Gallet, Dreyer & Berkey, LLP
As the year draws to a close, we offer valuable planning tips to our clients, colleagues, and friends of the firm regarding their assets, tax, and estate concerns.
Foremost, there are still some time-sensitive ways to save taxes that could result in much more money for your family.
As the year comes to a close, we offer some planning tips to our clients, colleagues and friends of the firm regarding their assets, tax and estate concerns.
Foremost, there are some time-sensitive ways to save taxes that could result in much more money for your family.
Tax season is again upon us. We remind readers that ownership of offshore assets (including a wide group of disparate assets, such as bank accounts, business interests, rental real estate, insurance policies, mutual funds, foreign corporations, foreign trusts) are subject to significant IRS reporting requirements. In addition, the new tax law changes passed by Congress at the end of 2017 now allow the IRS to reach, and tax, certain types of foreign companies that previously were not within IRS reach. It is important to understand and abide by the numerous, and complex, reporting requirements for foreign assets.
1.“Check the Box” on IRS Form 1040, Schedule B
If you owned or had authority over a foreign financial account (including a bank account, securities account, brokerage account, etc.) at any time during 2018, you must “check the box” on your IRS Form 1040, Schedule B, Part III, Line 7a.
If your foreign account(s) were valued at more than $10,000 in the aggregate, you must also “check the box” on line 7a regarding the FBAR form, FinCEN 114 (see item 4, below). On line 7b, you must enter the country or countries where the foreign account is located. The 2018 FBAR form is due on the same day that your tax return is due: April 15, 2019.
Even if you closed a foreign financial account during 2018, you must still “check the box” if the account was open during any part of 2018. If you received a distribution from, or were the grantor of, or a transferor to, a foreign trust or foreign foundation, you must “check the box” on Line 8 and also file IRS Form 3520.
2. Report Foreign Income
In addition to “checking the box” on IRS Form 1040, Schedule B, U.S. taxpayers must report all foreign income (including interest, capital gains, dividends, pension distributions, rent, royalties) earned during 2018. If you held investments in foreign mutual funds or hedge funds, you may be required to file additional tax forms applicable to “PFICs” (Passive Foreign Investment Companies) for tax year 2018 (e.g., IRS Form 8621).
In many cases, if the foreign income was taxed in a foreign country, whether by withholding at the source or by filing a foreign income tax return, you may be able to get a credit on your U.S. income tax return for foreign taxes that you paid. Even so, all foreign income should still be declared on your U.S. income tax return, even if U.S. tax due is minimized or eliminated due to foreign tax credits, foreign residency credits or other tax treaty benefits. Likewise, even if foreign rental income was offset by foreign real estate costs, you must still report the rental income and take the credits.
3. IRS Form 8938
IRS Form 8938, Statement of Specified Foreign Financial Assets, is yet another IRS form to report foreign bank, brokerage accounts and other foreign financial assets (including interests in offshore trusts and corporations, bonds, foreign mutual funds, foreign annuity and insurance policies). This form is due even though you may have already reported the very same foreign assets on a different IRS form and/or on the FBAR form (discussed below). IRS Form 8938 is due with your annual tax return (Monday, April 15, 2019, unless you obtain an extension).
4. The FBAR – also due April 15, 2019
The 2018 FBAR, Report of Foreign Bank and Financial Accounts (FinCEN Form 114), is due on the same day as your 2018 income tax return (Form 1040): April 15, 2019. The FBAR must be filed by U.S. taxpayers who had beneficial ownership of, or signature or other authority over, foreign financial accounts, including bank and securities accounts, if the aggregate value of such accounts exceeded $10,000 at any time during 2018. The FBAR also applies to foreign insurance policies, annuity policies, retirement plans and other financial products. Recent authority also extends the FBAR to on-line gambling/gaming accounts. If you owned Bitcoin or other virtual currencies in a foreign account or foreign exchange, you must declare the account. If you participated in the IRS Offshore Voluntary Disclosure Program (OVDP), Streamlined procedures or submitted FBARs for past years, you should ensure ongoing compliance by timely submitting the 2018 FBAR. If the accounts existed at any point during 2018, then the FBAR must be submitted by April 15, 2019. The FBAR must be filed electronically on FinCEN’s website. An extension to file the FBAR is available. The extended due date is the same as one’s extended income tax deadline (October 15, 2019).
5. Additional Forms for Entities (Foreign Trusts, Foreign Corporations, etc.)
If you had an interest in a foreign entity such as a foreign trust or foreign foundation, and/or during 2018 you received assets from the foreign entity, then you may also be required to file IRS Forms 3520 and 3520A. Please contact us for a copy of our memo about this issue. If you had an interest in a foreign corporation, and the foreign corporation is deemed to be a “Controlled Foreign Corporation” (CFC), then IRS Form 5471 is also due. These forms are usually due with your income tax return (IRS Form 1040, due April 15, 2019), but note that the due date for Form 3520A could be sooner (by March 15, 2019).
As part of the tax law changes that Congress passed at the very end of 2017, the U.S. tax rules for CFCs became more complex, and the reach of the IRS to foreign companies and foreign income has become more expansive. The new law imposes traps whereby interests in foreign companies that were previously not subject to U.S. taxation are now taxed. If you have interests in foreign companies, you must be sure that your interests are compliant with the new laws and IRS regulations.
6. Strategic Concerns
Although the IRS Offshore Voluntary Disclosure Program (OVDP) ended in 2018, taxpayers with non-compliant offshore assets still have the opportunity to come forward and become compliant, provided that the IRS does not already have their information (e.g., from a foreign bank, treaty request, FATCA, audit, etc.). For taxpayers whose facts may be considered by the IRS to be “willful” (e.g., intentional non-reporting, use of tax haven jurisdictions, use of foreign entities such as trusts or corporations), pre-emptive disclosure is still possible, with lower penalties than would apply if the IRS otherwise discovers the assets.
For taxpayers whose facts are non-willful or more benign, the IRS Streamlined Procedures continue to be available, with a limited look-back period and lower (or no) penalties. If there was no tax loss to the IRS from the foreign assets, then the Delinquent Informational Return Procedures may allow for zero penalties.
If you are still grappling with bringing your foreign asset into U.S. compliance but have not yet filed FBARs, submitted a Streamlined application, or consulted with a tax compliance attorney, or you are undecided as to whether or not to make a disclosure, you may want to consider requesting an extension for your 2018 tax returns and FBAR, until October 15, 2019.
You may request an extension for filing your income tax return by filing IRS Form 4868. Note that this is an extension to file the tax return, not pay tax due. You still must pay your tax liability by April 15, 2019, even though you have until October 15, 2019 to file your 2018 tax return and FBAR. You must formulate your offshore disclosure strategy prior to reporting to the Government the existence of foreign assets via the FBAR, Form 8938, etc.
Conclusion
Owning foreign assets is legal and proper, but all IRS reporting rules and regulations must be met to avoid expensive penalties. In addition, the recent changes in U.S. tax law creates a potential trap for U.S. taxpayers with ownership interests in certain foreign corporations.
If you have any questions or would like our assistance in formulating an offshore disclosure strategy or in preparing the 2018 FBAR or other IRS filings, please contact us.
The IRS recently announced various targets of investigation and enforcement in the business and international realms.
We would like to highlight one of the IRS’ target areas: tax and reporting compliance for foreign trusts. IRS issues arise for U.S. taxpayers who are named as beneficiaries of foreign trusts; for example, trusts created by foreign relatives who name their U.S. family members as beneficiaries. Compliance issues also arise for U.S. taxpayers who create foreign trusts, including American expats who form trusts for estate planning, as well as U.S. taxpayers who form offshore asset protection trusts.
The IRS announcement specifies “examinations and penalties” regarding IRS Forms 3520 and 3520-A, including “when the forms are received late or are incomplete”. Form 3520 is required to be filed by U.S. beneficiaries who receive distributions from foreign trusts, as well as U.S. grantors who settle foreign trusts or contribute assets to foreign trusts. Form 3520-A is required to be filed by a foreign trustee; however, if a foreign trustee does not file the form with the IRS, often a U.S. taxpayer will be deemed the “responsible party” who is obligated to file this form.
In addition, U.S. beneficiaries of foreign trusts and U.S. grantors of foreign trusts may be obligated to file the “FBAR” form, FinCEN Form 114. Grantors and beneficiaries may also be required to file IRS Form 8938.
The penalties for non-filing can be severe. For “willful” non-filing of the FBAR alone, the penalties can be 50% of the value of the trust’s foreign account that was not reported, plus the penalties for non-filing of Forms 3520 and 8938.
However, there are opportunities to self-correct such failures, provided that the IRS has not already initiated an audit or investigation. If the failure was merely the non-filing of an informational return (such as the FBAR, 8938 or 3520), with no tax loss to the IRS, the cure may be filing the returns with a carefully drafted explanation of non-willfulness and/or reasonable cause. An experienced offshore attorney can assist in drafting this statement. If there is also tax loss to the IRS (e.g., undeclared trust income, undeclared receipt of funds from a trust), then the situation is more complex and likely requires amending tax returns to declare additional income. In such a case, one should consider the IRS Offshore Voluntary Disclosure Program (“OVDP”) which is coming to an end on September 28, 2018, or the Streamlined Offshore Procedures. Again, an experienced offshore attorney can assist you in coming into IRS compliance.
The attorneys are Gallet Dreyer & Berkey have years of experience in foreign trust issues and IRS reporting. Please contact us to discuss your foreign trust issues.
Please also read the following related articles on the issue of foreign trusts and IRS reporting:
The IRS Offshore Voluntary Disclosure Program (OVDP) is closing on September 28, 2018, mere weeks away.
For taxpayers who own foreign assets that are not in IRS compliance, the ending of the OVDP presents a final opportunity to become IRS compliant, avoid criminal charges and much higher penalties if discovered by the IRS.
Readers considering making a voluntary disclosure of offshore assets to the IRS should be aware that the impending closure of the OVDP imposes a significant timing constraint during these final weeks of the OVDP. For instance, there is currently a rush of people to get into the OVDP before it closes, which has resulted in delays in approvals from the IRS. In addition, there is usually a need for information from foreign sources (such as financial statements and income information), which can also take time. Finally, because of the work involved in preparing an OVDP submission, and coordination with other parties (one’s CPA, for instance, along with foreign banks), OVDP applications should be addressed immediately. A last-minute attempt to enter the OVDP just before the closure date of September 28 is not practical nor advisable.
There are strategic considerations as well. For instance, the OVDP is only open to taxpayers who are not already under IRS audit or investigation. A “pre-clearance” requests is the normal way to inquire whether a taxpayer is already under IRS scrutiny. Because it is now taking weeks for the IRS to respond to the “pre-clearance” request, one question to consider is whether you should skip the “pre-clearance” process and proceed to the submission of background information to the IRS. If a taxpayer skips the pre-clearance request and submits information to the IRS, that person has just given the IRS incriminating information that could be used in a criminal tax fraud case or an assessment of civil penalties.
While the OVDP is closing, the “Streamlined” Procedures remain open for taxpayers who are able to certify, under penalties of perjury, that their offshore non-compliance was non-willful. While a taxpayer may believe that he or she is non-willful, the IRS may disagree. Thus, it is important to discuss one’s background facts with an attorney experienced in offshore tax issues who can help in assessing willfulness.
If you have undeclared foreign assets, now is the time to consult with an attorney about how to bring these assets into IRS compliance. After September 28, 2018, the risks and costs will increase substantially. Contact us for a consultation about your offshore issues.
Please also see the following related articles:
An Opportunity is Soon Closing to Voluntarily Disclose Offshore Assets to the IRS
A Current Assessment of the IRS Streamlined Offshore Procedures
The Wall Street Journal article, “The Tax Man Cometh and, Holy Cow, He Means Business” (WSJ, June 3-4, 2017), despite its provocative title, doesn’t break new ground on the IRS attack on offshore accounts. Instead, it offers us the following lessons:
The IRS has obtained a vast amount of information from sources that include foreign banks, the Panama Papers and the Foreign Account Tax Compliance Act (FATCA). Additional sources include Tax Information Exchange Agreements (TIEs), foreign bankers and other people’s voluntary disclosures. According to the IRS, there are hundreds of US taxpayers subject to criminal tax charges in relation to their offshore accounts, and thousands more subject to large civil fines and penalties.
There are also opportunities to come forward before the IRS gets a taxpayer’s name, in return for lower penalties. If a taxpayer willfully hid foreign assets and income (for instance, a taxpayer who set up an account in a tax haven country like Switzerland or Panama, without any legitimate ties to that country, or a taxpayer who utilized offshore entities like foreign trusts, corporations or foundations, or diverted business income away from the IRS), then such a taxpayer should apply to the IRS Offshore Voluntary Disclosure Program (OVDP) in return for lower penalties and no criminal prosecution.
On the other hand, if a taxpayer was non-willful (for example, a U.S. taxpayer who inherited a foreign account from a foreign relative, or a recent immigrant who was unaware that accounts “back home” become reportable to the IRS), then such a taxpayer may be eligible to make a Streamlined disclosure for much lower penalties, or in the case of US taxpayers who reside abroad, zero penalties.
Legal counsel experienced in representing people with offshore assets before the IRS can assess the background facts and help determine whether someone is willful or not, and can present the taxpayer and facts in the best light possible before the IRS.
Contact us to discuss IRS compliance for foreign assets including offshore accounts, the OVDP, Streamlined programs and alternatives to making a voluntary disclosure.
Annual tax season is upon us, and we remind readers of important tax reporting requirements that must be met with respect to foreign assets.
If you had signature authority or a financial interest (e.g., ownership) in a foreign financial account (including a bank account, securities account, brokerage account, etc.) at any time during 2016, you must “check the box” on your IRS Form 1040, Schedule B, Part III, Line 7. If your foreign account(s) were valued at more than $10,000 in the aggregate, you must also “check the box” on line 7 regarding the FBAR form, FinCEN 114 (see item 5, below). This requirement is applicable to taxpayers who had beneficial ownership of, or signature authority or other authority over, such financial accounts in a foreign country. Even if you closed the accounts during 2016, you must still “check the box” if you maintained the accounts during any part of 2016. If you received a distribution from, or were the grantor of, or a transferor to, a foreign trust or foreign foundation, you must “check the box” on Line 8 and also file IRS Form 3520.
In addition to “checking the box” on IRS Form 1040, Schedule B, U.S. taxpayers must report all income (including interest, capital gains, dividends and pension distributions) realized during 2016, on IRS Form 1040. If you held investments in foreign mutual funds or hedge funds, you may be required to file additional tax forms applicable to “PFICs” (Passive Foreign Investment Companies) for tax year 2016 (e.g., IRS Form 8621). If you received rental income from foreign real estate or realized gains from the sale of foreign real estate, you must declare it. You may be eligible to deduct real estate expenses and real estate taxes paid to a foreign tax authority. In many cases, if foreign income was taxed in a foreign country, you may be able to get a credit for foreign taxes paid. Even so, all foreign income should still be declared.
IRS Form 8938, Statement of Specified Foreign Financial Assets, first introduced in 2012, is yet another IRS form to report foreign bank, brokerage accounts and other foreign financial assets (including interests in offshore trusts and corporations, bonds, foreign mutual funds, foreign annuity and insurance policies). IRS Form 8938 is due with your annual tax return (April 18, 2017, unless you obtain an extension).
If you had an interest in a foreign entity such as a foreign trust or foreign foundation, and/or during 2016 you received assets from the a foreign entity, then you may also be required to file IRS Forms 3520 and 3520A. Please contact us for a copy of our memorandum about this issue. If you had an interest in a foreign corporation, and the foreign corporation is deemed to be a “Controlled Foreign Corporation” (CFC), then IRS Form 5471 is also due. These forms are usually due with your income tax return (IRS Form 1040, due April 18, 2017).
This year, 2017, is the first year that the deadline for the FBAR, Report of Foreign Bank and Financial Accounts (FinCEN Form 114), is the same as the deadline for submission of income tax returns (1040s), for calendar year 2016. The FBAR must be filed by taxpayers who had beneficial ownership of, or signature or other authority over, foreign financial accounts, including bank and securities accounts, if the aggregate value of such accounts exceeded $10,000 at any time during 2016. The FBAR also applies to foreign insurance policies, annuity policies, retirement plans and other financial products. Recent authority also extends the FBAR to on-line gambling/gaming accounts. If you participated in the IRS Offshore Voluntary Disclosure Program (OVDP), Streamlined procedures or submitted retroactive FBARs, you should ensure ongoing compliance by timely submitting the 2016 FBAR. If the accounts existed at any point during 2016, then the FBAR must be submitted by April 18, 2017. Note that the FBAR is now known as FinCEN Form 114, and must be filed electronically. This year, also for the first time, a taxpayer may obtain an automatic extension to file the FBAR. The extended due date is the same as one’s extended income tax deadline (October 15, 2017).
If you have not yet filed an application for the OVDP or submitted a Streamlined application, or if your application is pending at the IRS, or you are undecided as to whether or not to make a disclosure, you may want to consider requesting an extension for your 2016 tax returns and FBAR.
You may request an extension for filing your income tax return by filing IRS Form 4868. Note that this is an extension to file the tax return, not pay tax due. You still need to pay your tax liability by April 18, 2017, while you have until October 15, 2017 to file your tax return and FBAR. This means that your voluntary disclosure strategy needs to be formulated prior to reporting to the Government the existence of foreign accounts via the FBAR, Form 8938, etc.
Conclusion
Please ensure that your offshore assets are tax compliant by adhering to the ongoing reporting and tax requirements. If you have any questions or would like our assistance in formulating a disclosure strategy or in preparing the 2016 FBAR, please feel free to contact us.
If you are the owner of a foreign account or other foreign financial asset that has not been properly reported to the IRS, what are your options now?
Option One: come forward now. The IRS Offshore Voluntary Disclosure Program (OVDP) still remains open. Criminal prosecution is usually avoided if you come forward before you are caught. In addition, the penalties are much higher outside the OVDP in the event you are caught by the IRS. You may be caught because of FATCA, an investigation, an audit, an information request to a foreign bank, a subpoena upon a foreign bank, or another person’s disclosure of account info. Thus, if you have not entered the Offshore Voluntary Disclosure Program, you may still come forward; you will pay penalties, but the penalties will still be significantly lower than if you don’t come forward and the IRS catches you. In that case, jail time for criminal tax fraud is also a frightening possibility. In some cases, depending on the background facts, the penalties for an undisclosed foreign account may be as little as 5 percent or even zero, provided that the IRS doesn’t already know about your offshore assets.
Option Two: convert your account to a tax-compliant structure. We have long counseled the use of tax-compliant strategies to minimize U.S. taxation. We also advise clients on the legitimization of non-compliant offshore assets. We counsel clients regarding the proper steps to transform a non-compliant offshore account into one that complies with current U.S. laws. Although we cannot erase a non-compliant past, we can counsel on full compliance going forward. Such steps may significantly reduce the risk of detection and prosecution.
Option Three: do nothing and hope that the IRS does not discover your foreign account. You would be relying on past promises of banking secrecy as a means of future protection. However, as the events of recent years have proven, foreign banking secrecy no longer exists. Moreover, FATCA is now in effect, whereby virtually all foreign banks report bank data to the IRS. In light of this new world order, sooner or later the IRS will likely find your foreign account and then it will be too late. Even if you somehow remain “under the radar”, any attempts to access the foreign funds could raise “red flags” and thus your foreign assets are essentially inaccessible. Clearly, we do not recommend this “ostrich” strategy.
We do recognize that making a formal voluntary disclosure would include paying a penalty, and we recognize that this penalty, although much less than civil and criminal tax fraud penalties, may still be quite onerous. The question thus becomes: are alternatives available to come into IRS compliance, and, at the same time, to also avoid the OVDP penalty?
We do not believe that everybody with foreign assets should automatically rush to enter the OVDP and pay the high penalties. The OVDP, with its “one size fits all” penalty, is not always the best, or only, course of action in all offshore cases. In addition, if your background facts meet certain requirements, the “Streamlined” voluntary disclosure procedures may be appropriate, and would offer significantly lower penalties.
Every client has different facts. We must address the particular facts of the client’s foreign assets, the past non-compliance, the client’s reported income, the amount of unreported foreign income and the tax loss to the IRS. Not everyone with foreign assets should avoid the OVDP, but not everyone with foreign assets should enter the OVDP. We can examine the facts, assess the risks, and discuss alternative strategies that may reduce or even entirely eliminate IRS penalties.
Contact us to discuss your options regarding foreign accounts.
The year 2016 was an epic year in the offshore world due to the leaks of confidential offshore financial information known as the “Panama Papers”. In addition, in 2016, more countries began to report offshore financial information to the IRS under FACTA (the Foreign Account Tax Compliance Act).
Also in 2016, the IRS and U.S. Department of Justice (DOJ) continued to successfully attack offshore banking “secrecy”, moving beyond Switzerland to other foreign jurisdictions. “Going offshore” for the purposes of hiding money from the IRS is now impossible. Going offshore for asset protection from civil creditors and for tax minimization is still viable and effective, but must be tax-compliant.
This year has been an unprecedented year both domestically and offshore. We can assist you in navigating through the changing offshore world and advise you regarding offshore (and onshore) assets.