Congress, the IRS, and the Department of Justice are scrutinizing foreign account holders now more than ever. On February 19, 2014, the Senate Permanent Subcommittee on Investigations announced that it will be holding a hearing to crackdown on foreign tax evasion and to hold U.S. taxpayers accountable for unpaid taxes on accounts overseas. In the last five years, federal prosecutors have brought more than 100 criminal cases against taxpayers hiding money – hundreds of millions of dollars – overseas. In addition, more foreign banks are beginning to report their American account holders to the IRS pursuant to the Foreign Account Tax Compliance Act (FATCA), which was enacted in 2010. While the purpose of these programs is to catch individuals attempting to evade U.S. taxes, many ordinary citizens or new U.S. residents also face significant civil and criminal penalties as a result of these new efforts. In this climate of intense scrutiny, it is more important now than ever for taxpayers to fully report any assets held overseas. These assets include bank accounts, trusts, real estate, partnership interest, and even gifts from relatives.
A U.S. person, which includes U.S. residents and U.S. citizens (whether living in the U.S. or overseas), with a financial interest in or signature authority over a foreign financial account holding $10,000 or more of assets at some point during the tax year is required to file a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Following the passage of FATCA, U.S. and foreign citizens with an interest in foreign assets also may be required to file a Form 8938. A U.S. person must file a Form 8938 if he or she had an interest in foreign assets worth at least $50,000 on the last day of the tax year or $75,000 at any time during the tax year. The term “foreign assets” is broadly defined to include foreign accounts, foreign stock, foreign partnership interests, foreign mutual funds, debt issued by a foreign person, interests in foreign trusts or estates, and certain derivative instruments with a foreign counterparty. In addition to FATCA and FBAR reporting requirements, taxpayers with foreign assets may be required to file additional information returns, such as a Form 3520 (applicable to taxpayers treated as the owner of assets in a foreign trust), Form 5471 (applicable to taxpayers who hold certain interests in controlled foreign corporations), Form 926 (applicable to transfers of property to a foreign corporation), or a Form 8865 (applicable to U.S. person with certain interest in foreign partnerships).
Penalties for failing to file these information returns begin at $10,000 per account and may go as high as $60,000 for failing to file a Form 8938 or up to 50 percent of the highest aggregate account value for failing to file an FBAR. These penalties apply even if the taxpayer owes no U.S. tax on the foreign account holdings. If the foreign assets generated taxable income, the account holder is also liable for a 40% understatement penalty on unreported taxable income attributable to these foreign accounts or assets. Finally, in some cases failure to file these forms can subject the taxpayer to criminal penalties. If you or a client has failed to file these forms, there are several options you may have to reduce potential penalties. The best option for a majority of taxpayers with unreported foreign assets is the offshore voluntary disclosure program, which gives taxpayers an opportunity to become current on their filings and pay a reduced penalty.
OFFSHORE VOLUNTARY DISCLOSURE PROGRAMS
Since 2009, the IRS has offered three offshore voluntary disclosure programs (OVDP) pursuant to which taxpayers may disclose previously unreported foreign accounts and income earned on those accounts. Taxpayers accepted to these programs are assessed reduced penalties for nondisclosure, and they avoid criminal prosecution. The first OVDP was instituted in 2009 and has resulted in the collection of $3.3 billion to date. In 2011, the IRS opened a second offshore voluntary disclosure initiative (ODVI) through which it collected $1 billion in upfront payments. More than 33,000 taxpayers voluntarily disclosed offshore accounts under the 2009 and 2011 programs. As a result of the programs’ huge success, the IRS opened a new OVDP on January 9, 2012, which is outlined in IRS announcement IR-2012-5. That program is still open, though the IRS may close it at any time.
To enter the current OVDP, taxpayers must provide original and amended returns with appropriate schedules outlining the unreported income from foreign assets for the previous eight tax years for which the due date has passed. For example, taxpayers entering into the program after April 15, 2013, must submit original and amended returns for the 2005 through 2012 tax years, while taxpayers entering the program before April 15, 2013, must submit original and amended returns for the 2004 through 2011 tax years. Taxpayers must also file all required information returns over that eight-year period. Participants accepted into the program may pay a penalty of 27.5 percent of the highest aggregate balance in the foreign bank accounts/entities during the eight full tax years prior to the disclosure. This percentage is up from the 25 percent penalty in the 2011 program. In limited circumstances, taxpayers may be eligible for 5 percent or 12.5 percent penalties. In addition to failure to report penalties, taxpayers must pay an underpayment penalty of up to 40 percent of the taxes owed on all unreported income from foreign accounts. A taxpayer may also “opt out” of the program’s penalty framework if he or she faces lower penalties under the appliable statutes. “Opt out” taxpayers are still protected from criminal prosecution and have the opportunity to argue that reduced or zero penalties should apply. Taxpayers who are already under audit are not eligible for this program.
As part of this new OVDP, the IRS has issued guidance to encourage certain taxpayers who have inadvertently failed to disclose foreign assets to come forward to disclose those assets without facing a penalty. Pursuant to this guidance, taxpayers who properly reported all taxable income but only recently learned of the requirement to file an FBAR may file an FBAR with a statement explaining why the FBAR is late. In those cases, the IRS will not impose a penalty for the failure to file the delinquent FBAR. Similarly, taxpayers who failed to file Forms 5471 or 3520, but who have reported all taxable income associated with the controlled foreign corporation or foreign trust may file delinquent information returns with a statement explaining why the returns are late. In those cases, the IRS similarly will not impose failure to file penalties as long as the taxpayer has not been contacted by the IRS about the delinquent returns.
The deadline to file an FBAR reporting foreign financial accounts held in 2013 is June 30, 2014, regardless of whether you have received an extension to file your 2013 federal income tax return. Most other information returns must be filed with your tax return.