IRS has provided details on which domestic taxpayers are eligible for its streamlined offshore account compliance program as well as the specific steps they must take to come into compliance under the program. Under the streamlined program, formally called the Streamlined Domestic Offshore Procedures, eligible taxpayers pay a 5% miscellaneous offshore penalty and are relieved of otherwise applicable penalties.
Background on reporting responsibilities, etc. for offshore accounts. U.S. citizens, resident aliens and certain nonresident aliens are required to report worldwide income from all sources, including foreign accounts, and pay taxes on income from those accounts at their individual rates.
In most cases, taxpayers with offshore accounts need to fill out and attach Schedule B to their tax returns. Part III of Schedule B asks about the existence of foreign accounts and usually requires U.S. citizens to report the country in which each account is located. Certain taxpayers may also have to fill out and attach to their return Form 8938, Statement of Foreign Financial Assets, if the aggregate value of those assets exceeds certain thresholds that vary depending on filing status and whether the taxpayer lives abroad. Additional filing requirements apply to those with foreign trusts. Certain taxpayers with foreign accounts whose aggregate value exceeds $10,000 at any time during the year must also file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR), with the Treasury Department.
Failure to report the existence of offshore accounts or pay taxes on these accounts can lead to civil and criminal penalties.
In 2009, IRS announced an Offshore Voluntary Disclosure Program (OVDP) for those who voluntarily and timely disclosed unreported offshore income for 2003 through 2008. A second OVDP in 2011 allowed taxpayers with undisclosed income from hidden offshore accounts for 2003 through 2010 the chance to get current with their taxes. In 2012, IRS announced a new OVDP that was similar to the 2011 OVDP, but had no set deadline for using the program. IRS also provided streamlined filing compliance procedures for certain “low risk” nonresident U.S. taxpayers who were subject to different degrees of review based on the amount of the tax due and the taxpayer’s response to a “risk” questionnaire.
Streamlined procedures expanded. In June of this year, IRS issued IR 2014-73, which made key expansions in the streamlined procedures to accommodate a wider group of U.S. taxpayers who have unreported foreign financial accounts.
The expanded streamlined procedures became available to a wider population of U.S. taxpayers living outside the country and, for the first time, to certain U.S. taxpayers residing in the U.S. The changes include:
… eliminating a requirement that the taxpayer have $1,500 or less of unpaid tax per year;
… eliminating the required risk questionnaire; and
… requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct.
For eligible U.S. taxpayers residing outside the U.S., IR 2014-73 provided that all penalties are waived. For eligible U.S. taxpayers residing in the U.S., IR 2014-73 provided that the only penalty is a miscellaneous offshore penalty equal to 5% of the foreign financial assets that gave rise to the tax compliance issue.
Details on streamlined program for domestic taxpayers. In a series of documents posted on its website, IRS has now provided details on which U.S. taxpayers residing in the U.S. are eligible for the streamlined program—formally called the Streamlined Domestic Offshore Procedures—as well as the specific steps they must take to come into compliance under the new program.
Who qualifies. To use the Streamlined Domestic Offshore Procedures, individual U.S. taxpayers residing in the U.S. (or their estates) must:
(1) Fail to meet the applicable non-residency requirement for U.S. taxpayers residing outside the U.S. who wish to use the streamlined procedures. (In general, an individual U.S. citizen or lawful permanent resident, or estate of a U.S. citizen or lawful permanent resident, meets the applicable non-residency requirement if, in any 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, the individual did not have a U.S. abode and the individual was physically outside the U.S. for at least 330 full days.)
(2) Have previously filed a U.S. tax return (if required) for each of the most recent three years for which the U.S. tax return due date (or properly-applied-for extended due date) has passed.
(3) Have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law. Such taxpayers may have failed to file an FBAR and/or one or more international information returns (e.g., Forms 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations, 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, 8938, Statement of Foreign Financial Assets, 926, Return by a U.S. Transferor of Property to a Foreign Corporation and 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund) with respect to the foreign financial asset.
(4) Have committed the failures in (3), above, as a result of non-willful conduct.
IRS says 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.
If IRS has initiated a civil examination of a taxpayer’s returns for any tax year, regardless of whether the examination relates to undisclosed foreign financial assets, the taxpayer will not be eligible to use the streamlined procedures. Similarly, a taxpayer under criminal investigation by IRS Criminal Investigation is also ineligible to use the streamlined procedures.
Taxpayers eligible to use the streamlined procedures who have previously filed delinquent or amended returns must pay previous penalty assessments. Those eligible to use the streamlined procedures who have previously filed delinquent or amended returns in a attempt to address U.S. tax and information reporting obligations with respect to foreign financial assets (so-called “quiet disclosures” made outside of the OVDP or its predecessor programs) may still use the streamlined procedures. However, any penalty assessments previously made with respect to those filing will not be abated.
Coming into compliance under the new program. In general, U.S. taxpayers who want to come into compliance under the new Streamlined Domestic Offshore Procedures must:
(A) For each of the most recent three years for which the U.S. tax return due date (or properly-applied-for extended due date) has passed (the “covered tax return period”), file amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621);
(B) For each of the most recent six years for which the FBAR due date has passed (the “covered FBAR period”), file any delinquent FBARs; and
(C) Pay a Title 26 miscellaneous offshore penalty equal to 5% of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. The highest aggregate balance/value is determined by aggregating the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance/value from among those years.
The full amount of the tax, interest, and miscellaneous offshore penalty due in connection with the above filings should be remitted with the amended tax returns.
A foreign financial asset is subject to the 5% miscellaneous offshore penalty in a given year in the covered FBAR period if (a) the asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year; (b) the asset should have been, but was not, reported on a Form 8938 for that year; or (c) the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year. Foreign financial assets include: financial accounts held at foreign financial institutions or held at a foreign branch of a U.S. financial institution; foreign stock or securities not held in a financial account; foreign mutual funds; and foreign hedge funds and foreign private equity funds.
Other penalties won’t apply. Taxpayers eligible to use the Streamlined Domestic Offshore Procedures and who comply with all of the instructions will be subject only to the Title 26 miscellaneous offshore penalty and won’t be subject to accuracy-related penalties, information return penalties, or FBAR penalties.
Even if returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original return was fraudulent and/or that the FBAR violation was willful.
Any previously assessed penalties with respect to those years, however, will not be abated. Further, as with any U.S. tax return filed in the normal course, if IRS determines an additional tax deficiency for a return submitted under these procedures, it may assert applicable additions to tax and penalties relating to that additional deficiency.
The newly released guidance—which includes expanded FAQs—on the Streamlined Domestic Offshore Procedures provides specific filing guidance as well as details on how to compute the 5% penalty. For example:
… For 100% owners of incorporated businesses with various assets, including financial accounts, the 5% penalty base includes the stock in the corporation (and not the underlying financial accounts) unless it is a disregarded entity for federal income tax purposes. If it is, the rules require the reporting of the underlying foreign financial accounts, which would then be included in the penalty base. The same principle would apply to assets that are held in a foreign partnership or trust.
… Stock in a foreign corporation that is included in the 5% penalty base may be valued by any reasonable method, such as using the balance sheet on the Form 5471. But no valuation discounts may be taken on foreign financial assets subject to the 5% penalty.
… Any asset (tax compliant or non-compliant) that was not the kind of asset reportable on either FBAR or Form 8938 is not included in the penalty base for the Streamlined Domestic Offshore Procedures. Thus, income producing property in a foreign jurisdiction isn’t included in the base (such property isn’t reportable on FBAR or Form 8938).
Other guidance. IRS also issued detailed information on which U.S. taxpayers residing outside the U.S. are eligible for the Streamlined Domestic Offshore Procedures, and how they come into compliance under the streamlined process. It also issued guidance and a new FAQ on delinquent international information return submission procedures.