date (as extended) has passed** US abode for any 1 of most recent 3 years for which filing due date (as extended) has passed** Previously filed all 1040s/1041s for each of most recent 3 years for which filing due date (as extended) has passed Eligible for Streamlined Domestic Offshore Procedures Eligible for Streamlined Foreign Offshore Procedures Ineligible * Negligence, inadvertance or mistake, good faith misunderstanding of the law ** These are the non residence requirements, which must operate for both spouses if joint filers. The rules under section 911 are invoked for some parts of this rule but not others. (1) It is not clear if this 330 day rule is the same as the 330 days out of the rolling 365 day period under section 911 or a new rule that is strictly within a calendar year; it appears to be the latter. (2) This rule focuses on days outside the US whereas section 911 refers to days in a foreign country; not the same thing. (3) The definition of "abode" in the section 911 regs are specifically invoked; temporary presence in the US and maintenance of a dwelling in the US do not necessarily mean the abode is in the US. *** Reference to "prior 3 years" or "prior 6 years" means the three or six years immediately preceding for which the filing deadlines as extended have expired. That means if the due date for the immediately preceding year is still open the operative period leapfrogs back to the year before that one. **** There may still be an audit in due course under normal procedures and penalties assessed for other items; also if the original return was fraudulent or the FBAR non compliance willful.