A Good, Though Flawed, Option for Americans Living Abroad
There is a growing emphasis worldwide on combating tax evasion, which has been fueled by the U.S.’ high profile attack on Switzerland and the Swiss banking community. The U.S. Internal Revenue Service (IRS)’s efforts to uncover non-compliant U.S. individuals with foreign assets has been reinforced by the incorporation in 2010 of Chapter 4 to the Internal Revenue Code of 1986, as amended, relating to the Foreign Account Tax Compliance Act (or its acronym FATCA). The purpose of FATCA is to recruit foreign financial institutions and foreign non-financial entities to assist with the task of obtaining information relating to U.S. taxpayers and their reporting obligations. The FATCA framework also incorporates the possibility of the tax authorities of a foreign jurisdiction executing with the IRS an Inter-Governmental Agreement (IGA) for the exchange of information between the U.S. and the other contracting state.
As a result, many U.S. citizens (and green card holders) living abroad have come to realize, and fear, that they may become the targets of IRS and Department of Justice (“DOJ”) enforcement efforts now that the flow of information between governments has exponentially increased. This is particularly true for those individuals who were born U.S. citizens or acquired U.S. citizenship by virtue of their parentage and have been U.S. tax non-compliant for all the years they have lived outside of the United States. Many have heard about the information exchange that will flow under FATCA and the IRS’s Offshore Voluntary Disclosure Initiatives to cure this lack of compliance but remain uninformed about the details or have found the programs too onerous and costly.
For these individuals, the IRS’ Streamlined Program may offer a good option for coming into U.S. tax compliance at a relatively low cost and without too much complexity.
The benefit of the Streamlined Program can be illustrated by the following example.
Gabriela was born in the United States to Mexican parents. After her birth, her parents returned to Mexico where Gabriela was raised and has always lived, apart from attending university in Europe for a few years. Gabriela is now 30 years old. She works and pays taxes in Mexico and only has bank accounts in Mexico. Because she is a U.S. citizen by virtue of having been born in the U.S., Gabriela should have been filing U.S. income tax returns and was required to report her Mexican bank accounts. She never did so. Under the Streamlined Program, Gabriela can file delinquent tax returns for the last three years along with six years of foreign bank account reports (now FinCEN Form 114), and pay no penalties as long as the tax due (in the U.S.) for each of the three years does not exceed $1,500. In Gabriela’s case, based on foreign tax credits claimed on her U.S. tax returns and the exemption under IRC section 911 (the earned income exclusion), Gabriela would owe no taxes.
Gabriela is a perfect candidate to benefit under the Streamlined Program. She fits all of the criteria:
- She did not file a U.S. income tax return for the years covered by the program, i.e. for taxpayers residing outside of the U.S. since January 1, 2009 (in fact, she never filed U.S. returns);
- Her U.S. income tax liability for each of the three years is below $1,500;
- She has no foreign financial accounts outside her country of residence;
- She has lived in Mexico since at least 2009;
- Her delinquent returns do not claim a refund;
- She has no economic activity in the U.S. and no U.S. source income;
- She declared all her income in Mexico;
- She is not under audit or investigation by the IRS;
- She has never been assessed a Report of Foreign Bank and Financial Accounts (FBAR) penalty or received an FBAR warning letter; and
- There are no indications of sophisticated tax planning or avoidance (i.e., formation of offshore entities to hold offshore accounts).
These characteristics demonstrate a low-risk compliance profile. If the foregoing requirements are satisfied, the individual would proceed to file the tax returns (with a valid social security number (SSN), taxpayer identification number (TIN) or application therefor) for the past three years with the notation “Streamlined” at the top of the first page of every return together with the FBARs for the last six years and a complete questionnaire (available on-line) to a special IRS service center that processes streamlined filings. The taxpayer will not receive a closing agreement (as is typically required in a voluntary disclosure procedure) from the IRS.
If one or more of these characteristics differs from the hypothetical, the taxpayer’s risk profile increases and there is no assurance the IRS would accept such a person into the Streamlined Program. Submissions that present higher compliance risk are not eligible for the streamlined processing procedures and will be subject to a more thorough review and possibly a full examination, which in some cases may include more than three years.
The Streamlined Program also does not provide protection from criminal prosecution, as would a full voluntary disclosure, but if the facts present a low-risk compliance profile, criminal prosecution would be unlikely.
Another issue raised by the Streamlined Program relates to an individual’s decision to expatriate. The program establishes a three-year lookback period for tax returns; however, to undertake an expatriation, the taxpayer must have filed returns for the prior five years. This signifies that those considering expatriation must either (i) wait two years to commence expatriation after filing for the five year period; or (ii) file additional returns, which are not required under the Streamlined Program.
A U.S. citizen with non-U.S. residence considering a streamlined submission should consult an experienced U.S. tax practitioner. Generally, foreign practitioners and bankers are not experienced in handling these U.S. tax matters or in assessing an individual’s risk profile and determining whether the Streamlined Program is the appropriate solution to the U.S.non-compliance.