The world of US tax surrounding foreign income and asset reporting is extremely complex. Unfortunately, many domestic CPAs and those taxpayers who take a “do it yourself” attitude fail to properly report their foreign income and assets to the Internal Revenue Services (IRS) at tax time. This, in turn, can leave individuals and businesses alike exposed to potential penalties and IRS audits, which no one wants to face.
Thankfully, the US government and the IRS recognize the complexity of this system and offer a variety of voluntary disclosure programs for taxpayers to come out and correct their mistakes with minimal penalties and the avoidance of criminal tax prosecution. The team here at Evolution Tax & Legal has helped hundreds of businesses and individuals alike take advantage of these programs to get back into compliance and get back to sleeping properly at night.
Penalties for Failing to Properly Report Foreign Income and Assets
As mentioned above, the accurate reporting of all your international assets and income is extremely difficult to keep up with. You will also find out that many tax advisors do not understand the nuances of this area of law and may not be properly accounting for your foreign investments, assets, and income. So, what happens if you fall out of compliance with the timely reporting of your international assets and income?
Well, unfortunately, nothing good. The US government via the IRS and other enforcement agencies such as the US Attorneys Office is tasked with investigating and pursuing both criminal and civil penalties against those persons who fail to properly report their international activity.
If we are looking at the potential civil consequences of failing to accurately report your foreign assets, the most common penalty that you will see arise are those related to an FBAR filing. Generally, a US person has to file an FBAR to report foreign financial accounts if, in the aggregate, their value exceeds $10,000 at any point during the year. The failure to properly and timely file an FBAR can lead to significant penalties. For starters, a $10,000 penalty can be imposed against individuals for improper reporting or failure to file an FBAR due to “non-willful” conduct (i.e. mistaken non or inaccurate reporting). Furthermore, a penalty equal to the greater of $100,000 or 50% of the account value can be imposed against improper reporting of foreign accounts on an FBAR if it is determined the improper reporting was due to “willful” actions (i.e. there was intent behind the non or inaccurate reporting).
These civil penalties for an FBAR are just the tip to the potential iceberg you can hit for the failure to report your foreign assets and income. See the below list for the rest of the civil penalties related to the improper reporting of assets on other, applicable foreign information returns—
10% of the fair market value of the transferred property at the time of the transfer, but not to exceed $100,000 unless the failure with respect to such transfer was due to intentional disregard
5% of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% of the unpaid tax
$30 to $100 per form, depending on how late the form is filed.
If intentionally disregarded, $250 per form or, if greater, 10% of the total amount of items required to be reported.
3520, Parts I & III
3520 Part II & 3520-A
3520 Part IV
5% per month (25% maximum) of the gift or bequest for each month of failure to report
5471 Category 2 – 5 Filers
$1,000 ($10,000 for C Corp)
Technically no penalty, but IRS may view the associated Form 5471, Form 8865, or tax return, as the case may be, as incomplete (and triggering associated penalties) if Form 8858 is not filled out properly
8865 Category 1, 2 & 4Filers
8865 Category 3 Filers
What we have failed to address to this point are the potential criminal penalties for the failure to accurately and timely report your foreign income and assets to the IRS. Criminal penalties provided under the Internal Revenue Code are in addition to the civil penalties mentioned above. And unlike civil penalties, criminal penalties are no collected through the normal assessment procedures the IRS follows, but are imposed through criminal convictions. Below is a list of crimes that the US government can pursue, along with the related jail time, for the failure to properly report your foreign income and assets.
Attempt to Evade Tax
Up to 5 years imprisonment, and fine up to $100,000 ($500,000 for corporations)
Failure to Collect or Pay Over Tax
Up to 5 years imprisonment, and a fine up to $10,000
Failure to File Return or Pay Tax
Up to 1 year of imprisonment, and a fine up to $25,000 ($100,000 for corporations)
If the failure includes a failure to report cash transactions of $10,000 or more, these terms of imprisonment jumps to 5 years
False Withholding Exemption
Fraud and False Statements
Fraudulent Returns or Other Documents
These are but just a few of the potential crimes and associated penalties you could be subject to if you failed to report your foreign assets and income on your annual tax filings with the US government.
I Failed to Report Foreign Income and Assets – What are my Options?
Voluntary Disclosure Practice
The IRS’s Voluntary Disclosure Practice (VDP) is best suited for those who have potential criminal implications in their disclosure to the IRS. Really, it’s for those people who willfully did not disclose certain income or assets to the IRS.
In this program, an eligible person can disclose either their US domestic or international tax non-compliance in exchange for protection from criminal prosecution. In exchange for protection against criminal prosecution, the person enrolling in the program must go through an audit of at least 6-years of revised tax filings and pay a specified penalty related to their non-reporting.
So, who is an eligible person for the IRS’s VDP? To be eligible, a person must submit an application for disclosure through the IRS’s VDP prior to the time that the IRS—
- Commenced a civil examination or criminal investigation;
- Received information from a third party alerting them of your non-compliance; or
- Acquired information directly related to your non-compliance from a criminal enforcement action.
However, it is important to note that a person cannot take advantage of this program if their income is from illegal activity.
In order to disclose, there is a very specific set of rules and procedures that must be followed to submit your application, submit identifying information about yourself, and thereafter submit your revised tax filings to be audited by the IRS.
If you make it through the audit side of the VDP and final numbers are agreed to, a closing report will be provided to you. This closing report will list the total adjustments made between your original filings and revised filing positions. Additionally, it will list the total tax, penalties, and interest due to the IRS with your submission. Once executed and returned to the IRS, you will be done with your submission and only have to worry about paying the additional tax, penalty, and interest due.
Streamlined Offshore Disclosure Program
A not too far offshoot of the VDP is the IRS’s Streamlined Offshore Disclosure Program (the “Streamline Program”). This program is available and meant for those persons with foreign assets and income that went unreported to the IRS due to non-willful actions. Essentially, if you did not know you were required to report certain foreign income or assets or if your tax advisor did not inform you of such obligations, you qualify for this program. This program only provides limited civil protections against penalties applicable to the non-reporting of certain foreign assets and income.
The Streamline Program only requires the person making the disclosure to report the prior 3 years of income tax filings as well as the prior 6 years of FBARs. Additionally, there is no audit at the end of this program. In fact, the revised or non-filed returns and FBARs are submitted with an official Streamline Program form, this being either Form 14653 or Form 14654. The form you use to submit your Streamline Program disclosure with depends on whether you are a person residing in the US or outside of the US. This distinction also plays a role in who must pay a penalty imposed by the Streamline Program in return for protection against the myriad of civil penalties that could be imposed on the information submitted through the Streamline Program.
Whether or not a person has to pay a penalty in exchange for receiving penalty protection under the Streamline Program depends on where they reside. For those persons residing in the US, the person making the disclosure must pay a “5% Miscellaneous Offshore Penalty”. This penalty is paid in exchange for the Streamline Program’s civil protection against the normal penalties that could be assessed for the failure to disclose certain foreign income and assets. Additionally, a person residing in the US must submit their Streamline Package using Form 14653.
For those residing outside of the US, no “5% Miscellaneous Offshore Penalty” is imposed with their submission. Rather, the eligible person files their 3 years of income tax filings and 6 years of FBARs with Form 14653 with the applicable amount of tax and interest due with no further requirements. They too are afforded the same civil penalty protection as those persons residing in the US and submitting their package with Form 14654.
In addition to submitting 3 years of revised returns, 6 years of FBARs, and either Form 14653 or Form 14654, the person making the disclosure must include a “non-willfulness statement”. This statement in essence requires certain information about the disclosure as well as the facts related to their non-reporting. The IRS will review this statement submitted the Streamline Program disclosure to ensure that your non-disclosure of foreign assets and income is from non-willful conduct that is eligible for the program.
Delinquent International Information Return Submission Procedures
The next step down from a disclosure via the Streamline Program is the IRS’s Delinquent International Information Return Submission Procedure. This program allows those persons who have international form filing requirements to file them delinquently, without penalty, as long as they reported and paid tax on all income associated with the forms they should include as part of their return.
The IRS lays out very formal requirements to be eligible for this program—
- You must not have file one or more required international information returns;
- You must have “reasonable cause” for not timely filing the information returns;
- You must not be under criminal examination or criminal investigation by the IRS, and
- You must not have already been contacted by the IRS about the delinquent information returns.
So long as all four requirements are met, the delinquent international information return (i.e. IRS form) can be submitted through this program without any late penalties or interest assessed.
In addition to submitting the late IRS form, a “reasonable cause” statement must be prepared and filed with the delinquent IRS form. “Reasonable cause” is a legal term that is defined by years and years of case law. In order to determine that your non-filing was due to “reasonable cause”, please contact a tax advisor or someone on our team to help you make this assessment. If such a statement is not attached to each delinquent IRS form, penalties may be assessed in accordance with the existing IRS procedures.
Delinquent FBAR Submission Procedures
Very similarly structured to the Delinquent International Information Return Procedures are the Delinquent FBAR Submission Procedures. Under this program, a person who has reported and paid tax on all foreign income may use this program to submit delinquent FBARs without penalty, so long as they meet the program’s eligibility requirements. In order to be eligible for this program, a person must—
- Have failed to timely submit an FBAR to the US Treasury;
- Not be under a civil examination or a criminal investigation by the IRS; and
- Not have been contacted by the IRS about the delinquent FBARs.
In addition to submitting the delinquent FBAR, a statement explaining why the FBARs are being late must be included as part of the filing. It is best to explain this late filing in terms of “reasonable cause”, similar to that of the previous program discussed. Once again, “reasonable cause” behind the failure to timely submit an FBAR has its own definition defined by years of case law. In order to properly draft this statement, a tax advisor should be contacted.
If properly submitted through this program, no civil penalties for the failure to timely file the FBAR will be imposed so long as all the income from the foreign financial accounts reported on said FBAR is correctly reported and paid tax on.
The final disclosure option is informally known as a “quiet disclosure”. If you do not qualify for one of the potential voluntary disclosure programs mentioned above, your last option is to file amended or delinquent returns through the normal IRS procedures. This type of disclosure of course does not come with any criminal or civil protections. Really, the goal of this option is to slide under the radar of the IRS and hope that your returns are not selected for audit.
Generally, the IRS has a 3-year statute of limitations to assess taxes due on a return from the date of its filing. For substantial underreporting of income on a return, this statute of limitations grows to 6 years. For any returns in which fraud can be proven, there is no statute of limitations. Thus, if you are looking to use this program, your best is to ensure that you do not have a substantial underreporting of income or fraud related to your returns. If you do, you open yourself to an extremely long period in which the RIS can go back and review your returns.
This disclosure method is a last resort and should only be used sparingly.
If you are a person who has failed to properly report their past foreign income or assets, please contact our legal team to have a consultation discussing your options and the best route to move forward. We have helped numerous taxpayers pick the correct program and protect them both criminal, civilly, or both, through the appropriate disclosure program.