So, another question that we frequently get asked at Crepeau Mourges is: What are some of the tax responsibilities that I have with respect to my offshore assets, income, and accounts?
Well, that’s kind of a loaded question because there are many, many different compliance aspects related to these areas. As the world grows, more taxpayers are becoming subject to these compliance efforts, as well as the IRS continues to ramp up information reporting that’s required and continues to target individuals with offshore assets and income, as they feel that, at least in the past, individuals have used the borders of the United States to avoid tax compliance efforts.
Taxpayers who have anything from a financial perspective outside of the United States should be mindful and should contact a tax professional about any potential reporting obligations, as there are significant penalties that can be associated with any such failures, and the IRS can be expected to aggressively enforce any of these penalties associated with failures to report income and to provide information.
So, as a little bit of background, taxpayers that are U.S. persons are required to report their worldwide income. This is a common misconception. It’s not that a citizen of the United States can just open a bank account abroad that generates interest income or can invest in another asset that generates, for example, rental income, and say, “Well, it’s outside of the United States, so I don’t have to report that to Uncle Sam.” That’s not true, and that is a common misconception that can lead to significant penalties.
Taxpayers, again, must report worldwide income, and the failure to do so can result in significant penalties. Aside from the requirements to report worldwide income and the attendant accuracy-related penalties and information penalties that arise from it, it can also lead to potential criminal problems. It can have an impact on the statute of limitations, which means that if you’re subject to an audit for another issue and you failed to report foreign income or offshore income, the audit could be expanded. If there’s other years, it could lead to other adjustments from foreign income items as well as domestic income items.
So, you need to be mindful that this needs to be reported on your tax return, and you should probably, if you have any of this income, at least at the outset, consult with a tax professional to make sure that you are crossing your T’s and dotting your I’s.
In addition to some of the common misconceptions, there has been an incredible amount of additional legislation in the last decade or so, as well as enforcement involving perceived information gaps and enforcement gaps related to offshore income. People may have heard a bunch of acronyms related to offshore income, such as FATCA, FBARs, things like that. Well, those are serious things, and if you hear them or if someone implies that you might be subject to those requirements, you should consult a tax professional.
Well, what is FATCA? FATCA is the Foreign Account Tax Compliance Act. It’s basically a ramped-up version of information reporting with respect to taxpayers and their offshore holdings. It targets tax accounts or taxable accounts abroad, but it also affects information reports from banks, things like that.
In addition, one of the acronyms that I just discussed, and a potentially sore subject for many individuals with offshore items, is the FBAR. Now, what is that? FBAR is an acronym for basically a Foreign Bank Account Report. It doesn’t come with any tax requirement; it doesn’t come under Title 26, which is the Internal Revenue Code; it’s actually under Title 31. But it should be viewed within the same lens.
The Foreign Bank Account Report requires anyone that has foreign financial accounts that aggregated in value to more than $10,000 at any point in a year—it requires those individuals, if they owned it or if they had signatory authority over that account, to report it to FinCEN, which is a branch of the Treasury Department.
If you fail to report or file that FBAR and therefore report a foreign financial account, the penalties are astronomical. Even for non-willful failures to file, which are basically unintentional in nature, the penalties run up to $10,000 per account per year. Even worse, if you willfully fail to file such a report, the penalties can run up to 50% of the account balance per year.
What that means: If you had three accounts that were each worth a million dollars, and you failed to file that FBAR, and the IRS determined that the failure was willful, you could be hit with a $1.5 million penalty per year for every year within the statute of limitations. The penalty could potentially exceed the value within the account. So this is a serious issue that needs to be addressed by taxpayers, particularly those with non-compliance.
The standard for willfulness is evolving and is increasingly less taxpayer-friendly. So if you have any foreign financial account with any potential implication to file an FBAR, you should definitely talk to a tax advisor.
Aside from that information report, there’s a whole slew of other reports that either existed and are now being enforced more readily or are new forms altogether over the last decade. The numbers of these forms include:
- Form 8938
- Form 5471
- Form 8865
- Form 8621
- Form 3520
These are just a bunch of numbers, but basically, what those reports do is any type of foreign financial asset, regardless of how it is held, needs to be reported on some form to the IRS on an annual basis.
Form 8938—that’s attached to your individual income tax return. Penalties can run at $10,000 or more per failure to file. It can again carry other penalties; it can cause the statute of limitations to be kept open, which can again make your audit even worse for you, amongst other things.
The Form 5471, the Form 8865, the Form 8621—those are all forms that relate to foreign entities that individuals either own, control, or have some relationship with. Aside from significant monetary penalties, those are also used by the IRS frequently in connection with extending the statute of limitations, which again makes the audit worse, or in terms of proving that an individual who failed to report other items of income on the return has done so willfully.
So again, if you have any type of foreign entity—regardless of whether it even generates income—it’s probably going to be subject to an information report that can carry harsh, harsh penalties from both a civil financial perspective but also potentially from a criminal perspective.
The last form that I’ve actually seen cropping up and causing issues for taxpayers a lot more frequently as of late is the Form 3520. And what this form is—it’s a report that, again, there’s no tax associated with it, but it’s used by the IRS to identify and report certain transactions with foreign trusts and also to report certain large foreign gifts.
So even though a taxpayer wouldn’t have any gift tax liability on receipt of a gift from, say, their parent who lives in China or who lives in the UK, by virtue of just receiving that gift—even though there’s no tax liability—it may trigger an information reporting penalty. And the failure to report that receipt of that gift through a Form 3520, which is filed independent of the income tax return, can result in penalties based on the value of the gift, which can be significant and can be assessed automatically by the IRS if the form is filed delinquently.
So, in general, just know any time that you are transacting with a person or an entity abroad, or you have a financial holding abroad, you should be at least thinking that there is a potential information return that needs to be filed, and the failure to do so can cause you to experience significant troubles with the IRS.
That’s a lot of talk about, you know, what are some of the returns that need to be filed, what’s the income that I need to be reporting to the IRS. But even more often than I get clients who come in who say, “I need to address this going forward,” I get a lot of clients who say, “I’ve just spotted this issue. I’ve had, you know, this foreign entity or this foreign account for five years, and I’ve read this stuff in the news about the significant penalties. What do I do?”
Well, in that situation, more than even current compliance, that’s where a tax attorney versus a tax accountant can provide additional assistance. Again, there are significant civil and potentially criminal penalties for failure to report income and to report these assets. But on the other hand, there are different compliance options that can resolve these matters on a fair basis to taxpayers.
Taxpayers may have heard of the Offshore Voluntary Disclosure Initiative or the Offshore Voluntary Disclosure Program. Unfortunately, those are now closed. But what remains with the IRS is the Voluntary Disclosure Practice, and that’s a good avenue for certain individuals who have potential criminal exposure for failure to report these items.
Basically, what that option does is it says if you come forward, you will be subject to a full-blown audit, but you have the assurance of the IRS that it will not refer you for prosecution by the Department of Justice. For a discrete set of taxpayers, that is a very good option if there’s criminal exposure.
But what we frequently see more often is those that have not done this intentionally but just discovered after the fact that they didn’t do it right, and they want to come right with the IRS and just hear about all these astronomical penalties and don’t want to be bankrupted by doing so.
So for those, we typically will discuss the Streamlined Filing Compliance Procedures, the Delinquent International Information Return Submission Procedures, and the Delinquent FBAR Submission Procedures. Basically, what these options do is they provide an avenue for taxpayers who did not act intentionally to say affirmatively to the IRS, “I’m trying to come forward and resolve this issue. Here’s the information. I didn’t do so willfully. I have reasonable cause. I meet other eligibility criteria.” And these programs or procedures have developed a way for taxpayers to do so on a reasonably fair basis.
Now, even though I’ve just mentioned these options generally, it is imperative that those—even those that are non-willful—engage a tax professional if you’re trying to resolve your compliance issues through one of these options, because there are specific eligibility criteria, and failure to meet the eligibility criteria or failure to properly present the case through these procedures can result in substantial penalties and can basically end up in a taxpayer being worse off than if they had—maybe not worse off than if they had done nothing—but can basically put them back in the pile with the people who are perceived to be intentional offenders.
Now, there’s other options besides these cookie-cutter options, but to the extent that individuals want to address these prior tax or information reporting issues through those, it’s even more imperative to consult with a tax advisor because, as with those options, any compliance resolution is highly based on facts and circumstances, and you need an experienced advisor to be able to guide you through that process.
So, in conclusion, offshore issues are only going to increase going forward. They’re going to continue to be a hot-button issue for the IRS. The IRS is going to continue to ramp up enforcement. Legislatively, there’s likely to be more information reporting required, and there’s going to be more pressure on the IRS to increase enforcement.
Taxpayers have options but should try to address these issues without causing non-compliance in the first place. But if there is any non-compliance, they should seek out a tax professional to make sure that they’re doing so in such a way to minimize exposure to both civil and criminal liability.
If you have any further questions about this issue, at Crepeau Mourges, we handle these issues very frequently, and we would be happy to help you. Thank you.
