What s News in Tax Analysis That Matters from Washington National Tax Have Undisclosed Foreign Assets? IRS Offers Options There is good news for individuals who inadvertently failed to fulfill tax and information reporting obligations related to foreign assets: New IRS procedures may allow them to cure tax and information reporting failures often without the imposition of penalties. This article discusses four options being offered by the IRS to those seeking to redress compliance failures, with a focus on the streamlined filing option for individuals. Monday, July 28, 2014 by Steven Friedman, Washington National Tax Steven Friedman is a director in the Practice, Procedure, and Administration group of WNT. The IRS recently announced new procedures for individuals who have inadvertently failed to report income related to foreign assets to come forward, cure tax and information reporting failures, and in many cases, do so without the imposition of penalties. 1 This is welcome news for taxpayers who have become aware of deficiencies in their tax and information reporting obligations related to their ownership of foreign investments perhaps due to the increased enforcement efforts of the IRS and the Department of Justice in this area. The most generous offer is for those individuals who meet a non-residency requirement to avoid all penalties if they file delinquent returns and pay applicable taxes under the streamlined foreign offshore procedures. Because individual circumstances can vary widely, the IRS is offering four options for those seeking to redress compliance failures. This article focuses primarily on the streamlined filing option. 2 Streamlined Filing Option Initially introduced in 2012, the IRS has (1) expanded the streamlined filing compliance procedures to include a broader group of U.S. taxpayers, including certain U.S. residents, (2) eliminated a cap on the amount of tax owed to qualify for the streamlined program, and (3) eliminated the risk assessment questionnaire that applicants were previously required to complete. 1 2 IR-2014-73 (June 18, 2014). A more thorough discussion of the other options will be explored in an upcoming What s News in Tax article. entity. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.
Have Undisclosed Foreign Assets? IRS Offers Options page 2 General Eligibility Criteria The streamlined procedures are available to individuals residing outside the United States foreign offshore as well as those residing in the United States domestic offshore. There is a key difference between the two situations, however, in the cost of participation. In both scenarios, individuals must be able to certify that the failure to report all income, pay all tax, and submit all required information returns, including FinCEN Form 114, Report of Foreign Bank and Financial Accounts ( FBAR ), was due to non-willful conduct. This is generally defined as conduct due to negligence, inadvertence, or a mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. 3 Note that recent cases have determined that reckless disregard of a statutory duty and willful blindness can be an indicator of willfulness. 4 The second threshold requirement for participating in the streamlined program is that taxpayers cannot be under IRS examination, regardless of whether the exam relates to undisclosed foreign financial assets. Tax returns submitted under the streamlined procedures will be processed like any other return filed with the IRS. Thus, individuals will not receive an acknowledgment by the IRS that any returns filed were received. Also, the streamlined process will not culminate in the signing of a closing agreement with the IRS. Although tax returns submitted will not automatically be subject to IRS audit, they may be selected under existing audit selection procedures and subject to verification procedures for the accuracy and completeness of the submission, which may entail the IRS reviewing information received from financial institutions and other sources. There are two separate programs within the streamlined procedures. Which program an individual falls within is dependent on a non-residency test. Meeting the non-residency criteria qualifies an individual to participate in the more favorable foreign offshore program. Individuals failing the non-residency test qualify only for the more costly domestic offshore program. 3 4 As defined on the IRS website describing Eligibility for the Streamlined Foreign Offshore Procedures, http://www.irs.gov/individuals/international-taxpayers/u-s-taxpayers- Residing-Outside-the-United-States United States v. Williams, 489 Fed. Appx. 655 (4th Cir. 2012); United States v. McBride, 110 AFTR 2d 2012-6600 (D. Utah 2012).
Have Undisclosed Foreign Assets? IRS Offers Options page 3 Foreign Offshore Procedures Individuals meeting the non-residency requirement, who have failed both to report income from a foreign financial asset and to pay the required tax, are able to escape penalties under the streamlined foreign offshore procedures when such a failure stems from non-willful conduct. Non-residency U.S. citizens or green card holders Individual U.S. citizens or green card holders meet the non-residency requirement if, in at least one of the most recent three years for which the U.S. tax return due date (including applied-for extensions) has passed, the individual did not have a U.S. abode and was physically outside the United States for at least 330 full days. Under section 911 and its regulations, which apply for purposes of these procedures, neither temporary presence in the United States nor maintenance of a U.S. dwelling necessarily mean that the individual s abode is in the United States. The IRS directs individuals to IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, for more information on the meaning of abode. According to the IRS: 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. 5 Non-residency non-u.s. citizens or non-green card holders Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended (the Code ) or the applicable regulations promulgated pursuant to the Code (the regulations ). Individuals who are not U.S. citizens or green card holders meet the nonresidency requirement if, in at least one of the most recent three years for which the U.S. tax return due date (including applied-for extensions) has passed, the individual did not meet the substantial presence test of section 7701(b)(3). 6 Thus, for example, meeting the substantial presence test in 2013 and 2012 does not prevent a non-u.s. citizen, non-green card holder from utilizing the streamlined program if the substantial presence test was not met in 2011. 5 6 IRS Publication 54, page 12. See also Regulation section 301.7701(b)-1(c).
Have Undisclosed Foreign Assets? IRS Offers Options page 4 Procedural steps for eligible individuals Individuals who meet the non-residency requirement (which for joint return filers means both spouses meet the requirement) must: File delinquent or amended tax returns for the most recent three years for which the U.S. tax return due date (including applied-for extensions) has passed. The returns should include all required international information returns (e.g., Forms 8938, 8621, 5471, 5472, 3520, 3520-A, 926, 8858, and 8865), even if such information returns would normally be filed separately from Form 1040. Include at the top of the first page of each delinquent or amended tax return and each information return the words Streamlined Foreign Offshore in red to alert the IRS that the submission should be processed using the special procedures. Complete and sign an IRS statement, Certification by U.S. Person Residing Outside of the United States, certifying eligibility for the streamlined procedures: that all FBARs have now been filed, and that the reporting and payment failures were due to non-willful conduct. An original signed statement must be submitted, with a copy attached to each tax return and statement included with the submission, excluding FBARs (as they must be e-filed). Submit payment of all tax and interest due on the tax returns submitted. The individual s taxpayer identification number must be included on the payment check. File delinquent FBARs for the most recent six years for which the FBAR due date has passed (currently, calendar years 2008-2013). These must be e-filed using the BSA E-Filing System. On the cover page of the electronic form, select Other as the reason for filing late and in the explanation box that opens, enter Streamlined Filing Compliance Procedures.
Have Undisclosed Foreign Assets? IRS Offers Options page 5 If applicable, request an extension of time to make an election to defer income from certain retirement or savings plans (when permitted by treaty). Such a request must include a statement, under the penalties of perjury, regarding the events that led to the failure as well as its discovery, the role of a professional advisor (if any) in the failure, and, for Canadian plans, a Form 8891 for each tax year and each plan, and a description of the type of plan. These documents (except for the FBAR submission), together with any payment due, must be sent in paper form to: Internal Revenue Service 3651 South I-H 35 Stop 6063 AUSC Attn: Streamlined Foreign Offshore Austin, TX 78741 Taxpayers that fully comply with these procedures will not be subject to any penalties for the tax returns, international information returns, or FBARs submitted under the streamlined procedures. This waiver of all penalties applies even if the taxpayer s returns are subsequently selected for IRS examination, unless the exam results in a determination that the original tax noncompliance was fraudulent or that any FBAR violation was willful. Domestic Offshore Procedures Individuals meeting the general eligibility criteria (i.e., failures were nonwillful and currently not under IRS examination) but who fail to meet the non-residency requirements described above can make a submission under the streamlined domestic offshore procedures if they have: Previously filed a U.S. tax return (if required) for each of the most recent three years for which the U.S. tax return due date (including applied-for extensions) has passed; and Failed to report gross income from a foreign financial asset and pay the applicable tax due.
Have Undisclosed Foreign Assets? IRS Offers Options page 6 Such individuals may also have failed (as a result of non-willful conduct) to file a required FBAR or one or more international information returns (e.g., Forms 8938, 8621, 5471, 5472, 3520, 3520-A, 926, 8858, and 8865) for a foreign asset. Individuals submitting under the domestic offshore procedures can escape the traditional penalties that might apply for the late filing of tax returns, information returns, and FBARs. But taxpayers filing under the domestic offshore program must instead pay a five percent Title 26 miscellaneous offshore penalty (the five percent penalty ). The five percent penalty is based on those foreign financial assets the individual failed to report on Form 8938 or on an FBAR for a given year. Form 8938 reporting failures covering a three-year period ( covered tax return period ) and FBAR reporting failures covering a six-year period ( covered FBAR period ) are considered in calculating the five percent penalty. Foreign assets properly reported during the covered tax return period but which the individual failed to report the assets gross income in that year are also subject to the five percent penalty. The penalty appears to require an asset-by-asset calculation with potentially different calendar years being used for each asset. For example, apply a five percent penalty to the highest calendar year-end balance of a foreign bank account excluded from an FBAR over the prior six years. If a foreign asset was excluded from Form 8938, or the gross income from the asset was omitted from the tax return (even if the asset was disclosed), take the highest calendar year-end value of that asset over the prior three years and apply a five percent penalty. The five percent penalty would equal the aggregate of the five percent penalties calculated for each applicable foreign asset. Note that the calculation is limited to unreported foreign financial assets as opposed to an individual s total foreign holdings.
Have Undisclosed Foreign Assets? IRS Offers Options page 7 Procedural steps for eligible individuals Under the domestic offshore streamlined procedures, individuals must: File amended tax returns, 7 Forms 1040X, for the most recent three years for which the U.S. tax return due date (including applied-for extensions) has passed. The returns should include all required international information returns (e.g., Forms 8938, 8621, 5471, 5472, 3520, 3520-A, 926, 8858, and 8865), even if such information returns would normally be filed separately from Form 1040. Include at the top of the first page of each amended tax return the words Streamlined Domestic Offshore in red to alert the IRS that the submission should be processed using the special procedures. Complete and sign an IRS statement, Certification by U.S. Person Residing Inside the United States, certifying eligibility for the streamlined procedures: that all FBARs have now been filed; that the reporting and payment failures were due to non-willful conduct; and that the five percent penalty is accurate. An original signed statement must be submitted, with a copy attached to each tax return and statement included with the submission, excluding FBARs (as they must be e-filed). Submit payment of all tax and interest due on the tax returns submitted. The individual s taxpayer identification number must be included on the payment check. Submit payment of the five percent penalty. File delinquent FBARs for the most recent six years for which the FBAR due date has passed (currently, calendar years 2008-2013). These must be e-filed using the BSA E-Filing System. On the cover page of the electronic form, select Other as the reason for filing late and in the explanation box that opens, enter Streamlined Filing Compliance Procedures. 7 Delinquent tax returns cannot be filed using the domestic offshore streamlined procedures.
Have Undisclosed Foreign Assets? IRS Offers Options page 8 If applicable, request an extension of time to make an election to defer income from certain retirement or savings plans (when permitted by treaty). Such a request must include a statement, under the penalties of perjury, regarding the events that led to the failure as well as its discovery, the role of a professional advisor (if any) in the failure, and, for Canadian plans, a Form 8891 for each tax year and each plan and a description of the type of plan. These documents (except for the FBAR submission), together with any payments due, must be sent in paper form to: Internal Revenue Service 3651 South I-H 35 Stop 6063 AUSC Attn: Streamlined Domestic Offshore Austin, TX 78741 Delinquent FBAR Submission Option Those taxpayers not needing the streamlined filing compliance procedures to file delinquent or amended tax returns because all income related to their foreign financial accounts has been properly reported and all tax has been paid, have a different option for submitting their late FBARs. 8 Delinquent FBARs can be filed on a penalty-free basis if the U.S. person is not under IRS exam and has not been contacted by the IRS about missing FBARs. The delinquent FBARs should be filed electronically using the BSA E-Filing System. Note that there is a six-year statute of limitations on an FBAR, starting on the due date of the FBAR (June 30), regardless of whether an FBAR is filed. Thus, the relevant years for missing FBARs are currently calendar years 2008-2013. FBARs filed under the delinquent submission option should select Other as the reason for the late filing on the cover page of the electronic form. Selecting Other will open a window that will allow the delinquent filer to indicate that the criteria for penalty relief have been met: all income related to the foreign accounts has been reported; all 8 This option replaces old FAQ #17, which was part of the frequently asked questions issued under the Offshore Voluntary Disclosure Program (OVDP). Although FAQ #17 was withdrawn as of June 30, 2014, the delinquent FBAR submission option provides the same relief provision.
Have Undisclosed Foreign Assets? IRS Offers Options page 9 taxes have been paid; and the late FBARs are being filed before IRS contact. Taxpayers who inadvertently failed both to report income related to foreign assets and to file required FBARs do not qualify for the automatic penalty relief offered by the delinquent submission option. If such individuals do not qualify for the foreign offshore program described above, the alternative option of making a submission under the domestic offshore program may prove costly, as the aforementioned five percent penalty would apply. However, a course of action that strays from the options offered by the IRS may also be considered: correcting the inadvertently omitted income by filing qualified amended returns. 9 This would be followed by filing the late FBARs requesting penalty relief based on the individual s facts and circumstances. Note that taxpayers should be made aware of the potential for FBAR penalties under this approach. Delinquent International Information Return Submission Option Another option provided by the IRS allows persons who: 1) have not filed one or more required international information returns, 10 2) have reasonable cause for not timely filing the information returns, 3) are not under IRS exam, and 4) have not been previously contacted by the IRS about the delinquent information returns to file delinquent information returns and request that applicable penalties be waived. A statement of the facts establishing reasonable cause, along with a certification that any entity for which the information returns are being filed was not engaged in tax evasion, must be attached to each information return being submitted. The delinquent information returns, except for Forms 3520 and 3520-A, should be attached to an amended return and filed in accordance with the amended return s instructions. This 9 10 A qualified amended return avoids the imposition of an accuracy related penalty under section 6662. See Regulation section 1.6664-2(c)(2) & (3). As previously mentioned, this includes Forms 8938, 8621, 5471, 5472, 3520, 3520-A, 926, 8858, and 8865.
Have Undisclosed Foreign Assets? IRS Offers Options page 10 option is not as generous as the procedure it replaces as a statement of reasonable cause was previously not required in order to obtain penalty relief. 11 Offshore Voluntary Disclosure Option The last option, only briefly mentioned here, is a submission under the IRS s Offshore Voluntary Disclosure Program (OVDP). This program allows taxpayers who did not report taxable income in the past to avoid criminal prosecution if they come forward voluntarily and resolve their tax matters, including voluntary disclosure of foreign accounts and foreign assets and payment of any tax due plus substantial civil penalties. With criminal sanctions at issue, taxpayers should seek legal assistance before proceeding down this path. Conclusion With the IRS becoming stricter in its enforcement of the reporting provisions related to foreign assets, taxpayers should not delay in taking corrective action as eligibility for penalty relief is generally dependent on taking action before IRS contact. A careful analysis, however, of the available options being offered by the IRS is a critical first step for taxpayers trying to come into compliance while hoping to minimize or avoid potential penalties. KPMG s What's News in Tax is a publication from Washington National Tax that contains thoughtful analysis of new developments and practical, relevant discussions of existing rules and recurring tax issues. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author or authors only, and does not necessarily represent the views or professional advice of KPMG LLP. 11 This option replaces old FAQ #18, which was part of the frequently asked questions issued under the OVDP. For delinquent information returns filed by June 30, 2014, taxpayers could obtain penalty relief by qualifying under FAQ #18 (now withdrawn), which in lieu of the now-required more formal statement of reasonable cause, only required an explanation of why the information return was late.