Updated: Oct 5
I am sure you have all heard and read about Mr. Boris Johnson’s battle with the Internal Revenue Service (IRS). Mr. Johnson, as you know, had refused to pay the IRS bill on the gain from the sale of his home until earlier this year when he finally acquiesced and paid up the back taxes. Mr. Johnson’s case is a perfect illustration of the dilemmas faced by many of the 7.6 million US citizens living abroad as a result of a multi-year IRS crusade against secret offshore accounts.
The United States is one of only two countries in the world to levy tax based on an individual’s citizenship (in addition to residency). A US person (US citizen or a lawful permanent resident or more popularly known as a green card holder) who lives outside the US continues to have annual US income tax filing and financial disclosure obligations regardless of the fact that they could also be a citizen of another country and are compliant with that country’s tax filing requirements.
Although a US person may not owe any tax to the IRS largely due to foreign tax credits or the foreign earned income exclusion, noncompliance with other financial reporting obligations can amount to a sizeable penalty. For instance, US persons and other individuals who meet a certain criteria must annually report their direct or indirect interest in, or signatory or other authority over, financial accounts in foreign countries if aggregate balance in the accounts exceeds $10,000 by filing Form 114 – Report of Foreign Financial Accounts (FBAR). Wilful failure to file an FBAR can subject a taxpayer to a civil penalty equal to the greater of $100,000 or 50% of the total balance of the account for each year that the taxpayer wilfully failed to file the form. Criminal penalties may also apply. Other potential penalties may also be applied in addition to the above for failing to file a tax return, accuracy-related penalties, and fraud penalties, as well as penalties for failure to file some of the other required disclosures such as disclosures respecting to foreign trust or foreign corporations.
Since 2009, the IRS has offered several formal voluntary disclosure programmes or initiatives. These programmes have allowed qualifying US taxpayers (domestic and those living overseas) who were previously non-compliant with their tax filing and/or foreign bank account and asset reporting obligations, an opportunity to come forward and voluntarily comply with all their filing requirements in exchange for reduced penalty exposure and, in some instances, a promise that the IRS will not refer the taxpayers for criminal investigation.
In June 2014, the IRS announced several major changes to the Offshore Voluntary Disclosure Programme (OVDP) as well as to the Streamlined Filing Compliance Procedures (SFCP) (discussed later). Surprisingly (or not), the timing of the announcement came just weeks before the Foreign Account Tax Compliance Act (FATCA) came into effect on July 1.
Offshore Voluntary Disclosure Programme OVDP is available to taxpayers who wish to comply with their delinquent tax filing obligations and truthfully, timely and fully disclose to the IRS the existence of their previously undisclosed funds held in foreign jurisdictions, and who otherwise co-operate with the IRS. The OVDP is specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to wilful failure to report foreign financial assets and pay all tax due in respect of those assets. Primary benefits of the OVDP are (1) amnesty from criminal tax and FBAR prosecution, and (2) quantification of monetary penalties, thus eliminating possible exposure to multiple 75% civil tax fraud penalties, 50% of the account balance penalties applicable to willful failure to file FBARs and other high penalties.
The 2014 OVDP changes include: • Enabling taxpayers to submit voluminous records electronically (rather than on paper); • Increasing the offshore penalty percentage (from 27.5% to 50%) if, before the taxpayer’s OVDP pre-clearance request is submitted, it becomes public that the financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangements is under investigation by the IRS or Department of Justice (DOJ); and • Eliminating the reduced penalty percentage for certain non-wilful taxpayers in light of the expansion of the SFCP.
Applying for and obtaining a pre-clearance from the IRS is the first step in this process. Taxpayers wishing to participate in the 2014 OVDP must file: • 8 years of original or amended tax returns and pay back taxes and accuracy related or delinquency penalties; and • Original or amended reports of Foreign Bank Account Reports (FBARs) and pay a penalty based on the highest asset balance during the period of non-disclosure.
The overall penalty structure for the OVDP: • Accuracy or delinquency related penalty for each year – generally 20 to 25% of the total tax due • Interest on back taxes and penalty amounts • 27.5% of the total asset value in all unreported foreign bank account – calculated by reference to the year in which the value in the undisclosed foreign accounts was the highest. This penalty is in lieu of all other penalties that would otherwise apply.
Streamlined Filing Compliance Procedure From September 2012, certain non-resident US taxpayers who were deemed to present a “low compliance risk”, including dual citizens and US green card holders living abroad, have been provided the opportunity to become compliant under the ‘Streamlined Filing Compliance Procedures (SFCP)’. Taxpayers participating in the SFCP must file 3 years of delinquent US tax returns including any required information returns (Form 3520, Form 8621, Form5471) along with 6 years of Foreign Bank Account Reports (FBARs), and pay any tax and interest due. No late filing or late payment penalties apply to taxpayers in the SFCP.
The 2014 SFCP changes include: • Expanded to include taxpayers who are resident in the United States and may have filed a US tax return previously • Risk assessment (low compliance risk) criteria has been eliminated • Taxpayers submitting their information under the SFCP must certify that their failure to comply fully with their US tax obligations was not due to fraud or wilful conduct • Introduction of Form 14653 – Certification by US Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures and Form 14654 – Certification by US Person Residing in the United States for Streamlined Domestic Offshore Procedures • US resident taxpayers entering the SFCP will be subject to a penalty of 5% of the highest aggregate balance/value of the taxpayer’s foreign financial assets during the disclosure period.
The Penalty Structure For The Streamlined Programme: • Streamlined submissions for non-resident US persons will not be subject to any late payment or offshore account penalties • Domestic streamlined submissions will be subject to a 5% offshore penalty based on the value of the taxpayer’s unreported offshore assets.
Streamlined submissions will be processed on the same basis as other tax returns unless they are chosen for audit. Audited filings will not be subject to additional penalties unless the IRS determines that the taxpayer was willfully noncompliant or there is evidence of fraud.
IRS also does not issue closing letters to taxpayers participating in the SFCP unless the return is chosen for an audit. It is important to note that there is no protection against possible criminal prosecution by complying under the SFCP.
Other Less Talked About Compliance Procedures: • Quiet filing of delinquent returns – It has been IRS’ historic practice not to pursue criminal prosecution and not to seek tax or civil penalties for earlier years if six years of delinquent or amended returns and FBARs are filed to correct prior errant filings. Such ‘voluntary disclosures” outside of the OVDP may (not certain to) eliminate exposure to criminal tax prosecution but does not quantify penalty risk (possible assertion of multiple 50% FBAR willful failure penalties) if the returns are audited, nor does it necessarily eliminate exposure to civil penalties for years prior to six years of return for which the statute of limitations is open. It is important to note that the civil statute remains open indefinitely for years for which no return has been filed or fraud was involved. IRS has warned that it is on the lookout for quiet disclosure returns so that they can subject such returns to the audit process • Going Forward Compliance – Some taxpayers may choose to come into US tax compliance on a going forward only basis (and not correct past year delinquent or errant filing). This method involves full exposure to criminal penalties and tax and civil penalties for all prior years until applicable statutes of limitations burn off. The IRS has also warned that it is giving close scrutiny to first-time filers in this context • Do Nothing – Turn ostrich – By far the riskiest proposition and definitely not recommended in view of the new FATCA requirement for foreign financial institutions to identify US accountholders (and US owners of entity accountholders) to the IRS, doing nothing involves greater risk than ever with respect to the past years of non-compliance.
Considering the magnitude of the risk involved in terms of the penalty exposure and the complexities of the US Internal Revenue Code (IRC), it is highly recommended that you consult with an experienced US tax accountant to find the best alternative for your US compliance needs.
By Wayne Bewick CPA CA, CPA (Illinois) & Richard Watts-Joyce CTA, ATT, Global Tax Network.
Global Tax Network is a specialist provider of UK and US tax services with offices in London and Guildford, staffed by UK Chartered Tax Advisers and US Certified Public Accountants specialising in cross border tax planning and compliance issue.
For further information please contact Wayne Bewick or Richard Watts-Joyce on 0207 100 2126 or email: firstname.lastname@example.org.