Foreign Accounts Compliance

Overview of Reporting Requirement

The United States taxes its citizens and residents on their worldwide income. A “resident” of the United States for this purpose means a lawful permanent resident (“green card” holder) or an individual who satisfies the substantial presence test.

An individual satisfies the substantial presence test with respect to a given calendar year if the individual satisfies two tests:

  1. The individual was physically present in the United States on at least 31 days during the calendar year; and
  2. The sum of the number of days on which such individual was physically present in the United States during the current calendar year and the two preceding calendar years (when multiplied by the applicable multiplier determined under the following table) equals or exceeds 183 days:
Commerce in the Straits of Mackinac, Flik-0001
Commerce in the Straits of Mackinac, Corey Seeman, Flickr
The number of days in: The applicable multiplier is:
The current year                 1
The first preceding year              1/3
The second preceding year                1/6

There are exemptions including physical presence in the United States by certain foreign government-related individuals, teachers, trainees, and students.

The number of days in: The applicable multiplier is:
The current year                 1
The first preceding year              1/3
The second preceding year               1/6

There are exemptions including physical presence in the United States by certain foreign government-related individuals, teachers, trainees, and students.

An individual who resides in the United States likely satisfies the substantial presence test.

The U.S. Internal Revenue Code requires Americans to file international information returns. These include—

  • 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
Blue Water Bridge Photo 3-scaled
Blue Water Bridge, connecting Port Huron, Michigan, and Sarnia, Ontario

The Internal Revenue Code imposes substantial penalties for failure to file an income tax return where tax is due, underreporting of tax on an income tax return, and failure to file an international information return. Willful failure to file an income tax return where tax is due, and filing of an income tax return which willfully, materially underreports tax can be the subject of a criminal prosecution.

The U.S. Bank Secrecy Act supports the Internal Revenue Code by requiring U.S. citizens and residents to file an annual FinCEN Form 114, Report of Foreign Bank and Financial Accounts, “FBAR,” reporting their interests in foreign financial accounts. The failure to file an FBAR is subject to a penalty in the amount of $12,459. But if the failure was willful, the penalty is the greater of $124,588 or 50 percent of the total of account balances reportable on the FBAR. Willful failure to file an FBAR can also be criminally prosecuted.

Mackinac Bridge, St. Ignace, Michigan-scaled
Mackinac Bridge, St. Ignace, Michigan

Voluntary Disclosure Programs

Internal Revenue Service voluntary disclosure programs enable Americans to become compliant with U.S. laws concerning foreign income, accounts, and entities while avoiding or minimizing penalties for noncompliance. The programs are truly voluntary, meaning that an individual can avail of them only so long as the IRS has not become aware of the individual’s noncompliance. An individual should avail of voluntary disclosure programs as soon as possible. Further, the voluntary disclosure programs are available only to an individual whose noncompliance was nonwillful.

In our view, a willful individual is one who transfers financial assets overseas for the purpose of evading U.S. income tax on it, and then fails to report income from the overseas financial assets on a U.S. income tax return.

In a voluntary disclosure case, we first address FBAR compliance. The statute of limitations on assessment of penalties concerning an FBAR is six years, and it begins running when the FBAR is due, whether or not it is filed. So we are always dealing with a six-year lookback period for FBAR compliance. We file FBARs or mended FBARs as needed for the client for the last six years. If the client has not underreported tax or failed to file one or more international information returns, then filing delinquent FBARs is all we need to do for the client.

Under the Delinquent International Information Return Submission Procedures, an individual who has failed to file one or more international information returns, and who has not underreported tax on a U.S. income tax return, and whose noncompliance was nonwillful, can become compliant by filing the delinquent international information returns. We prepare and file with the delinquent international information returns a reasonable cause statement explaining that the taxpayer’s noncompliance was nonwillful. There is no penalty for proceeding under the Delinquent International Information Return Submission Procedures.

The assessment statute of limitations with respect to a delinquent international information return does not begin to run until the delinquent international information return is filed. In many delinquent international information return cases we file delinquent international information returns for five or more years.

Bald Eagle-Victor Walters, Flikr-0001
Bald Eagle, Victor Walters, Flickr

A resident of the United States who has underreported U.S. income tax, and whose noncompliance was nonwillful, can become compliant by means of the Streamlined Compliance Procedures for Residents of the United States. Under the Streamlined Procedures, we have amended U.S. income tax returns, reporting all income, prepared for the client as needed for the last three years. We prepare or have prepared international information returns as needed for the client for the last three years. We file the amended income tax returns and the international information returns with Form 14654, Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures. The Form 14654 includes our narrative explaining why the taxpayer’s noncompliance was due to reasonable cause and not willful neglect. The Form 14654 also computes the taxpayer’s miscellaneous Title 26 offshore penalty.

We enclose with the Form 14654 and the client’s amended U.S. income tax returns the client’s checks in payment of tax due on the amended income tax returns, interest on the tax, and the taxpayer’s miscellaneous Title 26 offshore penalty. The taxpayer’s miscellaneous Title 26 offshore penalty equals 5 percent of the taxpayer’s high balance of foreign financial accounts as of the end of each of the preceding six years.

A nonresident of the United States who has underreported U.S. income tax, and whose noncompliance was nonwillful, can become compliant by means of the Streamlined Compliance Procedures for Nonresidents of the United States. Procedure under the Streamlined Compliance Procedures for Nonresidents of the United States is the same as that under the Streamlined Compliance Procedures for Residents of the United States, except that under the Streamlined Procedures for Nonresidents there is no miscellaneous Title 26 offshore penalty, and the client’s amended income tax returns are filed not with Form 14654 but with Form 14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures.

A “nonresident” of the United States for purposes of the Streamlined Procedures is an individual who meets two tests:

1. The individual does not have a tax “abode” (~ domicile) in the United States; and

2. The individual was physically outside of the United States for at least 330 full days in at least one of the three most recent taxable years for which the taxpayer’s tax return filing deadline, as it may have been lawfully extended, has passed.

Sault St. Marie Intl Bridge-CBC.ca-0001
Sault St. Marie Int’l Bridge, CBC.ca

The Internal Revenue Service’s Voluntary Disclosure Practice is for a taxpayer whose noncompliance was willful, and therefore it almost never applies. The taxpayer must request preclearance into the VDP. The IRS checks its files and, if it concludes that it had not been notified of the taxpayer’s noncompliance, it accepts the taxpayer into the VDP. Under the VDP, the taxpayer must waive the assessment statute of limitations and file amended U.S. income tax returns as needed for the last six years. The taxpayer must pay all tax and interest due on the tax returns. The taxpayer must pay all penalties due, including a civil fraud penalty equal to 75 percent of the tax due for the year with the highest tax due. The IRS assigns a Revenue Officer to review the taxpayer’s disclosure. At the conclusion of the case, the taxpayer and the IRS enter into a closing agreement. The closing agreement provides that if the taxpayer’s voluntary disclosure was truthful and complete, the IRS will not prosecute the taxpayer.