Non-compliance with tax and foreign financial account reporting was addressed by the Internal Revenue Service (IRS) with voluntary disclosure initiatives in 2009, 2011 and 2012 (see prior alerts: March 2009, May 2009, February 2011, December 2011, January 2012 and June 2012). The prior programs were particularly onerous and harsh for U.S. citizens and green card holders who resided outside the United States for an extended period of time and who failed to file U.S. income tax returns and reports of Foreign Bank and Financial Accounts (FBARs). The IRS recognized the unfairness for non-resident U.S. taxpayers and, on June 26, 2012, announced a new streamlined compliance procedure to go into effect on September 1, 2012. The streamlined procedure allows non-compliant non-residents to come into compliance by filing a limited number of returns without suffering penalties. The IRS waited until August 31, 2012 to announce the details of the program. As described below, not every non-resident will qualify for this simplified program, and, therefore, individuals should confer with their tax advisors to evaluate the applicability and risks of proceeding in the new streamlined program.
The Streamlined Procedure
The IRS’s instructions for the new procedure state that it “is designed for taxpayers that present a low compliance risk.” The IRS defines taxpayers who are low risk as those who file “simple returns with little or no U.S. tax due.” Submitted returns that show less than $1,500 in tax due in each year are treated as low risk, absent any “high risk” factors. Taxpayers with low risk submissions will be subject to expedited IRS review of the returns and FBARs. In exchange for admission into the IRS’s new program, the IRS will not assert penalties or pursue further actions.
Taxpayers will be required to file delinquent income and information returns, such as Forms 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts”, or 5471, “ Information Return of U.S. Persons With Respect to Certain Foreign Corporations,” for the past three years, and delinquent FBARs for the past six years, along with a questionnaire described below. Payment of any tax and interest due must be submitted with the delinquent tax returns. For taxpayers with retirement and savings plans subject to deferral through relevant tax treaties, late elections will be allowed retroactively and must be submitted with the other returns. Instructions for utilizing the streamlined procedure are set forth in the IRS’s published guidance.
Not every non-compliant non-resident U.S. taxpayer is eligible for the streamlined procedure. To be eligible, a taxpayer must have resided outside the United States since January 1, 2009 and he or she cannot have filed a U.S. tax return at any time since 2008. All taxpayers must have a valid Taxpayer Identification Number (“TIN”), i.e., a social security number or individual taxpayer identification number, in order to make the submission in the new program.
U.S. taxpayers who previously filed tax returns during any of the years from 2009 through present will be treated as “high risk” and will be subject to examination. Excepted from the category of “high risk” are taxpayers who are filing solely to submit late-filed Forms 8891 to seek relief for failure to timely elect deferral of retirement accounts by relevant treaty. Canadians with RRSP’s (Registered Retirement Plans), for example, who did not make timely deferral elections will be given relief under this provision.
Compliance Risk Determination
The IRS will determine the level of compliance risk presented by each submission from the returns filed and from additional information provided in response to the questionnaire required to be filed with the returns. The questionnaire asks a series of “yes” or “no” questions concerning the taxpayer’s eligibility, financial accounts and entities, tax advisors, and tax position. The taxpayer is required to sign the questionnaire under penalty of perjury. Some “yes” answers to the questionnaire automatically disqualify a taxpayer from the streamlined program. Other “yes” answers, alone or in combination, will increase the risk factors for full audit, penalties, and possible referral for criminal investigation, although the IRS provides no guidance on how it will weigh those factors. The risk level factors include:
- If any of the returns submitted through this program claim a refund;
- If there is material economic activity in the United States;
- If the taxpayer has not declared all of his/her income in his/her country of residence;
- If the taxpayer is under audit or investigation by the IRS;
- If FBAR penalties have been previously assessed against the taxpayer or if the taxpayer has previously received an FBAR warning letter;
- If the taxpayer has a financial interest in, or authority over, financial accounts located outside his or her country of residence;
- If there is U.S. source income; or
- If there are indications of sophisticated tax planning or avoidance.
Taxpayers who are not “low risk of tax non-compliance,” as defined by the IRS, will receive no protection from a full IRS audit of the returns, the assertion of penalties or the pursuit of criminal prosecution. The IRS warns taxpayers who are concerned about criminal prosecution to consult with their legal advisors about the 2012 Offshore Voluntary Disclosure Program (OVDP). Once a taxpayer makes a submission under the new procedure, the 2012 OVDP is no longer an option.
The Bottom Line
The streamlined procedure is limited in its applicability. In most cases, before considering whether to submit under this procedure or under the more costly OVDP, taxpayers would be wise to complete draft tax returns under the guidance and control of a tax attorney who can protect the attorney/client privilege while evaluating the client’s risk factors and recommending the appropriate course of action.