If you’ve read installments 101 – 107 of our series on US international taxation for individuals, you know that 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 timely reporting of your international assets and income?
We 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. If you go back and read Series 104: How to Report your Foreign Assets [insert link to article here] you will see that an 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 and FBAR can lead to significant penalties. For starters, a $10,000 penalty can be imposed against individuals for the 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—
|926||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|
|1042||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|
|1042-S||$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.|
|1116||5% per month (maximum 25%) of the tax deficiency attributable to a foreign tax redetermination|
|3520, Parts I & III||Greater of $10,000 or 35% of gross reportable amount|
|3520 Part II & 3520-A||Greater of $10,000 or 5% of gross reportable amount|
|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||$10,000|
|8833||$1,000 ($10,000 for C Corp)|
|8858||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||$10,000|
|8865 Category 3 Filers||10% of FMV of contribution|
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 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, this terms of imprisonment jumps to 5 years|
|False Withholding Exemption||Up to 1 year of imprisonment or a fine up to $1,000, or both|
|Fraud and False Statements||Up to 3 years of imprisonment or a fine up to $100,000, or both|
|Fraudulent Returns or Other Documents||Up to 1 year of imprisonment or a fine up to $10,000, or both|
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.
So, how do you protect yourself if you find yourself in a situation where you failed to disclose foreign assets and income? Well, fortunately the US government and the IRS have provided several options for people to come back into compliance with US tax law. These options are informally known as “disclosure programs” and are described below. Each program has its own qualifications for eligibility and provides varying levels of protection, starting with basic civil penalty protection to total protection against any potential criminal penalties for a person’s failure to properly report their foreign income and assets.
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 form 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. For example, a person who purposefully decides to not report certain foreign bank accounts, while willfully not make such disclosure, generates all of their income from a normal day job where they make widgets. Their disclosure of their illegal actions for not reporting their foreign accounts does not make them ineligible for this program. However, take for an example an illegal arms dealer. A person generating income from an illegal arms business would not be eligible for the IRS”s VDP as the income they are earning, and the related assets not reported, stem from an 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. First, you have to submit certain identifying information to the IRS’s Criminal Investigation (CI) unit disclosing who you are, the types of tax issues you have, and information on bank accounts used as part of your noncompliance. This is called a “pre-clearance” check where the IRS uses the information provided to determine if you are eligible person for disclosure through the VDP. Once accepted, a notice will be provided requiring the same person to thereafter provide more identifying information about their non-disclosure including a narrative providing the facts and details surrounding the non-disclosure. This must be filled out on Form 14457, Part 2 and returned to the IRS within 45-days of receiving notice you pass the IRS’s “pre-clearance” check. The IRS will then review your submission on Part 2 of Form 14457 and determine if you can participate in the VDP. If approved, the IRS will provide you a notice and have your case assigned to an auditor who will work with you to audit and approve your revised tax filings.
If you make it through the audit side of the VDP and final numbers are agreed to n the amount of tax owed to the government, 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.
If you believe you are an ideal candidate for the VDP, please do not try to make it through this program on your own. There are many traps for the unwary that could ultimately still lead you to being prosecuted by the IRS for information provided to them through your submission. It is important tot note that the criminal protection provided by this program is not absolute. In fact, the IRS says right on their website the same thing, such that immunity is not automatically granted but rather that a voluntary disclosure may result in a prosecution not being recommended to an US Attorney.
Streamline Domestic and Foreign Offshore Disclosure Program
A not too far offshoot of the VDP is the IRS’s Streamline 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.
Unlike the IRS’s VDP, it does not protect you against potential criminal prosecution. In fact, if criminal information is disclosed during this program, the IRS is free to recommend your case to their CI unit where the case could be recommended for prosecution. So, if you think you want to disclose unreported income and assets through this program, you must make sure there are no potential crimes you could be prosecuted for.
Also, differently from the VDP, 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 on who must pay a penalty imposed by the Streamline Program in return for protect against the myriad of civil penalties that could 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 person’s 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.
If you believe that you are eligible for this program due to the non-reporting of foreign income or assets, please contact our team to assist you with preparing your disclosure. This is a formal process that requires the advice and guidance of an expert to guide you through. Without that, you could be subjecting yourself to potential criminal liability and prevent your self from making a clean disclosure.
Delinquent International Information Return Submission Procedure
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, s long as they reported and paid tax on all income associated with the forms they should included as part of their return.
For example, let’s say a taxpayer has a Form 8938 reporting requirement because they hold several foreign bank and securities accounts valued over the applicable filing threshold amount [insert link to Form 8938 filing threshold]. However, let’s assume the taxpayer did not know of this reporting requirement and did not include a Form 8938 as part of his return reporting such accounts, but did however report all dividend and interest income as taxable to them on their tax filing with the IRS. Because the taxpayer simply forgot to include Form 8938 but still reported and paid tax on all foreign income associated with their accounts that should have been reported as part of their tax filing, they can file the delinquent Form 893 through these procedures.
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 programs 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, an 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 an “quiet disclosure”. If you do not qualify for one of the potential voluntary disclosure programs mentioned above, you 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 n a return from the date of its filing. For substantial underreporting of income on a return, this statue of limitation 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 your self to an extremely long period in which the RIS can go back and review your returns.
Additionally, if you do have indicia of fraud on your return, and the IRS picks this up, they will likely refer the return to their CI unit. The CI unit from there will review and audit the return, from which they could make a recommendation for criminal prosecution.
Not only do you have large amounts of criminal exposure through this filing technique, you also have large amounts of civil penalty exposure. Through this filing method, the IRS could proverbially “throw the book” at you with their civil penalties.
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 team to have a consultation discussion 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.