Coming Clean Could Be Much Easier Than You Think
Perhaps you were born and raised in the United States, but left years ago to make a life in another country. You never thought about filing tax returns in the United States because you did not live here. Then one day your bank informs you that your name and Social Security number, as well as the value of your accounts, has been given to the IRS. You wonder why, and with a little Googling you discover that your obligation to file a US tax return never ended. You also discover, with shock and horror, that you might be on the hook for massive penalties for failing to file something called an FBAR.
Like you, millions of U.S. taxpayers hold foreign bank accounts and other foreign financial assets for purely benign and legitimate purposes. Many are unaware of the reporting requirements to the U.S. government, or that banks face penalties if they fail to disclose information about U.S. citizen depositors to the IRS. Others who have become aware are simply afraid to come forward when faced with overwhelming and crippling penalties.
FBAR REQUIREMENTS AND ENFORCEMENT
The obligation to report foreign bank and financial accounts to the U.S. Treasury was initially imposed by the Bank Secrecy Act in 1970. The law requires each U.S. person who has a financial interest in or signature authority over any foreign financial account to file an FBAR (Report of Foreign Bank and Financial Accounts) if the aggregate value of the foreign financial accounts exceeds $10,000 at any time during the calendar year. A "U.S. person" is any citizen or permanent resident (green card holder) of the United States (regardless of where they live) and any foreign national who has passed the substantial presence test (see Residency Status). It also includes a nonresident alien making the first year election under Section 7701(b)(4) of the Internal Revenue Code (IRC), but does not include a nonresident alien electing to file a joint return under IRC Section 6013(g) or (h) (as clarified in the Preamble to 31 CFR 1010.350, published Feb. 24, 2011, and in Section 184.108.40.206.1.2 of the Internal Revenue Manual).
The term "financial account" includes the following:
- Bank accounts such as savings accounts, checking accounts, and time deposits,
- Securities accounts such as brokerage accounts and securities derivatives or other financial instruments accounts,
- Commodity futures or other options accounts,
- Insurance policies with a cash value (such as a whole life insurance policy),
- Mutual funds or similar pooled funds,
- Most retirement accounts, and
- Any other accounts maintained in a foreign financial institution or with a person performing the services of a financial institution.
For over three decades after enactment, enforcement of this requirement was largely ignored by the U.S. Treasury. Since the majority of taxpayers were not even aware of the filing requirement, noncompliance was the norm.1
In 2004, the IRS was granted a very big stick when penalties for willful failure to annually file the FBAR form (previously FinCEN Form 90-22.1, now Form 114) were dramatically increased. It was at this time that the IRS accelerated it’s enforcement efforts, but carrots for reporting delinquent accounts were slow to follow.
Under 31 U.S.C. section 5321(a)(5), the civil penalty for a non-willful failure to report is $10,000 per violation, as adjusted for inflation, and the civil penalty for a willful violation was increased to the greater of $100,000, as adjusted for inflation, or 50% of the amount in the account at the time of the violation. For penalties assessed after January 15, 2017, the inflation-adjusted penalty for a non-willful failure to report increased to $12,921, and the inflation adjusted penalty for a willful failure to report increased to $129,210 (31 CFR section 1010.821). Willful violations may also be subject to criminal penalties under 31 U.S.C. section 5322 or 18 U.S.C. section 1001.
In spite of the massive increase in penalties after a long period of non-enforcement, the IRS did not initially offer a compliance incentive for delinquent filers who were simply unaware of the filing requirements. Instead, in 2009 the IRS offered, through an offshore voluntary disclosure program (OVDP), to forgo criminal prosecution and maximum penalties in exchange for fairly severe penalties for non-filers who came forward. Participants were required to pay a 20 percent accuracy related penalty and an additional penalty of 20 percent of their highest offshore account balance (plus non-financial foreign assets) during a six-year period. The OVDP program was revised and extended in 2011 and again in 2012 and 2014, with more severe terms with each extension.
These were one-size-fits-all programs, designed for people with criminal intentions rather than the honest folks who became their main participants. The programs did not serve to promote trust and goodwill toward the IRS among the taxpaying public. On March 13, 2018 the IRS announced that the OVDP program would be discontinued on September 28, 2018. There had only been 600 participants in 2017.
THE NEW STREAMLINED FILING PROCEDURES
Sensing it needed a more appropriate enticement for inadvertent non-filers, the IRS created the original streamlined procedure in 2012. This program was offered only to taxpayers living outside the United States who qualified for the foreign earned income exclusion. It was further restricted to taxpayers with unreported income of $1,500 or less.
In June of 2014, the IRS relaxed and expanded the streamlined procedure to apply to all non-willfully delinquent taxpayers. The new streamlined programs allow taxpayers, living either in the United States or abroad, who failed to disclose their foreign accounts and report their foreign income, to become fully compliant at a much lower cost than entering the OVDP (IR-2014-73). There are now multiple procedures. Taxpayers qualifying for the foreign offshore procedures face no penalties at all, while a 5 percent of highest balance penalty is offered to participants living in the United States who qualify for the domestic offshore procedures. There is no longer an unreported tax threshold (formerly $1,500) that could bar hopeful participants from the program, so participants do not need to worry about being rejected if they have substantial foreign income to report. There was also a risk assessment process under the old program that applicants had to sweat through before being accepted. That is now gone.
If you previously tried to fix the problem by filing delinquent or amended returns outside the OVDP (deemed a “quiet disclosure”), you are not off the hook if the IRS decides to initiate an audit, but you are still eligible for the new streamlined procedures. You must now follow the specific rules of either the Streamlined Domestic Offshore Procedures or the Streamlined Foreign Offshore Procedures to guarantee against additional penalties.
These procedures are for individuals (and estates of individuals) who have under-reported their foreign income and have failed to report foreign financial assets, and who certify that their failure to do so did not result from "willful" conduct on their part. Additionally, the IRS must not have initiated a civil examination of the taxpayer's tax returns for any year, regardless of whether the examination relates to undisclosed foreign financial assets. If that has happened, the taxpayer will not be eligible for the streamlined procedures.
Willful vs. non-willful: Distinguishing willful conduct from non-willful conduct is critical, so what is the difference? The IRS offers this: “Non-willful conduct is 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.” (IR-2014-73.)
The IRS definition of non-willful covers a lot of territory. Negligence, for example, includes “any failure to make a reasonable attempt to comply with the provisions of the Code” (IRC Sec. 6662(c)) or “to exercise ordinary and reasonable care in the preparation of a tax return” (Reg. Sec. 1.6662-3(b)(1)). Further, “negligence is a lack of due care in failing to do what a reasonable and ordinarily prudent person would have done under the particular circumstances.” (Kelly, Paul J., (1970) TC Memo 1970-250). The court also stated that a person may be guilty of negligence even though he is not guilty of bad faith.
So the fact that you ignored the FBAR filing requirements for many years, and failed to report your foreign income, might be negligent behavior, but it’s probably not willful. That means you likely qualify for one of the new streamlined procedures. On the other hand, if you loaded piles of cash into a suitcase and lugged it over to Switzerland to conceal it from the IRS, you are not a candidate for the streamlined procedures, because that is willful conduct. If you believe your behavior may have been willful under these guidelines, consult with an attorney before submitting returns through one of the streamlined procedures. We work with attorneys who are experts in this field and would be happy to provide a referral, free of charge or obligation.
Qualifying for the Foreign Offshore Procedures
The foreign offshore procedures allow you to become compliant penalty free, so this is the preferred process over the domestic offshore procedures. If you fail to qualify for this process, and you have unreported income, the domestic offshore procedures might be your next option. In addition to meeting the general eligibility requirements, individual U.S. taxpayers, or estates of individual U.S. taxpayers, who seek to use the Streamlined Foreign Offshore Procedures must also satisfy the following requirements.
1) They must meet the non-residency requirement described below. If filing jointly, both spouses must meet the non-residency requirement for at least one of the most recent three calendar years for which the due date has passed.
2) They must have failed to report the income from a foreign financial asset and pay the required tax, and may (not must) have failed to file an FBAR (FinCEN Form 114) and/or one or more international information returns, such as Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621. In other words, an international information return that was required to be filed may be filed as part of this streamlined submission, but a delinquent international information form is not a requirement to qualify. If all international information returns have been filed, but gross income from foreign accounts has been omitted, this streamlined program is available.
3) These failures must have resulted from non-willful conduct, as defined above.
Non-residency requirement for U.S. citizens and green card holders: This requirement is met if the US citizen or permanent resident, (or the estate thereof), in any one or more of the most recent three years for which the U.S. tax return due date (or properly extended due date) has passed, did not have a U.S. abode and was physically outside the United States for at least 330 full days. To read about the meaning of "abode," see IRS Publication 54. This means that even if you were living in the United States for two of these years, you still qualify if you meet the 330 day test in the third year. These criteria mean that you will meet the tests for the foreign earned income exclusion in the year or years of absence from the United States.
Non-residency requirement for foreign national visa holders: Foreign nationals who are not permanent residents must meet the substantial presence test to be considered residents of the United States for tax purposes. If they are not considered residents, they are generally not subject to the FBAR filing requirements. A foreign national who does not meet the substantial presence test for one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed meets the non-residency requirement. For more information on the substantial presence test, see our U.S. Tax Guide for Foreign Nationals under Residency Status.
If you are eligible to use the Streamlined Foreign Offshore Procedures and comply with the filing instructions, you will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties. There are no penalties at all. However, your returns could still be selected for audit under the normal audit selection process. If the IRS determines an additional tax deficiency for a return submitted under these procedures, the IRS may assert applicable additions to tax and penalties relating to that additional deficiency.
What you must do: The procedures are to 1) file delinquent or amended returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 8938, and 8621) for each of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed, 2) for each of the most recent six years for which the FBAR due date has passed, file any delinquent FBARs, and 3) complete and sign a statement on Form 14653 certifying that you are eligible for the Streamlined Foreign Offshore Procedures, that all required FBARs has now been filed, and that your failure to fully comply with US tax laws resulted from non-willful conduct. The full amount of the tax and interest due in connection with these filings must be remitted with the streamlined submission.
Qualifying for the Domestic Offshore Procedures
In addition to meeting the general eligibility requirements, individual U.S. taxpayers, or estates of individual U.S. taxpayers, who do not qualify for the foreign offshore procedures because they do not satisfy the non-residency requirements defined above, and who seek to use the Streamlined Domestic Offshore Procedures, must also satisfy the following requirements.
1) They must have previously filed a U.S. tax return (if they were required to) for each of the most recent three years for which the U.S. tax return due date (or properly extended due date) has passed. (Note that this is not a requirement for using the foreign offshore procedures.)
2) They must have failed to report gross income from a foreign financial asset and pay tax as a result of this failure. If no gross income has been omitted, the taxpayer is not a candidate for these procedures, but may benefit from the delinquent FBAR submission procedures or the delinquent international information return submission procedures, as described below.
3) They may (not must) have failed to file an FBAR and/or one or more international information returns, such as Forms 3520, 3520-A, 5471, 8938, 926, and 8621. In other words, an international information return that was required to be filed may be filed as part of this streamlined submission, but a delinquent international information form is not a requirement to qualify. If all international information returns have been filed, but gross income from foreign accounts has been omitted, this streamlined program is available.
4) These failures must have resulted from non-willful conduct, as defined above.
If you qualify for these procedures, and comply with the filing instructions, like taxpayers filing under the foreign offshore procedures, you will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties. However, you will be on the hook for a Title 26 miscellaneous offshore penalty.
What You must do: The main procedures are to 1) submit a complete and accurate amended tax return, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621), for each of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed, 2) for each of the most recent six years for which the FBAR due date has passed, file any delinquent FBARs, 3) complete and sign a statement on Form 14654 certifying that you are eligible for the Streamlined Domestic Offshore Procedures, that all required FBARs has now been filed, that your computation of the miscellaneous offshore penalty (which you will show on Form 14654) is accurate, and that your failure to fully comply with US tax laws resulted from non-willful conduct. The full amount of the tax, interest and miscellaneous offshore penalty due in connection with these filings must be remitted with the streamlined submission.
The penalty: This is a rather arbitrary penalty, imposed on only those taxpayers that fail to meet the non-residency requirements. The IRS rationale is apparently that those taxpayers residing in the United States should have been aware of their filing requirements and are therefore deserving of a penalty. However, the penalty is only a small fraction of the penalties the IRS is statutorily authorized to impose (and that was imposed through the OVDP programs).
The Title 26 miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer's foreign financial assets that should have been, but were not, reported on an FBAR or Form 8938, or were properly reported, but gross income with respect to the assets was not reported on a return submitted under the streamlined procedures. The penalty is computed by taking the highest aggregate balance/value determined by aggregating the year-end account balances and year-end asset values of all the financial assets subject to the penalty for each of the years in the covered periods, and selecting the highest aggregate balance/value from among those years.
General Treatment Under the Streamlined Procedures
The IRS will probably not acknowledge the filing of your streamlined package, and there is no closing agreement to sign. Since there is no admission procedure and the IRS will not contact participants in response to their filings, there is no need to hire an attorney to deal with this if you are confident that your non-filing was “non-willful.” This is not to say a subsequent audit will not occur. These returns could be selected for audit under the normal audit selection process applicable to any tax return, and returns may also be subject to verification procedures relating to the accuracy and completeness of the information submitted. If the IRS determines that you were in fact willful, there is no protection from additional civil or criminal penalties. If unreported income is discovered after your submission through the streamlined procedures, the returns may be subject to additional civil penalties, and even criminal liability if appropriate, so it's important to bear all with the streamlined submission. Also, if the specific filing requirements dictated by the IRS are not met, the IRS would have an excuse to kill the deal. The procedures must be followed precisely to prevent this. Although an attorney may not be required if you can demonstrate non-willfulness, a knowledgeable and astute accountant is.
Delinquent FBAR Submission Procedures and Delinquent International Information Return Submission Procedures
Taxpayers who have not under-reported their U.S. tax obligations, and are therefore not candidates for the Streamlined Procedures, but who qualify for the Delinquent FBAR Submission Procedures or the Delinquent International Information Return Submission Procedures, are also offered the opportunity to submit delinquent forms penalty free.
Take Action - Don't Wait
If you have unreported foreign accounts because of non-willful inadvertence or negligence, and believe you are a candidate for one of these procedures, it will be the best deal you are going to get to set things straight with the IRS and be absolved of crippling penalties. Take advantage of it, and do it now. It is not prudent to sit back and ponder your options. Once you are contacted for audit by the IRS, for any year and for any purpose, the deal is off. You are then at the mercy of the IRS. If you want to get started, contact me and I will answer any questions you have about the process. For more information about the tax forms required of expats, and procedures for delinquent filing, see US Tax Guide for Expats. For a general menu of our fees see Our Fees For Tax Service.
1 A Report to Congress In Accordance With Sec. 361(b) of the USA Patriot Act, Submitted by the Secretary of the Treasury, April 26, 2002.