Taxpayers with offshore financial assets exceeding $10,000 at any point in the year must annually disclose those assets to the IRS. Even if the money in the account isn’t yours, you must still report if you have signature authority over a reportable account. Reporting is done on Schedule B of the Individual Income Tax return. The account must also be declared on a separate FBAR form. FBAR is short for Report of Foreign Bank and Financial Accounts. That form is a Treasury form, Form 114 (formerly TD F 90-22.1). Depending on the value of those accounts, a Form 8938 (FATCA form) must also be filed.
If that sounds confusing, it is. The IRS and Financial Crimes Enforcement Network have different filing thresholds and definitions of qualifying accounts. For example, an offshore hedge fund may be reportable on one form but not the other. Luckily, there are a growing number of CPAs and enrolled agents with foreign reporting experience. (We are still not ready to trust tax preparation software or nationwide tax reporting franchise operations.)
The IRS estimates that millions of U.S. taxpayers are not in compliance. Many of those folks are expats living overseas, dual nationals and foreign born Americans who keep accounts in their “home” country. We are frequently asked what options these folks have to come into compliance.
Great question. There are but 4 answers.
Believe it or not, that remains a popular option. And incredibly foolish.
The penalties for a missing FBAR can include prison and huge civil penalties that could exceed the value of the entire account! While criminal prosecutions are thankfully rare, 50% penalties are the norm. That’s 50% of the highest account value!
The IRS and Justice Department have become incredibly efficient on finding folks with unreported accounts. (We have many posts on this issue… just use our search engine in the upper right corner of our Due Diligence blog. Folks reading this on TaxConnections can find also plenty of info from our prior posts.)
Beginning next year, the Foreign Account Tax Compliance Act (FATCA) requires foreign financial institutions to research their client base and identify those account holders or signers who are U.S. taxpayers. Once identified, the information is sent to the IRS.
A variation on the “do nothing” option is to close the account and repatriate the money. It sounds great on paper but the IRS is asking banks to perform a “look back”. Unless you closed the account years ago, its probably too late. More importantly, the IRS considers this trick to be an affirmative act of tax evasion. Do this and the likelihood of a prison sentence increases substantially.
Want another bad idea? Try a Quiet Disclosure. That trick isn’t likely to work either.
A “quiet disclosure” occurs when the taxpayer files all of his or her missing returns to an IRS Service Center hoping the big bureaucracy simply processes the returns and doesn’t ask any questions. That worked in the past but both the IRS and US General Accounting Office know about it. The IRS has the ability to program its tax processing software to identify individuals who late file certain returns. On its offshore reporting page, the IRS has said that it strongly discourages these so called quiet disclosures. Get caught and you will likely face those harsh 50% penalties.
“New” disclosures are a variant of quiet disclosures. In a new disclosure, the taxpayer just files the present year FBAR and makes the other required disclosures for the present year only. Those returns have a much higher chance of being audited. Already, the General Accounting Office has said that the number of new filings is rising at a rate higher than the number of new accounts. That means people are not bothering to file the older missing returns. Once again, the risks and penalties are high if caught.
IRS Amnesty Program – Offshore Voluntary Disclosure Program
This is the IRS’ preferred method of coming into compliance. Under the program rules, taxpayers who participate in the “OVDP” process pay a reduced 27.5% penalty, avoid an audit and avoid prosecution. If you knew about your offshore reporting obligations but didn’t think you would be caught, OVDP is a great choice.
The program requires a great deal of paperwork. It is also lengthy; the average time to complete is well over a year, although once the IRS accepts you, there is little risk of problems.
The amnesty program has some interesting opportunities to reduce penalties even more. If you are an expat with no US income, have accounts that don’t exceed $75,000 or inherited an account that you don’t use, you may qualify for even lower penalties. Some pension like accounts may also be completely excluded.
Voluntary or Traditional Disclosure
A traditional disclosure means that you come forward directly to the IRS and negotiate the penalties. Filing a return with a service center does not qualify. There are no guaranties with traditional disclosures. That means you may pay much higher penalties than that offered by OVDP. Expect an audit too.
On the plus side, if you can demonstrate your failure to file FBARs and report the account on your tax return was not willful, you may qualify for a flat fee $10,000 penalty or even no penalty.
Traditional disclosures are not for the faint at heart. If you are going this route, be sure you know what you are doing and seek an experienced FBAR lawyer.
We recommend that people that are considering the traditional disclosure route start in the OVDP amnesty program. Why? Because you can always opt-out of the amnesty program but once you start elsewhere you can never later enter it.
This post offers general information. The offshore reporting rules are very complex. We strongly recommend that you find an experienced tax attorney to help you navigate these dangerous waters.
If you wish a free consultation to discuss your options, give us a call. All inquiries are protected by the attorney-client privilege and kept in strict confidence.
About the author. Brian Mahany is a tax attorney / FBAR lawyer specializing in foreign reporting for individuals and corporations. He is admitted to the United States Tax Court and writes for TaxConnections as well as his own blog, Due Diligence. He can be contacted at email@example.com or by telephone at (414) 704-6731 (direct). Most services can be handled for a flat fee.