Many people with offshore financial accounts want to become US tax compliant, but they don’t know the best way forward. A quick Internet search reveals information on filing FBAR forms, making a voluntary disclosure of the accounts to the IRS, or a “streamlined disclosure”. There is a lot of information on the Internet and in the media, much of it frightening, including the end of bank secrecy, banks telling the IRS about American clients, and criminal prosecution of American taxpayers with undeclared foreign assets. People want to bring their foreign assets into IRS compliance, but the choices to do so are daunting and unclear. The best path forward to tax compliance will depend on the background facts.
In situations involving foreign assets, there may be two different problems to rectify: First, there is the failure to tell the government of the existence of the account, such as by filing the FBAR form. A second and completely distinct problem is the failure to tell the IRS about income earned in the account, and to pay tax on that income.
The best possibility is that a foreign account may not have been declared to the IRS, but there was no income in the account and therefore no tax loss to the IRS. Such may be the case, for example, if the funds were in an account that earned zero interest. In such case, compliance may be achieved by filing late FBARs, along with an explanation, without making a formal voluntary disclosure to the IRS via one of the voluntary disclosure programs. If the facts support an FBAR-only approach, we have been very successful in avoiding penalties in such cases.
If there was income in the foreign account, whether interest, dividends, capital gains or a combination, then the FBAR-only strategy will not achieve tax compliance. In such a case, one must not only file past FBAR forms, but also amend back tax returns to report the previously undeclared foreign income, and pay tax on that income. This is best achieved by making a voluntary disclosure to the IRS of the foreign assets and the foreign income. Such a disclosure must be commenced before the IRS learns of the foreign account, which could happen by way of an audit or examination, of if the IRS obtains information from the bank itself. Foreign banks are now reporting information directly to the IRS as a result of a law called the Foreign Account Tax Compliance Act (FATCA). Almost all Swiss banks are reporting account information to the US government in order to settle tax fraud investigations. If the IRS already knows about the account, it is too late to make a voluntary disclosure.
There are two types of voluntary disclosures of foreign assets. The more expansive and onerous is known as the “Offshore Voluntary Disclosure Program”, or OVDP, and requires amendment of tax returns for the last eight years, payment of all back taxes, interest and “accuracy” penalties, plus a penalty of 27.5% of the highest account values over the eight year look back period. However, there is a list of foreign banks, most (but not all) of them in Switzerland, which are already under investigation by the US Department of Justice, and for disclosures of an account at a bank on this list, the OVDP penalty will be 50% and will apply to all foreign accounts, whether or not on this list of banks.
While the OVDP has an eight-year tax look back period and a 27.5% or 50% penalty, the “Streamlined” voluntary disclosure program has a three-year tax look back period and a penalty of 5% (0% for US taxpayers who live abroad). Obviously, the Streamlined program is less onerous and would be the preferred choice for coming into tax compliance. However, there are eligibility standards for being accepted into the Streamlined program. The most important standard is that the US taxpayer could not have “willfully” failed to disclose the foreign asset. Willful non-compliance is the intentional violation of a known legal duty. In simple terms, it means “I know I have to report my foreign account, but I am not going to.” However, since it is unlikely that the IRS would obtain such a confession from a U.S. taxpayer, the IRS will look at the taxpayer’s actions in assessing willfulness. The following examples would all suggest a willful failure to disclose foreign accounts:
- An American taxpayer opening an account in a tax haven jurisdiction (Switzerland, Cayman, Panama, etc.), although that taxpayer has no personal connection to that jurisdiction (e.g., never lived there).
- Opening the account in the name of a foreign entity, such as a foreign corporation, trust or foundation.
- An American taxpayer answering “no” when his CPA asks if he has a foreign account.
- Diverting foreign earned income to a foreign account, rather than sending the earned income to a US account and reporting it to the IRS.
- Opening a foreign account under a “code name” and/or requesting that statements not be sent to the US.
- Opening a foreign account using a foreign passport and/or a foreign address.
The above facts would suggest that the US taxpayer “willfully” failed to report the foreign account. Additional factors could be the education level and occupation of the US taxpayer. A well-compensated financial professional with an advanced degree might be held to a higher standard. Facts such as these would suggest “willfulness” and an application for the Streamlined program would be rejected. Importantly, if one’s Streamlined application is rejected, it would then be too late to apply to the OVDP.
The following facts might support a Streamlined application based on non-willfulness:
- The foreign account was created by a foreign relative and was inherited by the US person who only recently learned about the account and US tax reporting requirements.
- The US taxpayer created the account while living in the foreign country, and then moved to the US, did not know the account was reportable and did not access the account after moving to the US.
- The US taxpayer disclosed her foreign accounts to her CPA, who reported them and tax was paid on the foreign income; however, one small account was accidentally omitted.
- The taxpayer has lived abroad for many years, filed US tax returns properly, but did not realize that some assets, such as foreign retirement plans, are also reportable and taxable.
- The taxpayer reported the foreign account and paid tax on the foreign income to the foreign government and believed that since the account was already subject to foreign tax and reporting, it wasn’t also subject to U.S. reporting.
These are clearly more benign facts that may support “non-willfulness” and the lower penalty of the Streamlined program. The danger is that many US taxpayers believe their conduct to be non-willful, and yet the IRS disagrees. The taxpayer must submit a sworn affidavit detailing the facts supporting his or her “non willfulness”. Another danger is that if the IRS concludes that the statement is false, the taxpayer could be subject to prosecution for filing a false statement or even perjury.
Given the risks involved for offshore non-compliance, it is important to bring the foreign assets into US tax compliance, but the different avenues to come into IRS compliance are themselves risky. It is crucial to consult with an attorney experienced in offshore matters, IRS representation and the various avenues to tax compliance. Such an attorney can analyze your facts and assist you in deciding the best path forward with the IRS.