David S. Howard, CPA

New Streamlined Procedures for Foreign Bank Account Compliance

As of July 2017, the procedures set up by the Internal Revenue Service set up in 2014 are still available including a streamlined program for getting foreign investment and bank accounts into full compliance with US income tax reporting laws.

Generally speaking a US taxpayer may have a US bank or investment account outside of the USA as long as they report their taxable income and disclose the account. Briefly, these are the requirements.

Reporting Taxable Income: First of all, if you are a US Citizen or US Green Card holder, for the rest of your life, no matter where you live you must file a personal income tax return (some low income people are exempt). If you are a US taxpayer for other reasons you also must file. (Form 1040 famously due April 15 of following year.)

Penalties for failure to report the income and pay the tax: Assuming no criminal fraud there is a a 3 year statute of limitations (unless the underpayment is very large and then a 6 year statute may apply). If the IRS catches you then you much pay the taxes, interest plus a negligence penalty, usually 20% added to both the taxes and the interest. – Most of us are familiar with these penalties.

Disclosing Your Interest in Foreign Accounts: In addition to reporting your taxable income you must file a completely separate form disclosing to the US Treasury via the IRS that you either own, have an interest, or have signature authority over a foreign account and these accounts all together come to $10,000 or more. – This is not an income tax form. It is merely a disclosure. (FBAR – Form 114, Foreign Bank Account Report, due June 30 of following year.)

Examples of Some Foreign Accounts that must be disclosed. The account your grandfather set up in Hong Kong in his name and your name together and never told you. The account your great aunt set up in Switzerland in her name payable on death to your children. – Your children must disclose the account. Your Canadian retirement account that built up while you were working there long ago. A life insurance policy issued outside of the USA that has cash value.

Other Disclosures: You must also disclose any gifts you received from non-US taxpayers (over $100,000), the fact you are the creator or beneficiary of a foreign trust, the fact that you may be a part owner of a foreign corporation that is owned 50% or more by 5 or fewer US taxpayers, and other holdings. There are several different forms used to make these disclosures. There are penalties associated with all these disclosures if not made.

Many US tax return preparers only focus on the Form 1040 and really don’t even think about or even know about the disclosure requirements. These are separate forms and are usually not included in the tax return preparation engagement.

Penalties for failure to disclose have nothing to do with failure to pay your income taxes. These are additional penalties. Until the Union Bank of Switzerland scandal that came to light in 2008 the IRS did not much focus on imposing the penalties that were on the book. But their first impression was that there was mass fraud and they started imposing massive penalties.

Summary of NEW Disclosure Program and Penalties as of July 1, 2014. After smashing mosquitos with sledge hammers for the last six years the IRS has come up with a program that matches the penalty more closely to the gravity of the failure to disclose. They have also come up with much easier procedures for people voluntarily get all their accounts property tuned up with US tax reporting and disclosure laws.

Let me put the alternatives now availabe into tiers. I hope this makes it easier to see where you or “your friend” might fit into the new program.

Tier One – Criminals, Drug Dealers, Terrorists, Money Launderers, Intentional Defrauders: Huge penalties and jail time. This with willful intent to commit tax fraud in addition to the criminal activities that was the source of the funds.
Tier Two – Individuals with large accounts in secret accounts where the US Department of Justice has forced the bank to disclose the account information. Assuming the source of the funds is from non-criminal activities. These folks may have to pay a penalty of 50% of their account balance for each of the years not disclosed over the last six years plus all income taxes plus interest plus penalties. Criminal tax fraud sanctions may be imposed. If the failure to disclose was for non-willful reasons the large penalties may be waived and only a $10,000 per year penalty imposed. In the case of reasonable cause for failure to file the penalty may be waived completely.
Tier Three – If the account is not yet known to the IRS and the taxpayer is not yet under audit there is the 2012 voluntary compliance program where the taxpayer agrees to pay a penalty of 27.5% of the highest balance in the account over the six year period plus file tax returns for all years open under the statute of limitations, pay all taxes, interest and penalties. This procedure requires much documentation and full disclosure of all foreign activities. It usually triggers and IRS audit. This is a good program for folks who would be considered willful non-filers including criminal tax fraud. – If you are a step ahead of being in Tier Two this might be the best place for you as soon as possible.
Tier Four – This is the new streamlined program just announced. If the US taxpayer is not under audit and is not yet known to the IRS as a possible Tier One or Tier Two taxpayer. The failure to disclose needs to have been non-willful which includes negligent, confusion, lack of knowledge and bad advice from a US tax professional who has been told all the facts. If you can fit into this category you will have to file 6 years of late disclosure forms and also report the income tax for all tax years still open under the statute of limitations. And here will be the penalties:

If you are not now resident in the USA all failure to disclose penalties will be waived. You will still owe the income taxes plus interest but there will be no 20% negligence penalty imposed.
If you currently reside in the USA the total failure to disclose penalty will be limited to 5% of the highest balance of your accounts. You will still owe income taxes and interest but the negligence penalty will not be imposed.
Tier Five – If the US taxpayer failed to disclose but did not underreport US income taxes there is a procedure for filing all late foreign disclosure forms without penalties at all.

Now is the time to take action. You must be proactive. If you wait too long you may wind up in Tier Two. I have handled many cases in this area and I have found that if the taxpayer will be completely honest and fully report and pay the income taxes and fully disclose all foreign accounts that IRS is patient and cooperative. If the taxpayer chooses to be evasive or appears to disingenuous the cases do not go so well. The new Tier Four opportunity is a good time for people who are basically honest but have been confused or afraid to step up.

The following applies to US persons with undisclosed foreign bank accounts. You were required to report any bank or brokerage account(s) outside of the US with more than $10,000. This is the combined balance of all your foreign accounts. For example, if you had $6,000 in an account in France and $6,000 in an account in Switzerland, your combined balance was $12,000 and you had a filing obligation. This filing requirement is based on the highest balance in the foreign account for any one day of the year. It’s not your average balance during the year or year-end balance. That is to say, you are required to report any offshore account in your name or under your control. Having a nominee on the account doesn’t eliminate the filing requirement because you still maintain control. The focus of the IRS Offshore Voluntary Disclosure Program has been offshore bank accounts. There are many other filing deficiencies can be cured through the OVDP. For example, you should be filing Form 5471 if you hold shares in an offshore company. Then there’s Forms 3520 and 3520-A for foreign trust and Form 8938, Statement of Foreign Financial Assets. Bottom line, if you had an interest in a foreign bank account or structure, you probably had a US filing requirement and should consider the IRS OVDP. IRS Offshore Voluntary Disclosure Program for 2017 Settlement Terms Those who are coming forward after their foreign bank entered into an agreement with the IRS, or who’se financial advisor made a deal to turn over their client list, will need to go with the more expensive traditional program. Likewise, those with no valid cause for the account, or who took steps to hide the account from the IRS, should go with the traditional program. Traditional Offshore Voluntary Disclosure Program The penalties under the traditional OVDP are as follows: A 20-percent accuracy-related penalty on the tax due with the filing of your amended returns for all years. If no tax is due with the filing, then no accuracy penalty will apply; Pay failure-to-file and failure-to-pay penalties, if applicable; and Pay, in lieu of all other penalties 27.5% of the highest aggregate value of your foreign assets during the period covered by the voluntary disclosure. If your bank is under investigation, a 50% penalty might apply rather than the 27.5% above. Remember that the purpose of the program is to convince Americans to come forward voluntarily. If the IRS believes they’d have caught you eventually without the disclosure, they’re going to hit you hard. The 27.5% penalty applies to all foreign assets which you failed to disclose. If all you had offshore was a bank account, the penalty is based on the highest value of the account during the OVDI period. In my example above, a client had an offshore bank account that held $200,000 for only one day. In that case, the standard OVDI penalty is 27.5% of $200,000, or $55,000. If you have other reportable assets, such as foreign real estate, an offshore trust, and a brokerage account, the penalty can apply to the highest value of these assets combined plus the highest value of your offshore bank account. The OVDP penalty is often assessed on the highest value from a few years back because that’s when you were making money offshore. Since that high-water mark, the brokerage account may lost money, the bank accounts depleted, and the real estate has gone to foreclosure… I even had a client that had all his money stolen by an offshore scammer. None of these losses matter. The penalty is on the highest value and later losses are disregarded. See FAQ 8 and 31 through 41 on the IRS website for more details on how to calculate the standard penalty. Streamlined Offshore Voluntary Disclosure Program The streamlined filing compliance program is available to those who can certify that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. You must state, and should be able to prove, that you didn’t intend to use the offshore account to avoid paying your taxes. That is to say, you must state under penalty of perjury that your conduct was not willful. That the failure to report all income, pay all tax and submit all required information returns, including FBARs was due to non-willful conduct. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. The risk with the streamlined program is that the IRS doesn’t buy your claim of non-willfulness. If they have evidence that you intended to hide money from the Service, or that you lied on the streamlined application, they will come after you with guns blazing. The reduced penalties under the streamlined OVDP are as follows: For US persons living in the United States: File original or amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) for the last years properly reporting your offshore accounts, assets, and income, File original or amended FBARs for the last 6 years, and Pay the tax, interest, and a miscellaneous 5% penalty with the filing of your OVIP. The streamlined penalty for US residents is equal to 5% of the highest aggregate balance/value of your reportable foreign financial assets. For this purpose, the highest aggregate balance/value is the highest year-end balance… which might not be the highest balance for the year. In our example above, you had $200,000 in an offshore account for one day. Assuming that wasn’t December 31, you’re streamlined penalty won’t include that deposit. A foreign financial asset is any asset that should have been reported on the FBAR (FinCEN Form 114) or Form 8938. The most common examples of foreign financial assets include: Bank and brokerage accounts held at foreign financial institutions; Bank and brokerage accounts held at a foreign branch of a U.S. financial institution; foreign stock or securities not held in a financial account; foreign mutual funds; and foreign hedge funds and foreign private equity funds. Note that the streamlined OVDP penalty applies to foreign financial assets while the traditional OVDP applies to all foreign assets. If you’re eligible for the Streamlined Domestic Offshore Voluntary Disclosure Program, you can avoid accuracy-related penalties, information return penalties, and FBAR penalties. In most cases, the 5% miscellaneous penalty will be the only penalty assessed. For US persons living abroad: If both you and your spouse are non-residents for US tax purposes, you might be eligible for the zero penalty version of the streamlined program. If you’re living abroad, and otherwise qualify for the Streamlined Foreign Offshore Voluntary Disclosure Program, the IRS will allow you to file or amend your returns without the 5% penalty. Keep in mind that your failure to file or pay taxes must have been non-willful. This criteria is the same for both domestic and foreign filers. You’re a US citizen “living abroad” for the streamlined OVDP if you were out of the United States for 330 days for one of the last three tax years. If you’re OVDP filing covers tax years 2014, 2015 and 2016 (it is now 2017), then you must have been out of the country for 330 days during one of those years. If you qualify for the foreign streamlined OVDP, you must submit your last 3 years of returns, 6 years of FBARs, and pay any tax and interest at the time of filing. The purpose of the foreign streamlined program is to allow American’s living abroad to get back into the system without a penalty. The IRS has determined that, on balance, US persons who are out of the US for 330 days, and thus have few ties to this country, are the most innocent when it comes to their failure to file and pay taxes. And, when you take the Foreign Earned Income Exclusion and the Foreign Tax Credit into account, most American’s living abroad pay little or no US taxes on their income. In that case, you will pay little to nothing with your foreign streamlined OVDP. A US citizen who is a resident of a foreign country, or is out of the US for 330 days during any 365 day period, qualifies for the Foreign Earned Income Exclusion. The FEIE allows you to earn about $100,000 in salary or business income free of Federal income taxes. For more on the FEIE, see: Foreign Earned Income Exclusion for 2017 You also get to deduct any foreign taxes paid on your US returns, even when those returns are filed as part of an OVDP. You essentially get a dollar for dollar credit against any taxes paid on your US return. So, if you’re living in a country with a tax rate equal to or higher than the United States, you shouldn’t owe any US tax on your foreign income. In that case, you’ll pay nothing with your foreign streamlined OVDP. If you’re living in a zero or no tax country, or aren’t required to pay local tax to your country of residence, then you’ll pay some US tax with your OVDP. If your salary exceeded the FEIE, you will owe US tax on the excess. If you have capital gains, they’ll will be taxable when you file or amend your US returns.

IRS Circular 230 Disclosure. IRS regulations generally provide that, for the purpose of avoiding federal tax penalties, a taxpayer may rely only on formal written advice meeting specific requirements. Any tax advice in this message (including any attachments) does not meet those requirements and is not intended or written to be used, and cannot be used, for the purpose of avoiding federal tax penalties or promoting, marketing or recommending to another party any transaction or matter addressed herein.