Avoiding IRS penalties: Substantial compliance with foreign returns
Recently released IRS international audit guidance, IGA/C/17_03_01-2, helps define the meaning of “substantially complete” as it relates to international information return penalties. Years ago it was not unheard-of for taxpayers to file their international information returns with the entity’s name, maybe a foreign tax ID number, and “financials available upon request.” To be clear, this approach does not work today, and probably didn’t really work at any point.
IRS efforts over the past 20 years have made it clear that they mean business when it comes to international information return compliance. Prior to 1997, the penalty for failure to file Form 5471 was only $1,000. Today taxpayers failing to timely file their Form 5471 face an automatically assessed $10,000 penalty and the statute of limitations remains open for the entire return. So, taxpayers today have a big incentive (stick not carrot) to get their foreign information returns filed. But what is required to be in that filing?
Foreign entity financial information is not always perfect, and errors are not always found in time to meet U.S. reporting deadlines. For certain international information returns, filers must “substantially complete” the forms in order to avoid penalties. But what qualifies as substantial compliance has long been a grey area as no court has provided a usable definition.
The recent IRS guidance provides a clearer picture of what the IRS considers to be substantial compliance. For example, the failure to convert information into U.S. GAAP and multiple small offsetting errors were both sufficient enough for the IRS to find that a taxpayer failed to substantially comply with their filing obligation.
Taxpayers with current and historic foreign information return filing obligations should speak to their tax advisors in order to evaluate how this recent guidance may impact their open return years and penalty exposure.
For additional analysis of this guidance, please see: IRS provides audit guidance on certain international return penalties.