Sam Brotman June 24, 2020 79 min read

The Complete Guide to International Tax Compliance

Under the law, U.S. citizens, resident aliens and certain nonresident aliens are required to report worldwide income from all sources including foreign bank and financial accounts. Required reporters must pay taxes on income from these accounts at their individual tax rates. 

The IRS recognizes that there are many legitimate reasons for U.S. taxpayers to have offshore accounts such as convenience, investing, and to facilitate international banking transactions. However, U.S. taxpayers are prohibited under law from using offshore accounts, including foreign banks, security accounts and trusts, to avoid paying tax. [1] 

To fully understand the problem, it is necessary to understand what the reporting requirements for foreign assets are.

FATCA – The Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA) mandates that U.S. taxpayers, including those living outside of the United States, report their financial accounts held outside of the U.S. It also requires that foreign financial institutions report information to the IRS about their U.S. clients. 

The U.S. is also in pursuit of Intergovernmental Agreements with other countries to make sure that the requirements of FATCA are carried out by foreign financial institutions. FATCA was passed on March 18, 2010, as an amendment to an appropriations bill known as the HIRE Act.

FATCA has three main provisions[1]:

  • It requires foreign financial institutions, such as banks, to enter into an agreement with the IRS to identify their U.S. personal account holders and to disclose the account holders’ names, TINs, addresses, and the transactions of most types of accounts. Some types of accounts, notably retirement savings and other tax-favored products, may be excluded from reporting on a country-by-country basis. U.S. payers making payments to non-compliant foreign financial institutions are required to withhold 30 percent of the gross payments. Foreign financial institutions which are themselves the beneficial owners of such payments are not permitted a credit or refund on withheld taxes absent a treaty override
  • U.S. persons owning these foreign accounts or other specified financial assets must report them on a new Form 8938 which is filed with the person’s U.S. tax returns if the accounts are generally worth more than $50,000; a higher reporting threshold applies to U.S. persons who are overseas residents and others. Account holders are subject to a 40 percent penalty on understatements of income in an undisclosed foreign financial asset. Understatements of greater than 25 percent of gross income are subject to an extended statute of limitations period of six years.It also requires taxpayers to report financial assets that are not held in a custodial account,(i.e. physical stock or bond certificates
  • It closes a tax loophole that foreign investors had used to avoid paying taxes on U.S. dividends by converting them into “dividend equivalents” through the use of swap contracts.

Armed with new weapons to make foreign governments and financial institutions comply, the Departments of Treasury and Justice wasted no time in testing out their new powers. The first target was the most obvious – Switzerland. 

UBS was the target of an aggressive enforcement action. In the end, UBS was forced to turn over the names and information of 4,000 U.S. taxpayers. In order to settle a corporate criminal action for failure to comply, UBS paid a $780 million dollar fine. 

Switzerland’s oldest bank, Wegelin & Co. fared far worse. It paid only $74 million in fines, restitution and forfeitures, but it was dealt the death penalty when its board agreed to cease to do business to avoid criminal liability. 

In August of 2013, to avoid further prosecutions, the United States and Switzerland signed an agreement that provides for fines in exchange for non-prosecution agreements for banks that have facilitated American tax evasion. 

Given the success in shutting down the Switzerland offshore banking industry for U.S. taxpayers, it is believed that the Treasury and Justice will be launching its next assault on Israel and the Caribbean.

[1] http://www.irs.gov/Businesses/Corporations/Foreign-Account-Tax-Compliance-Act-FATCA

 

Why Americans Hold Foreign Accounts

There are numerous reasons why many Americans have assets in foreign countries. Some have left established businesses and homes, fleeing persecution in their country of origin. There are those who have fled war-torn regions of the world and left their assets in tax havens; or maintain foreign financial accounts to support family abroad. Other individuals with immigrant roots may have inherited from a relative in the old country who passed away and left them a sum of money abroad.

Of course, American business interests have also grown far and wide across the globe. Multinational corporations and individuals maintain accounts abroad to fund their various business operations and provide for their living expenses.

Since 2002, when the FBAR (A Report of Foreign Bank and Financial Accounts) was first implemented, the methods and means of seeking out these individuals and enforcing reporting obligations has grown tremendously. Due to pressure placed on international banks by the U.S. government, many foreign banks volunteer to disclose information relating to accounts held by U.S. persons. 

Although it may not be apparent from the start that an individual has been audited for their foreign account holdings, this motivating factor will often surface at some point over the course of an audit.

 

What is FBAR?

The acronym FBAR stands for Foreign Bank Account Report and refers to a disclosure form that must be filled out by certain taxpayers with respect to financial accounts maintained abroad. Although this is often a concern for the millions of expatriates living and working in foreign countries, FBAR applies to an even broader demographic of taxpayers. 

If you are a U.S. person with a foreign financial account in your name, authority to act on another’s behalf for a foreign account, or a financial interest in a foreign account held in someone else’s name, you may have certain reporting obligations to fulfill in compliance with Federal tax law. 

Although the FBAR is important, there are also separate information forms that individuals with an international presence should also be aware of for Federal Income tax purposes.

If you have already received a notice, it is best to seek experienced counsel to guide you in your efforts to be forthcoming. If you have not yet been audited but are concerned that you may have failed to make required disclosures for previous years, it is best to be proactive in order to take advantage of the full range of options available to help taxpayers resolve their delinquent foreign account reporting obligations. 

The full range of approaches may no longer exist once an audit is opened and the path to a resolution may become considerably more difficult. Criminal sanctions, penalties and available relief may also depend on the factual circumstances involved in the taxpayer’s failure to complete the required disclosure.

The objective of this guide is to inform taxpayers with foreign accounts on whether they may have an obligation to disclose a foreign financial account or other required information returns, how to make those disclosures and what to do if they have previously failed to meet those reporting requirements. 

This guide will also discuss the penalties involved, and the programs available to help non-compliant taxpayers fulfill their disclosure obligations and return to a position of good standing. 

Let us start with an explanation of who has an obligation to make financial disclosures under the FBAR.

 

Who is Required to File

As mentioned above, there are a variety of reasons why American citizens and residents have ties to foreign financial accounts. Under the FBAR reporting requirements, A United States person must file an FBAR if that person has a financial interest in, signature authority over or any other authority over any financial account(s) outside the U.S. and the aggregate maximum value of the account(s) exceeds $10,000 at any time during the calendar year.

To make this disclosure you must determine the maximum value using periodic account statements. Then you must convert this figure to U.S. dollars using the end of the year exchange rates and report the figure in U.S. dollars. As of 2014, the report must be electronically filed through FinCEN’s website.The FBAR does not get filed with the federal income tax return.

There are some exemptions to the filing requirement. You do not have to report an account held in a U.S. branch of a foreign bank. Foreign stock or securities which are not held in a financial account do not have to be reported. Foreign partnership interests are not subject to reporting. 

Domestic mutual funds that invest in foreign stocks or securities, foreign hedge funds and private equity funds are also exempt. If owned directly, personal property, such as jewelry and art, real estate, currency and precious metals held abroad are all exempt.

 

Understanding the Statute

United States Person

A United States person refers to both citizens and residents. However, it also includes entities such as corporations, partnerships and limited liability companies and even trusts or estates that are organized under U.S. law. 

In fact, even entities that are disregarded for federal tax purposes might still have an obligation to file an FBAR disclosure because FBARs are required under a Bank Secrecy Act provision of Title 31 and not under any provisions of the Internal Revenue Code.

Financial Accounts

Financial accounts include the following types of accounts: 

  • Bank accounts such as savings accounts, checking accounts, and time deposit
  • Securities accounts such as brokerage accounts and securities derivatives or other financial instruments accounts 
  • Commodity futures or options accounts
  • Insurance policies with a cash value (such as a whole life insurance policy)
  • Mutual funds or similar pooled funds (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions)
  • Any other accounts maintained in a foreign financial institution or with a person performing the services of a financial institution

Financial Interest

Financial interest includes being the owner of record or holder of legal title. You are also considered to have a financial interest if the account is in your name, but you are acting on behalf of a United States Person. In that case, you both likely would have an obligation to make an FBAR filing.

A corporation is considered to have a financial interest if a U.S person owns either 50 percent of the total value of shares of stock, or more than 50 percent of the voting power of all shares of stock.

A partnership in which a United States person owns an interest in more than 50 percent of partnership profits or an interest in more than 50 percent of the partnership capital, has a financial interest.

If a United States person has greater than 50 percent present beneficial interest in the assets or income of the trust for the calendar year, they are also considered to have an economic interest. 

Additionally, a trust grantor is considered to have a financial interest if they have an ownership interest in the trust for federal tax purposes.

Financial interest also exists for any other entity in which a United States person owns more than 50 percent of the voting power, total value of equity interest or assets or interest in profits.

In all of the above cases, financial interest exists whether the ownership exists both directly or indirectly.

Signature Authority

Signature authority exists when an individual has control over assets held in a foreign account and can exercise that control by direct communication (including but not limited to a communication in writing). Whether or not they have ever previously exercised the authority would not matter.

For example, a U.S. resident who has a power of attorney for his elderly father’s accounts in Mexico would be required to file an FBAR if the power of attorney gives him signature authority over his father’s financial accounts and the aggregate maximum value of the accounts exceeds $10,000.

It is important to have a clear understanding of these terms because you will need them when completing and filing the required forms and schedules to accompany your 1040/1040a.

 

Calculating the Aggregate Maximum Value of a Foreign Financial Account

The first step is to determine the maximum account value for each of your foreign accounts. The maximum account value is a reasonable approximation of the greatest value of currency or non-monetary assets in the account during the calendar year. Once you have determined the maximum account value for each account, use the exchange rate on the last day of the calendar year to convert each value into U.S. dollars. 

This should be done using the Treasury Reporting Rates of Exchange. Lastly, you add up each of your converted maximum account balances. If the total amount of all your account maximum values exceeds $10,000, all the accounts must be reported on the FBAR.

For example, a U.S. person owns foreign financial accounts X, Y and Z with maximum account balances of $200, $9,000 and $4,000 respectively. This individual would be required to file an FBAR because the aggregate value of the accounts would be $13,200, which is greater than the $10,000 threshold in the statute. 

All three accounts would have to be reported on the FBAR, and it does not matter whether an account is individually less than the threshold.

 

Deadline to File/Postpone Filing

An FBAR must be filed by April 15 of every year. You must continue to file the form on a yearly basis, even if you have no new accounts to report. If needed, you may also get an extension to file until October 15.

Bear in mind that you must also likely file Form 8938. This form is one of a few different information reports that is an attachment that must be filed along with your Federal income tax return. Notice that this is different from the FBAR, which is submitted separately and has its own due date.  

Examples of other forms that pertain to international tax which you may be required to file along with your federal income tax return are Form 5471, 5472 and 3520/3520A. We will briefly touch on all of the required forms and hone in on specific questions below.

As part of the Coronavirus pandemic relief effort, the IRS issued notice 2020-23 which has extended the federal income tax filing deadline to July 15, 2020 for the 2019 tax year. Because the forms discussed above must be filed attached to the tax return, the due date for these schedules has also been postponed to July 15, 2020.

If you have any doubt whether you are required to file, err on the side of precaution and make the filing. The amount of penalties can be severe if you fail to file either a Form 8938 or FBAR when you were required to do so. 

If you believe that you have failed to meet your filing requirements for previous years, it is best to be proactive in taking measures to correct non-compliance for reasons that will be discussed below.

Required Forms and Specific Questions

To get started, we will focus first on the very basics — your Federal tax form — whichever version of Form 1040 that you are required to file.

1040/1040-SR — Schedule B

Individuals who meet the requirements set out by the Internal Revenue Service are required to file income tax returns on a yearly basis. This requirement is completed by filing a 1040 or a 1040A. Typically, taxpayers must fill out and attach Schedule B to their income tax return (1040/1040A) if they had any interest or dividends regardless of whether the source was foreign or domestic. 

If the taxpayer had a foreign account or received a distribution from, created or contributed to a foreign trust, they are required to complete section III of Form B. Section III is comprised of two questions (four if you count subparts). These four “simple” questions lead to a world of confusion.

1040 Schedule B — Question 7a

The first question, question 7a, requires you to report if you had a financial interest or signature authority over a financial account in a foreign country. The term financial account includes but is not limited to: 

  • Securities, brokerage accounts
  • Savings accounts
  • Demand accounts
  • Checking accounts
  • Deposit accounts
  • Time deposit accounts
  • Other accounts maintained with a financial institution or other person performing the services of a financial institution
  • Commodity accounts
  • Futures accounts
  • Options accounts
  • Insurance policies with cash value
  • Annuities
  • Shares in mutual funds or similar pooled funds

1040 Schedule B — Question 7a Line 2

If you answer “yes” to the first part of question 7a, you are then asked if you are required to file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR.) A logical person would probably search the IRS’s incredibly well-developed website for Form 114. This would leave the taxpayer confused. 

While there are vague references to the form on the IRS site, the form itself is not there because it is not an IRS form. FinCEN is officially known as the Financial Crimes Enforcement Network. It is a separate division of the Department of Treasury. FinCEN’s mission is to safeguard the financial system from illicit use and combat money 

laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities.[2] 

FBAR is designated as Form 114 in the FinCEN system.

[1]26 U.S. Code § 720126 U.S. Code § 7201

[2]http://www.fincen.gov/about_fincen/wwd/mission.html

1040 Schedule B — Question 7b

For the taxpayer who is still reading, after the grueling determinations under the two parts of 7a, 7b of Section III is a softball question. This question is actually straight forward if you figured out the answer to question 7a line 2. 

If you have to file FinCEN 114, you are required to divulge the name of the country in which the financial account or other holding is located. A taxpayer whose primary goal is other than to hide offshore accounts should be able to complete this question simply.

1040 Schedule B — Question 8

If you received a distribution from, created, or transferred money into a foreign trust, the IRS wants to know. They also want to know if you received more than $100,000 in gifts from an individual or foreign estate, or $15,102 from a foreign corporation or partnership. 

If you answer “yes” to this question, you must then determine if you need to file an IRS Form 3520. This question is somewhat deceptively simple unless you have generous relatives who reside outside of the U.S.

[1] The Bank Secrecy Act of 1970 31 CFR 1010.350

Form 3520/3520A

If you have an interest in a foreign trust, you may be required to also complete these forms. Form 3520 is an Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts and Form 3520A is an Annual Information Return of Foreign Trust with a U.S. owner.

The instructions for Form 3520 specify who must file. [1] You are required to file the form 3520 if:

1. You are deemed the responsible party for reporting a reportable event. A reportable event is:
  • The creation of a foreign trust by a U.S. person
  • The transfer of any money or property, directly or indirectly, to a foreign trust by a U.S. person, including a transfer by reason of death
  • The death of a citizen or resident of the United States if the decedent was treated as the owner of any portion of a foreign trust, or any portion of a foreign trust was included in the gross estate of the decedent
2. You are a U.S. person who, during the current tax year, was treated as the owner of any part of the assets of a foreign trust.
3. You are a U.S. person who received, directly or indirectly a distribution from a foreign trust, (including uncompensated use of trust property) or a related foreign trust held an outstanding obligation issued by you that you treated as a qualified obligation
4. You are a U.S. person who during the current year received either:
  • More than $100,000 from a nonresident alien individual or a foreign estate that you treated as a gift or a bequest.
  • More than $15,102 from a foreign corporation or partnership that you treated as a gift.

It should be noted that if you are required to file Form 3520 and it is due on the same date as your income tax return but gets sent to a different address, and not is included with your 1040 income tax filing.

Form 8938

This is the Statement of Specified Foreign Assets Form that you likely will have to file along with your income tax return if you must also complete an FBAR. U.S. citizens, resident aliens and certain non-resident aliens who have an interest in specific foreign financial assets and meet the filing thresholds must file this report yearly with their income tax returns. [2]

Here is a link to instructions provided by the IRS to guide you in completion of the form. 

To understand the differences between the FBAR and Form 8938, here is a chart which illustrates the comparison of requirements under both.

Form 8938 is required if the total foreign-held asset value was $50,000 on the last day of the tax year, or $75,000 at any time during the tax year. If you are married and file jointly with your spouse, the threshold is $100,000 on the last day of the year or $150,000 at any time during the tax year.

If your tax home is a foreign country under the IRS’s rules, an unmarried taxpayer is required to report only if their assets were more than $200,000 on the last day of the tax year or more than $300,000 at any point during the year. The threshold for married taxpayers living abroad is $400,000 on the last day of the tax year or $600,000 at any time during the tax year.

You must report the maximum value of the foreign financial assets or financial accounts with foreign financial institutions, and certain other foreign non-account investment assets. The assets are reported in U.S. dollars using the end of the taxable year exchange rates. 

Like FinCEN Form 114, there are reporting exemptions, but they differ from those of form 114. You do not have to report an account held in a foreign branch of a U.S. bank. Domestic mutual funds that invest in foreign stocks or securities or private equity funds are exempt. If held directly, personal property, such as jewelry and art, real estate, currency, and precious metals held abroad are all exempt.

[1] Internal Revenue Service Instructions for Form 3520.
https://www.irs.gov/pub/irs-pdf/i3520.pdf 

[2] Internal Revenue Service Instructions for Form 8938. http://www.irs.gov/pub/irs-pdf/i8938.pdf

Form 5471

In addition to having an interest in a foreign account, you may own an interest in a foreign entity. If so, you may have obligations to file Form 5471 — Information Return of U.S. Persons With Respect to Certain Foreign Corporations. The rules for 5471 can be somewhat complicated, and you should determine whether or not you may fit in the category of individuals who have an obligation to file. 

One example that would trigger an obligation to file a Form 5471 is if a corporation has had more than a 10 percent change in ownership. However, there are categories which apply to officers of a corporation as well so you may want to look further to determine whether your particular circumstances require you to file. 

Remember, failing to file a required disclosure form that is attached to your 1040 form can mean that the statute of limitations will be open indefinitely — not just for the form, but for the entire tax return. This form carries a $10,000 fine per form per month with a continuation penalty maximum of $50,000.

Form 5472

This form is required in cases of a 25 percent foreign ownership of a U.S. corporation; or a corporation engaged in a U.S. trade or business. The penalty under this form is $25,000 per year with a $25,000 continuation penalty per month.

Form 926

This is a return that is required to be filed by a U.S. transferor of property to a foreign corporation. 

 

Penalties

An area of difficulty that has arisen with regard to FBAR cases is the ambiguity of penalties potentially faced by an individual in violation of disclosure requirements. The statute tells us that there are two categories of penalties that may be imposed:

  1.   Willful penalty
  2.   Non-willful penalty

Aside from criminal sanctions, a willful penalty that is the greater of $100,000 or 50 percent of all non-disclosed accounts, per year; and for every year for which the statute of limitations is open. This means that the statute allows the IRS to fine a taxpayer up to 300 percent of the amount of an account in violation of disclosure obligations. 

Of course, these large fines have had their critics who have raised the issue of whether these excessive fines taken to their full extent under the statute, may violate a taxpayer’s rights under the Eighth Amendment. 

Perhaps as a recognition of this complaint, the IRS has generally adopted a policy of limiting actual implementation of these 50 percent penalties to once or twice over the collection period; which is still burdensome enough to drain your account entirely.

Willful Penalties

While cases of intentional concealment or fraud are generally distinguishable as willful violations, often there are cases where the distinction between a willful and non-willful violation can be difficult to assess without professional guidance. Depending on the circumstances surrounding the taxpayer’s failure to file, the courts may find that a taxpayer is “willfully-blind” to their filing obligations. 

This means that the taxpayer made a conscious effort to avoid learning about their FBAR reporting obligations. For example, if the taxpayer failed to inform his tax preparer about any foreign accounts he owns, a court may find that the taxpayer willfully avoided learning about their disclosure obligations.

On the other hand, if a taxpayer did inform their tax preparer, the court may look a bit deeper to the facts of the circumstances that led to the taxpayer’s failure to file. The court looks to determine whether or not the taxpayer had reasonable cause; does the taxpayer have a good reason that would allow the court to excuse the violation? 

For example, if the taxpayer told his tax return preparer about the foreign accounts and the preparer misinformed the taxpayer – was it reasonable for the taxpayer to rely on the tax preparer’s advice?

This can be a very fact-specific inquiry. If the return preparer was unpaid or known to be inexperienced, or if you had filed an FBAR in a previous year, these facts will not likely weigh in your favor. 

The court’s rulings in FBAR cases have indicated that the reasonable cause defense that is usually available in other contexts is severely limited in FBAR cases. However, if you are able to give a valid and acceptable reason as to why you violated the FBAR filing requirement, you will qualify for a non-willful penalty.

Non-Willful Penalties

A non-willful penalty carries a fine of $10,000 per year you are in violation. The non-willful penalty has been limited to a $10,000 penalty per open year, regardless of the number of accounts. Unfortunately, the government has taken the position that the fine can be applied to each non-disclosed account. 

As mentioned previously, the IRS has generally operated under a circumscribed policy limiting the application of the penalty to its full extent. However, depending on the facts and how egregious the violations are, the IRS may push the penalties further than they normally do. The IRS has had cases go in their favor in this area, but these FBAR penalty cases are still being litigated.

For now, this means that if you have three foreign bank accounts that fall under FBAR reporting obligations, you could potentially be fined $30,000 (3 accounts x $10,000 fine) for every year that you did not fulfill your filing requirements. This stacking of penalties under the non-willful penalty has imposed a pretty severe punishment on taxpayers who unintentionally failed to file. 

The IRS is serious about FBAR compliance. The possibility of being penalized to this extent provides enough incentive to file an FBAR, even in cases where you are not entirely convinced that your circumstances require doing so. It is better to make the filing beforehand, and square away the rest later.

Criminal Penalties Other Than FBAR Penalties

The Internal Revenue Service has an arsenal of potential criminal charges:

  • Failure to file an income tax return – IRC §7203 – not filing a required return in a timely manner. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000.
  • Filing a false return – IRC §7206(1) – filing a return containing false information. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000.
  • Tax evasion – IRC §7201 – willfully attempting in any manner to evade paying tax. A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000.
  • Tax perjury – IRC §7206(1) – willfully signing false returns under penalty of perjury. A person convicted of perjury is subject to a prison term of up to five years and a fine of up to $250,000.
  • Tax obstruction – IRC §7212(a) – corruptly impairing the lawful function of the IRS. A person convicted of obstruction of justice is subject to a prison term of up to and not more than 10 years or a fine of up to $250,000.
  • Conspiracy – 18 U.S.C. §371 – conspiring to commit one of the above crimes or impairing the IRS from enforcement. A person convicted of conspiracy to commit one of the above offenses or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
  • Willfully failing to file an FBAR – 31 U.S.C. §5322 – Knowing of the obligation to file the FBAR and not doing so. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

Willfully filing a false FBAR – 31 U.S.C. §5322 – Filing a FBAR with inaccurate information. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

 

How Long Does the IRS Have to Collect? (Statute of Limitations)

A “statute of limitations” is a law which defines the time within which a legal action may be brought against a person or entity for an act or omission. Once that period of time has run out it is said that the statute of limitations has “tolled” which means you are exempt from having a legal action, civil or criminal filed against you. 

With regard to tax matters, the statute of limitations is the time period that the government can come back against you criminally or civilly regarding issues concerning your tax returns.

The HIRE Act has made changes to the statute of limitations for informational form penalties. The changes only apply to the informational returns which are required to be submitted along with the federal income tax return; not the FBAR. The FBAR statute of limitations is six years.

The statute of limitation for attachments such as Form 8938 or 5471 would be three years because this is the statute of limitations that is assigned to the income tax report. If you fail to file Form 8938 or fail to report a specified foreign financial asset that you are required to report, the statute of limitations for the tax year may remain open for all or a part of your income tax return until three years after the date on which you actually file Form 8938.[2]

If a completed form 3520 is not filed by the due date, including extensions, the time for assessment of any tax imposed with respect to any event or period to which the information required to be reported in Parts I through III of such Form 3520 relates, will not expire before the third anniversary of the date on which the required information is reported.[3] 

However unlike the FBAR, which has a statute of limitations of six years whether or not you file the form, the HIRE Act made it so that the clock does not start running for the income tax and corresponding forms until the taxpayer files the appropriate informational return. So, if you never file the delinquent return the statute of limitations does not start to run.

In addition, the statute of limitations on the income tax return itself will not start to run until you complete the appropriate forms. This means that the statute of limitations on your income tax will also never time out until you fill out the missing forms. 

Simply put, if you never file the delinquent return, the statute of limitations never starts to run. This period can be extended if you do not include in your gross income an amount relating to one or more specified foreign financial assets. If the amount you omit is more than $5,000, any tax you owe for the tax year can be assessed at any time within six years after you filed your return.

This could lead to further liability, so it is important to fill out the appropriate disclosures as soon as possible so the three-year countdown can begin.

Whether you are in appeals or litigation, the government may request that the taxpayer agree to extend the statute of limitations. It may be in your favor to extend in FBAR cases. 

This is because both you and the government may need time to prepare your argument and evidence, and there is no interest on FBAR penalties until the actual penalty has been assessed. 

Refusing to grant the statute of limitations extension will result in the IRS making an assessment of the penalty. Because appeals and litigation may take years to get through the process, you do not want interest and other penalties to accumulate on the FBAR penalty during that time. 

For this reason, it is best to work with the IRS agent assigned to your case, and sometimes that means signing the statute of limitations extension in order to avoid the penalty from being assessed. This is another situation where you would benefit from the advice of an experienced tax attorney.

[1] Internal Revenue Manual – IRM§ 4.26.16.4.5.3.5

[2] Internal Revenue Service Instructions for Form 8938. http://www.irs.gov/pub/irs-pdf/i8938.pdf

[3] Internal Revenue Service Instructions for Form 3520. http://search.irs.gov/search?q=3520&output=xml_no_dtd&proxystylesheet=irs_portals_frontend&client=irs_portals_frontend&oe=UTF-8&ie=UTF-8&num=10&ud=1&exclude_apps=1&site=default_collection&numgm=5&requiredfields=-archive%3A1

 

Appeals

If you cannot come to an agreement in resolving the issue in the IRS examination stage, you still have a right to take your case to Appeals. As mentioned above however, it may currently be in your best interest to work with the IRS agent and not depend on the case to go your way in Appeals.

The restructuring of IRS Appeals paired with budget cuts have undercut the traditional functionality of the Appeals division. Additionally, IRS agents have a surprising amount of discretion in this area; discretion that the Appeals division has been reluctant to wield.

Pre-assessment vs. Post-assessment

There are two ways for a case to go forward from the examination stage to appeals — pre-assessment or post-assessment. As mentioned previously, there is no interest that accrues on the FBAR penalty until the penalty is assessed. 

This means you are incentivized to work closely with the agent assigned your case in the examination stage to ensure that if your case does need to continue on to appeals, 

it gets there pre-assessed. It is better for the case to go forward in pre-assessment. However if it does go forward to post-penalty assessment, there is an additional requirement that the Department of Justice must approve any settlement agreement that may be reached. 

This Department of Justice approval is not required at the examinations stage, which provides another reason to try and work to resolve the issue with the IRS agent.

Litigation

If Appeals does not resolve the dispute, you still have the option to pursue litigation. There is currently much litigation for ongoing FBAR cases. Depending on how these cases turn out, you may or may not need to pursue the litigation option.

 

Resolution Programs Available

You have options available to help you resolve your tax and foreign account reporting obligations if you voluntarily come into compliance before the IRS is aware. Once a civil investigation is started, it may be too late to get a favorable deal and avoid heavy penalties. 

To allow taxpayers with international tax issues get back in compliance, the IRS has a number of programs and options available.

Streamlined Programs

One option to consider is the Streamlined Programs. These programs allow you to come into the program if you have made a non-willful violation. Remember, this is a very fact-sensitive determination, and you likely should seek tax counsel’s advice on whether your circumstances would allow you to qualify. 

The benefit of these programs is that you can walk away with only paying a 5 percent penalty after making full disclosures. However, you should really approach this with caution because there are no guarantees and an audit may accompany to verify that the disclosures are full and complete. 

The requirements for this program are:

  • Available to U.S. persons and estates only
  • There has been a failure to report foreign financial assets or pay all tax due in respect of those assets
  • The taxpayer is able to certify that the failures to comply were non-willful violations
  •  The taxpayer is not currently under IRS examination or criminal investigation
  • The taxpayer has a valid Social Security of Taxpayer Identification Number

Streamlined Domestic Offshore Procedures (for Residents)

Forms needed: Form 14654

Additional Steps: You must file amended tax returns and file all required information returns (for example: 3520, 3520-A, 5471, 5472, 8938, 926, and 8621)

You must also file any delinquent FBARs for any of the last six years missing a filing.

Streamlined Foreign Offshore Procedures (for Non-Residents)

Forms needed: 14653

Additional Requirements: The taxpayer was outside of the U.S. for at least 330 full days for one of the streamline years

If you pay the full amount of tax and interest at the time you submit these missing or corrected returns, you can also avoid the 5 percent penalty.

Because you are required to make a certification that the failure to complete the appropriate disclosures or tax obligations, be sure that this is the appropriate resolution for your circumstances.

The IRS has already ended the OVPD Program, and has stated that they may end the streamlined programs. If you think this may be a viable option for you, do your best to take advantage of the program soon.

 

 Delinquent Filing Procedure Option

Informational Return Delinquent Filings

If you are not in need of the Streamlined Procedures because you do not owe additional tax, and you have reasonable cause for not filing an informational return, you may file the delinquent information returns along with an explanation of the facts that support your claim of having reasonable cause for failing to file on time. You must do this before a civil examination or criminal investigation has been opened.

If you must file a delinquent form 3520 and 3520-A, you will file it according to the instructions on the form which can be found here.

For all other delinquent information returns (e.g., 5471, 5472, 8938, 926, and 8621): attach the completed forms and reasonable cause supporting fact statement to an amended tax return and file according to the instructions for an amended return; which can be found here.

FBAR Delinquent Filings

Some taxpayers may not need to use the Streamlined Filing Compliance Procedure options, but still may have a delinquent FBAR. FinCEN has established a procedure to address this problem.[1]

The solution is available to those who:

  1. Have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN) (Form 114, previously Form TD F 90-22.1)
  2. Are not under a civil examination or a criminal investigation by the IRS, and
  3. Have not already been contacted by the IRS about the delinquent FBARs

Filing a FinCEN 114 or FBAR

Time is of the essence when dealing with a delinquent FBAR.

A taxpayer who has not already been contacted should immediately file the delinquent FBARs electronically according to the instructions on the FinCEN website

The filing must include a statement explaining why the FBARs were filed late. Professional counsel should be retained to assist in the preparation of this letter.

On the cover page of the electronic filing, you will be required to select from options as to the reason for the late filing. If you are absolutely unable to file electronically you should contact FinCEN’s Regulatory Hotline for guidance concerning alternatives.

Keep in mind FinCEN form 114 (the FBAR) is not an IRS filing.

The IRS will not impose a penalty for the failure to file the delinquent FBARs as long as you properly reported the income on your U.S. tax return and paid the tax on the income from the foreign financial account. 

You will also be exempt from a failure to file penalty as long as you have not otherwise been contacted regarding an income tax examination or received a request for delinquent returns for the years in which the delinquent FBARs are submitted.  

The audit process with regard to FBARs is similar to the selection process in place for tax returns. The key to curing the delinquency is to get the FBAR filed before FinCEN or the IRS comes looking for it.

 

Delinquent International Informational Returns Submission Procedures

Taxpayers who do not need to use the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns could still have additional issues. If the taxpayer:

  1. Has not filed one or more required international information returns
  2. Had reasonable cause for not timely filing the information returns
  3. Is not under a civil examination or a criminal investigation by the IRS and
  4. Has not already been contacted by the IRS about the delinquent information returns

They should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file in a timely manner.  

As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion.  If a reasonable cause statement is not attached to each delinquent information return filed, penalties may be assessed in accordance with existing procedures.

Required Attachments for Amended U.S. Tax Returns

All delinquent international informational returns other than Forms 3520 and 3520-A should be attached to an amended U.S. tax return and filed according to the applicable instructions for the amended return.  All delinquent Forms 3520 and 3520-A should be filed according to the applicable instructions for those forms.  

A reasonable cause statement must be attached to each delinquent informational return filed for which reasonable cause is being requested. Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.

Similar to Informational Return Delinquent Filings, you must include a statement that explains why you have reasonable cause; and you must take action before being contacted by the IRS about the delinquent FBAR(s).

Delinquent FBAR disclosures are made electronically. This must be done on the FinCEN BSA e-filing system. You may find additional instructions from the IRS here.

Keep in mind that any of these filings can be selected for audit, so be sure your reasonable cause has sufficient support and your disclosures are complete! 

If you should find yourself in need of further assistance, please feel free to reach out and set up a consultation with our experienced Senior Counsel at Brotman Law.

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