Immigration to the United States continues at a strong pace. The people coming over tend to be members of the technical, educated class, from countries like India. We are also seeing many people retiring in the U.S. from countries like the United Kingdom. Most of these individuals have assets in their native country, and they need to comply with U.S. laws concerning foreign income, accounts, and entities.
Penalties for Noncompliance
Substantial civil penalties lie for noncompliance with the U.S. Bank Secrecy Act or Internal Revenue Code. The penalty for failure to file a FinCEN Form 114, Report of Foreign Bank and Financial Accounts, “FBAR,” is $12,459. But if the failure is willful, the penalty is the greater of $124,588 or 50 percent of the aggregate of account balances reportable on the FBAR.
The penalty for failure to timely file a U.S. income tax return is five percent of the amount of tax reportable on the tax return for the first month of the failure, plus an additional five percent for each month thereafter that the failure continues, up to a maximum of 25 percent of the amount of tax required to be reported on the tax return.
The penalty for failure to pay tax reported on a filed U.S. income tax return is five percent of the underpaid tax for the first month of the failure, plus five percent for each month that the failure continues, up to a maximum of 25 percent of the amount of underpaid tax. But if any part of an underpayment of tax is due to fraud, the civil penalty is 75 percent of the part of the underpayment due to fraud.
The penalty for failure to file a Form 8938 is $10,000. But if the IRS mails the taxpayer a notice requesting that the Form 8938 be filed, and the taxpayer fails to file the Form 8938 within 90 days after the IRS mails the notice, then there is an additional $10,000 penalty for each 30 day-period the failure continues after the 90 days, up to a maximum penalty of $50,000.
The penalty for failure to file a Form 5471 is $10,000. But if the IRS mails the taxpayer a notice requesting that the Form 5471 be filed, and the taxpayer fails to file the Form 5471 within 90 days after the IRS mails the notice, then there is an additional $10,000 penalty for each 30 day-period the failure continues after the 90 days, up to a maximum penalty of $50,000.
The penalty for failure to file a Form 3520 is the greater of $10,000 or—
- 35 percent of the gross value of property transferred by the U.S. person to the foreign trust during the tax year;
- 35 percent of the gross value of distributions received by the U.S. person from the foreign trust during the tax year; and
- 5 percent of the gross value of the foreign trust’s assets treated as owned by the U.S. person under the grantor trust rules.
The U.S. owner of a foreign trust is subject to a penalty equal to the greater of $10,000 or 5 percent of the gross value of the trust’s assets treated as owned by the U.S. person as of the close of that tax year if the foreign trust (a) fails to timely file Form 3520-A, or (b) fails to furnish all of the information required to be reported on Form 3520-A.
Willful failure to file an FBAR may be the subject of a criminal prosecution. Willful failure to file a U.S. income tax return, where the taxpayer owes a material amount of tax, may be the subject of a criminal prosecution. The filing of a U.S. income tax return willfully underreporting tax by a material amount may be the subject of a criminal prosecution.
Voluntary Disclosure Programs
The Internal Revenue Service voluntary disclosure programs are available by which an individual can comply with the U.S. laws concerning foreign income, accounts, and entities while avoiding or minimizing penalties for noncompliance. The voluntary disclosure programs are as follows:
- Delinquent FBAR Filing Procedure.
- Streamlined Compliance Procedures.
- For Residents of the United States.
- For Nonresidents of the United States.
- Delinquent International Information Return Submission Procedure.
- Voluntary Disclosure Practice.
The above disclosure programs are voluntary, meaning that an individual may avail of them only so long as the Internal Revenue Service has not learned of the individual’s noncompliance. Voluntary disclosure programs should be availed of as soon as possible.
Filing Delinquent FBARs
The first thing we do for foreign nationals living in the United States is file FinCEN Forms 114, Report of Foreign Bank and Financial Accounts, “FBARs”, as needed for the last six years. This defuses the spectre of imposition of penalties against the client, especially the penalty for willful failure to file an FBAR (currently, the greater of 50 percent of the aggregate account balance reportable on an FBAR or $124,588). If the client has not underreported tax, or failed to file an international information return, filing delinquent FBARs is all we need to do for them.
Streamlined Procedures for Residents of the United States
If an individual has underreported tax on foreign financial accounts, and his or her noncompliance was non-willful, he or she can become compliant by means of the Streamlined Compliance Procedures. Under the Streamlined Procedures for a resident of the United States, we first file FBARs or amended FBARs as needed for the client for the last six years. Then we have amended U.S. income tax returns prepared as needed for the client for the last three years. We file the amended income tax returns with a Form 14654, Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures. The Form 14654, computes the client’s miscellaneous Title 26 offshore penalty, equal to 5 percent of the high balance of his or her foreign financial accounts as of the end of each of the preceding six years. The Form 14654 why the client’s noncompliance was due to reasonable cause and not willful neglect. We enclose with the Form 14654 and the amended U.S. income tax returns the cleint’s checks in payment of the tax due on the amended tax returns, interest on the tax, and the miscellaneous Title 26 offshore penalty.
Pre-pandemic, the IRS acknowledged a taxpayer’s self-assessed miscellaneous Title 26 offshore penalty. The IRS also sent the taxpayer a statement computing a refund due or a balance due for each amended tax return filed by the taxpayer. Post-pandemic, such correspondence has ceased. Hopefully it will resume at some point. We make our submissions by courier, and we request signed delivery receipts form IRS Service Center personnel.
Streamlined Procedures for Nonresidents of the United States
Under the Streamlined Procedures for a nonresident of the United States, we first file FBARs or amended FBARs as needed for the client for the last six years. Then we have amended U.S. income tax returns prepared as needed for the client for the last three years. We file the amended income tax returns with a Form 14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures. We explain on the Form 14653 why the client’s noncompliance was due to reasonable cause and not willful neglect. We enclose with the Form 14653 and the amended U.S. income tax returns the client’s checks in payment of tax due on the amended tax returns, and interest on the tax. There is no miscellaneous Title 26 offshore penalty in a Streamlined Procedures filing for a nonresident of the United States.
A “nonresident” of the United States for purposes of the Streamlined Procedures is an individual who satisfies two tests:
- The individual does not have a tax “abode” in the U.S. “Abode” for this purpose is tantamount to domicile.
- The individual was physically outside of the U.S. for at least 330 full days in any one or more of the most recent three years for which the U.S. income tax return due date (or properly applied for extended due date) has passed.
Delinquent International Information Return Submission Procedures
If a client has not underreported tax, but has failed to file one or more international information returns, and their noncompliance was non-willful, then Internal Revenue Service’s Delinquent International Information Return Submission Procedures may be their route to compliance. Under the DIRSP, we first file FBARs or amended FBARs as needed for the client. Then we prepare or have prepared delinquent international information returns as needed for the client. We prepare a Reasonable Cause Statement for the client explaining that the client’s noncompliance was due to reasonable cause and not willful neglect. We sign the Reasonable Cause Statement under oath as having prepared it. The client also Reasonable Cause Statement under oath as having read it.
International information returns include the following:
- Form 8938, Statement of Foreign Financial Assets
- Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts
- Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner
- Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations
There is no miscellaneous Title 26 offshore penalty under the DIIRSP.
The Streamlined Procedures are discrete, requiring amended income tax returns only for the last there years. The DIIRSP have no such provision. Internal Revenue Code § 6501(c)(8) tolls (suspends) the statute of limitations on assessment of penalties with respect to a delinquent international information return until such time as the delinquent international information return is filed.
How far back should a taxpayer file delinquent international information returns? Commonly-required international information returns were first required as follows:
- Form 8938 – Tax years beginning after December 11, 2011.
- Form 3520 – Every person who, on or after October 16, 1962, either creates a foreign trust or transfers money or property to a foreign trust, directly or indirectly.
- Form 3520-A – Tax years beginning after December 31, 1976.
- Form 5471 – January 1, 1963.
As a rule of thumb I file international information returns back for as many years as the taxpayer has been living in the United States, but in no case more than five years.
Voluntary Disclosure Practice
The Internal Revenue Service’s Voluntary Disclosure Practice is a program in which the taxpayer concedes willfulness under oath, and accepts sever financial consequences from the IRS. The taxpayer must request preclearance from the IRS Criminal Investigation Division. IRS CI reviews its files and determines whether it has received any notice of the taxpayer’s noncompliance. If IRS CI accepts the taxpayer into the VDP, the taxpayer must file FBARs or amended FBARs as needed for the last six years. The taxpayer waives the assessment statute of limitations and must file and U.S. income tax returns or amended income tax returns as needed for the last six years. The taxpayer must pay tax due on the income tax returns or amended tax returns, and interest on the tax. The taxpayer must pay all income tax penalties due, including a civil fraud penalty equal to 75 percent of the tax due for the year with the largest understatement of tax. An IRS Revenue Agent reviews the taxpayer’s submission and determines adjustments to be made to it. The IRS enters into a Closing Agreement with the taxpayer. In the Closing Agreement the taxpayer concedes willfulness under oath, and the IRS agrees not to criminally prosecute the taxpayer’s violations of the Bank Secrecy Act of Internal Revenue Code.
The Voluntary Disclosure Practice is almost never applicable. A willful taxpayer is one who transfers financial assets overseas for the purpose of evading U.S. income tax. Few taxpayers are willful.
Summary
Americans must comply with U.S. laws concerning foreign income, accounts, and entities. The sooner they comply the better, in terms of minimizing the tax, penalties, and interest incurred in complying.