Options for US taxpayers with undisclosed foreign financial assets
INSIGHT ARTICLE |
The IRS recently modified its offshore voluntary disclosure program and released new alternatives for U.S. taxpayers with undisclosed foreign financial assets to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution, where applicable. Outside of these alternatives, the civil penalties may be so onerous as to exceed the balance or value of the foreign financial assets, and the statute of limitations may remain open indefinitely for failure to file required international information returns. Under any of the programs offered by the IRS, the penalties are capped and non-compliant taxpayers may calculate, with a reasonable degree of certainty, the total cost of resolving their offshore tax issues.
U.S. taxpayers with non-U.S. investments, dual citizens, and/or U.S. citizens living abroad are often unaware of the full scope of their U.S. tax filing and information reporting obligations. As part of a comprehensive U.S. anti-evasion global reporting regime designed to locate foreign income and assets held by U.S. taxpayers and ensure that they are reported, the IRS and the Department of Justice have launched a series of initiatives to raise awareness and ensure compliance by those parties with U.S. tax obligations, including:
- Enhanced Foreign Bank Account Reporting (FBAR) enforcement
- Prosecution of tax evaders and facilitators
- Enhanced information exchange with non-U.S. governments
- Foreign Account Tax Compliance Act (FATCA) requirements
- Required reporting of specified foreign financial assets (Form 8938)
These initiatives are aimed at preventing tax evasion, money laundering and terrorist financing, but the reporting obligations they impose apply much more broadly. As a result, U.S. taxpayers have been left to deal with a complex and often confusing set of compliance requirements. U.S. taxpayers holding foreign financial assets such as foreign bank accounts, brokerage accounts, mutual funds, life insurance policies with cash surrender value, and foreign IRAs or foreign pension plans (e.g., Canadian Registered Retirement Savings Plans and Australian Superannuation Funds) may be subject to an array of U.S. tax filing and information reporting obligations. Compliance requirements may include FBAR and specified foreign financial asset reporting (Form 8938), foreign trust filings and reporting, and passive foreign investment company (PFIC) investment filings and reporting, among others. Further, notwithstanding that a foreign retirement plan may be very similar in design and operation to a corresponding U.S. plan, there is no deferral of U.S. tax on income earned through foreign retirement accounts unless the accounts meet all the specific requirements of “qualified” pension plans under U.S. law. This is a problem for Australian Superannuation Funds, for example. Moreover, even if a foreign plan may be treated as U.S. “qualified” pursuant to a relevant U.S. tax treaty, the filing of certain international information returns may still be required (e.g., Form 3520, Form 8938, etc).
In recognition that many U.S. taxpayers have failed to identify and comply with their tax filing and information reporting obligations with respect to their foreign financial assets or non-U.S. investments, the IRS recently modified its offshore voluntary disclosure program and released new alternatives for taxpayers to come into compliance with the law. Eligibility and applicable penalties vary depending on whether income from foreign assets has been reported on income tax returns, whether non-reporting of income and/or non-filing of information returns was willful, and whether the IRS has already identified or would have inevitably identified the undisclosed foreign financial assets. Key factors include whether the foreign financial institution is already under investigation by the IRS or the Department of Justice in connection with the undisclosed foreign accounts, whether the institution is already cooperating with the IRS or the Department of Justice, and whether the institution has already been identified in a court-approved “John Doe” summons. Applicable penalties under the different options range from zero to 50 percent of the highest aggregate balance/value of the unreported foreign financial assets plus any tax due, interest and accuracy-related (or delinquency) penalties. Currently, the IRS offers taxpayers the following options:
- Offshore Voluntary Disclosure Program
- Streamlined Filing Compliance Procedures
- Delinquent FBAR submission procedures
- Delinquent international information return submission procedures
Taxpayers with undisclosed foreign accounts or non-U.S. investments should consider making a voluntary disclosure under one of the foregoing programs in order to become compliant, avoid substantial civil penalties, and generally eliminate the risk of criminal prosecution, where applicable. The civil penalties may be so onerous as to exceed the balance or value of the foreign financial assets when the non-compliance persisted for multiple years. In addition, the statute of limitations may remain open on your income tax return indefinitely in some situations where required international information returns are not filed. Voluntarily participating in one of the programs offered by the IRS also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Under any of these programs, the staggering penalties the IRS can assess are capped. Some of the options also provide unique opportunities to make retroactive tax elections, such as to defer U.S. tax on contributions to and income earned in a Canadian Registered Retirement Savings Plan.
The IRS does not treat people whom they catch as favorably as those who come forward under the IRS voluntary programs. “Reasonable cause” explanations are no longer taken into consideration, and “quiet” disclosures are not effective when it comes to assessing penalties related to undisclosed foreign financial assets.
Because every compliance plan involves both tax and non-tax considerations, it is important to develop a practical solution through consultation with a qualified advisor.