U.S. Tax Compliance Concerning Foreign Income, Accounts, and Entities
United States citizens and residents (“U.S. persons”) need to comply with two U.S. statutory schemes concerning foreign income, accounts, and entities.
The Bank Secrecy Act requires U.S. persons to report foreign financial accounts. Specifically, a U.S. person with a financial interest in, or signature authority over, foreign financial accounts with an aggregate balance of $10,000 or more during a calendar year must file a FinCEN Form 114, Report of Foreign Bank and Financial Accounts, (“FBAR”), reporting the foreign accounts for that year. An FBAR for a given calendar year is due on the ensuing April 15th, though it may be extended to October 15th.
Penalties apply for failure to timely file an FBAR. The statute of limitations on assessment of the penalties is six years, and it begins running on the FBAR due date, whether the FBAR was filed or not. If delinquent FBARs are filed before the Internal Revenue Service discovers the delinquency, the IRS will not penalize the taxpayer. Therefore, a taxpayer with unfiled FBARs due in the preceding six years should file them as soon as possible.
The Internal Revenue Code requires U.S. persons to report worldwide income on a U.S. income tax return. The Internal Revenue Code also requires U.S. persons to file certain international information returns, including Form 8938, Statement of Specified Foreign Financial Assets; Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations; 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; and Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. Forms 8938, 5471, and 8621 are part of, and are filed with, with the taxpayer’s U.S. income tax return for the tax year.
Forms 3520 and 3520-A are signed separately under oath. They may be filed with the taxpayer’s income tax return, or separately.
Forms 8938, 5471, 8621, and 3520 for a given calendar year are due to be filed by the ensuing April 15th. They may be extended to October 15th by filing a Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, by April 15th.
A Form 3530-A for a given calendar year is due to be filed by the ensuing March 15th. It may be extended to September 15th by filing a Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, by March 15th.
Penalties apply for failure to timely file a U.S. income tax return, for underreporting of tax on a U.S. income tax return, or for failure to timely file a U.S. international information return. The income tax assessment statute of limitations is three years. It begins running when the taxpayer files the income tax return in question.
The statute of limitations on assessment of a penalty with respect to Form 3520-A is three years. It begins running when the taxpayer files the Form 3520-A.
Internal Revenue Service voluntary disclosure programs are available for a taxpayer to avoid or mitigate penalties in becoming compliant with the Internal Revenue Code concerning foreign income, accounts, or entities. The programs are available only if the taxpayer’s noncompliance was due to reasonable cause and not willful neglect. The programs are truly voluntary—they are not available if the IRS is conducting a civil examination or criminal prosecution of the taxpayer’s tax returns, or if the IRS has contacted the taxpayer concerning his noncompliance.
If the taxpayer has not underreported tax with respect to foreign income, accounts, or entities, then the taxpayer can become compliant by means of the Delinquent International Information Return Submission Procedures (“DIIRSP”). Under the DRIISP, the taxpayer must file all delinquent international information returns due for all prior years. There is no penalty under the DIIRSP.
If the taxpayer did underreport tax with respect to foreign income, accounts, or entities, the taxpayer may become compliant by means of the Streamlined Compliance Procedures. Under the Streamlined Compliance Procedures, the taxpayer must file amended U.S. income tax returns as needed for the last three years, and pay tax and interest on the tax. The taxpayer must also pay a “miscellaneous Title 25 offshore penalty” equal to five percent of the taxpayer’s highest aggregate balance of foreign financial accounts as of the end of each of the preceding six years. There is no miscellaneous Title 25 offshore penalty if the taxpayer qualifies as a nonresident of the U.S. A taxpayer qualifies as a nonresident of the U.S. for this purpose if, in at least one of the last three years, the taxpayer satisfies two tests: (1) the taxpayer was physically not present in the United States for at least 330 full days; and (2) the taxpayer did not have an abode (domicile) in the U.S.
A taxpayer can be prosecuted for willfully failing to file an income tax return; willfully, materially underreporting tax on an income tax return; or willfully failing to failing to file an FBAR. Such prosecutions are rare. In my experience, most noncompliance in this area is not willful. The law in this area is unclear. Proving willfulness is a heavy burden; I would never presume that a client was willful. But if there is a genuine concern that noncompliance concerning foreign income, accounts, or entities was willful, and the taxpayer otherwise qualifies to make a voluntary disclosure, the taxpayer could consider the IRS’ Voluntary Disclosure Practice (“VDP”). Under the VDP, the taxpayer files delinquent or amended FBARs, income tax returns and international information returns as needed for the last six years. The taxpayer must pay or arrange to pay tax and interest due for the last six years. The taxpayer must submit to an audit for the last six years. At closing of the case, the taxpayer will owe a substantial penalty. VDP is rarely if ever appropriate.
This article is but an overview of foreign accounts compliance. If you have an issue of U.S. tax compliance concerning foreign accounts, income, or entities, you should seek the assistance of competent counsel who has handled many such cases.