by Brian Mahany
The phones continue to ring off the hook as the deadline for the IRS’ last chance offshore tax amnesty looms. (This amnesty program, called the Offshore Voluntary Disclosure Initiative or OVDI is the third such last chance initiative offered by the IRS over the last 10 years.) Frequently we are asked two questions, “Will I get caught if I don’t report my offshore accounts?” and “What are the penalties if I get caught?” The answer to the first question has been well covered in this blog, just type in “tax amnesty” in our own blog search engine for a list of OVDI stories and information.
So what are the penalties for unreported offshore accounts and income?
First, it is important to realize that there can be both penalties for not reporting the account (foreign accounts are reported on a Report of Foreign Bank and Financial Accounts or “FBAR”) and for not reporting income from foreign accounts. With that distinction in mind, let’s look at what Uncle Sam can do with unreported offshore income and accounts.
— The biggest penalty is prison. Failing to file an FBAR can be a felony. Same for not reporting offshore income. Failing to properly mark that tiny box on schedule B that asks about signature authority or ownership interest in foreign accounts can land you in prison too.
–The civil penalty for not reporting an offshore account is the greater of $100,000 or 50% of the total balance of the foreign account per violation. If the violation was not “willful”, the penalty may be 10%. Don’t relax yet, the IRS takes the position that by filing a tax return, you have an obligation to read all the instructions and should have known that foreign accounts need to be reported. They say “willful blindness” is enough to establish willfulness. Note also that the penalty is for each violation. FBAR’s are due yearly so one could easily owe far more than is in the account.
For this reason alone, the present amnesty program, as onerous as it appears, may be the only way of holding on to much of your money.
There are many other penalties too that can be imposed. Some are the traditional penalties applied whenever income is not reported. Some are unique to special offshore arrangements. We will start with the common ones.
–Fraud penalties. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, you can be assessed a penalty of 75% of the unpaid tax.
–Failure to File Penalty. Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5% of the balance due, plus an additional 5% for each month or fraction thereof during which the failure continues may be imposed. The penalties max out at 25%.
— Failure to Pay Penalty. If you don’t pay the amount of tax shown on the return, you can be assessed a penalty of 0.5% of the amount of tax shown on the return per month. The maximum penalty is capped at 25%.
–Accuracy & Negligence Penalties. If you have an underpayment due to negligence or disregard of the tax laws or your underpayment is substantial, you may be liable for a penalty of 20% or 40% of the underpayment.
These are some of the common ones. Unfortunately there are many more. Some additional penalties unique to offshore accounts and business interests are shown below.
–Foreign Trusts and Foreign Gifts. There are penalties for failing to file IRS Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.” If a foreign trust, the penalty is the greater of $10,000 or 35% of the gross reportable amount. If a gift, the penalty is 5% of the gift per month up to a maximum penalty of 25%.
— Foreign Trusts. There is a related penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Even if you have no transactions with a foreign trust you must still report your interest in the trust. If you don’t the penalty is 5% of the gross value of trust assets.
–Foreign Corporations. There is a penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. If you are an officer, director or shareholder in certain foreign corporations, you may have to file the form 5471 information return. The penalty for failing to file is $10,000 per month for each month the return is late to a maximum of $50,000 per return.
–Foreign Owned US Corporations. By now you are figuring out that if the word “foreign” is any way associated with your investment or account, there are many special returns and penalties. This one is quite complex so I wont go into the details but the penalties are also $10,000 per month.
–U.S. Transferor of Property to a Foreign Corporation Penalties. Taxpayers must report transfers of property to foreign corporations. The penalty is 10% of the value of the property transferred, up to a maximum of $100,000 per return. If the failure to report the transfer was intentional, the penalties can be much higher.
— Foreign Partnerships. Again, complex rules but if you are a U.S. taxpayer and invest in, transfer property to or sell an interest in a foreign partnership, Uncle Sam wants to know. Failing to properly report involves a penalty of $10,000 per month.
There are of course provisions to seek an abatement of penalties. Don’t expect the IRS to be very sympathetic with offshore investments, however. One notable exception is for taxpayers who relied on the advise of a CPA or lawyer. Unfortunately the offshore rules are so complex that even professionals have a hard time keeping track of the thousands of pages of regulations. If you received bad advice from your preparer, they may be on the hook for your penalties.
What I call “accidental” Americans – people born to U.S. parents but living abroad – and people that inherited a foreign account can sometimes obtain relief as well.
If you have any type of foreign or offshore account or investment, you really should speak with a lawyer well versed in offshore reporting. If you have an unreported foreign account, consider the offshore amnesty but remember that time is running out. You must act NOW.
For more information and a completely confidential consultation, contact attorney Brian Mahany at (414) 704-6731 (direct) or by email at
Mahany & Ertl, LLC -America’s tax lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine & San Francisco, California (coming soon). Services nationwide.