By Stephen J. Dunn
The United States taxes its citizens and its resident aliens on their worldwide income. U.S. taxpayers are required to report their foreign income on their U.S. income tax return. They must also answer a series of questions on Schedule B to their U.S. income tax return asking them about foreign financial accounts. Failure to perform these reporting obligations subjects the taxpayer to civil penalties, and to potential criminal prosecution.
A U.S. taxpayer with foreign accounts totaling more than $10,000 in value as of December 31 must report the accounts to the IRS by the ensuing June 30. The accounts are reported on Form TD F 90.22-1 (“FBAR”). Failure to file an FBAR, or omission of an account from a filed FBAR is punishable by a fine of up to $10,000. But if the failure to file an FBAR or omission of an account from the filed FBAR was willful, the penalty is the greater of $100,000 or 50 percent of the value of the accounts required to be filed on the delinquent FBAR, or of the value of the accounts omitted from the filed FBAR.
The IRS’ Offshore Voluntary Disclosure Program (“OVDP”) enables eligible taxpayers to become compliant with their Federal income tax and FBAR reporting requirements while avoiding criminal prosecution and some civil penalties. Qualifying taxpayers must—
• File Federal income tax returns or amended Federal income tax returns, as the case may be, and FBARs, for the last eight years, or for as long as the noncompliance exists, whichever is shorter.
• Cooperate with the IRS in the voluntary disclosure process, including providing information on offshore accounts, institutions, and facilitators, and executing waivers of the statute of limitations for assessing tax and applicable penalties.
• Pay the additional tax due on the income tax returns or amended returns, and related 20% accuracy penalties.
• Provide the IRS full documentation concerning the subject accounts.
• Pay the penalty due under 31 USC § 5321. Currently this is 27.5% of the highest balance in the accounts in the subject period. If the taxpayer’s undisclosed balance in the accounts for the subject period does not exceed $75,000, then the penalty is 12.5% of such balance. The penalty is 5% of the highest balance in the accounts for the subject period if the taxpayer meets these four criteria: (1) the taxpayer did not open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of the account, upon the death of the owner of the account); (2) the taxpayer has exercised minimal, infrequent contact with the account, for example, to request the account balance, or update accountholder information such as a change of address, contact person, or email address; (3) the taxpayer has, except for a withdrawal closing the account and transferring the funds to an account in the United States, not withdrawn more than $1,000 from the account in any year for which the taxpayer was noncompliant; and (4) the taxpayer can establish that all applicable U.S. taxes have been paid on funds deposited into the account (only account earnings have escaped taxation).
The OVDP is not available to a taxpayer as to whom the IRS has initiated a civil examination or a criminal investigation. The mere fact that the IRS has served a John Doe summons, made a treaty request or has taken similar action does not make every member of the John Doe class or group identified in the treaty request, or other action ineligible to participate. However, once the IRS or the Department of Justice obtains information under a John Doe summons, a treaty request, or other action that provides evidence of a specific taxpayer’s noncompliance with the tax laws or Title 31 reporting requirements, that particular taxpayer is ineligible for the OVDP program.
To find out if a criminal prosecution is underway against a taxpayer, the taxpayer’s representative faxes a pre-clearance request identifying the taxpayer to the IRS Criminal Investigation Division (“CID”) Lead Development Center. A power of attorney executed by the taxpayer in favor of the representative must accompany the request. CID will to the representative within two-three weeks.
Beginning for tax returns filed in 2012, the Foreign Account Tax Compliance Act (“FATCA”) requires taxpayers to report not only foreign financial accounts, but also foreign financial assets that are not in the form of a financial account but are nonetheless held for investment. Foreign financial assets that must be reported by FATCA include:
• Stock issued by a foreign corporation.
• A capital or profits interest in a foreign partnership.
• A note, bond, debenture, or other form of indebtedness issued by a foreign person.
• An interest in a foreign trust or foreign estate.
• An interest rate swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement with a foreign counterparty.
• An option or other derivative instrument with respect to any of these examples or with respect to any currency or commodity that is entered into with a foreign entity.
FATCA reporting is done on Form 8938, Statement of Specified Foreign Financial Assets, filed with the taxpayer’s Federal income tax return. Form 8938 must be filed by—
• An individual who is not married, or who is married but files an income tax return separate from his or her spouse, and who does not live abroad, if the total value of his or her foreign financial assets exceeds (1) $50,000 on the last day of the tax year, or (2) $75,000 on any day during the tax year. These amounts double for a married couple filing a joint income tax return (and hence a joint Form 8938).
• An individual who is not married, or who is married but files an income tax return separate from his or her spouse, and who does live abroad, if the total value of his or her foreign financial assets exceeds (1) $200,000 on the last day of the tax year, or (2) $300,000 on any day during the tax year. These amounts double for a married couple filing a joint income tax return (and hence a joint Form 8938).
There are many intricate interpretations to the above rules. One should not attempt to navigate them without the assistance of experienced tax counsel.
FATCA requires the reporting not only of foreign financial assets, but also of the income produced by such assets, and the cross-referencing of the reporting of such income on the taxpayer’s federal income tax return.
Form 8938 reporting is in addition to, and not in lieu of, FBAR reporting.
Failure to timely file Form 8938 is subject to a $10,000 civil penalty. After the first 30 days of the delinquency, there is an additional $10,000 penalty for each additional 30 days of the delinquency up to a total penalty of $50,000.