by Brian Mahany
On September 1st, the IRS implemented new procedures to help “low risk” taxpayers with undisclosed foreign accounts come into compliance. Eligible taxpayers can avoid all foreign reporting penalties (although if you are found to be ineligible, it’s too late to opt in to the regular amnesty program.) The IRS is making a last ditch effort to reach the hundreds of thousands of taxpayers with unreported foreign accounts.
For many years, federal law has required holders of most foreign bank and brokerage accounts to annually report their offshore holdings. Reporting is usually done both on the 1040 form (Schedule B) and by completing a Report of Foreign Bank and Financial Accounts (or FBAR). One without the other is not sufficient. Beginning in 2012, some taxpayers were also required to complete a FATCA form (Form 8938) as part of their income tax return.
The definitions of foreign financial asset differ between FBAR and FATCA as do the reporting thresholds meaning it is possible to need only to file one and not the other.
Failing to file an FBAR form annually is a felony. If the IRS believes you willfully failed to report your offshore holdings you could face a 5 year prison term and penalties of 50% of your highest account balance for each year the account was not reported!
Until now, non-filers had only two choices. Come into compliance through the amnesty program (called the Offshore Voluntary Disclosure Program or “OVDI” or “OVDP” for short) or do a traditional disclosure. The amnesty program carries a one time penalty of 27.5% for most filers based on just one year. The penalty is steep but the trade off is no prosecution (meaning no jail). If you acted willfully and simply hoped you wouldn’t get caught, OVDI may be the best deal around.
People who are confident they can demonstrate their failure to report was an innocent mistake were better off opting out of amnesty and going the traditional disclosure route. Unfortunately, there are no guarantees with this option and a traditional disclosure usually involves an audit.
Doing nothing has not been an option in recent years; the IRS has become really good at ferreting out unreported foreign accounts. Even those accounts opened in a nominee or false name. Beginning in 2013, foreign banks will now be supplying information on US account holders or those suspected of having ties to the U.S. Time is running out to come into compliance.
As of this weekend, the IRS has released a third option. For lack of a better term we call it OVDP – EZ. If you are a non resident / dual national and have little or no tax due, you are considered “low risk” and can take advantage of the new program. More on the threshold requirements below. Eligible filers need to amend / file tax returns for the last 3 years and FBARS for the past 6 years. If you are found to be low risk, expect no penalties for failing to report the accounts. That’s a substantial savings from the typical amnesty penalties.
Of course, there is a hitch. Because it is a brand new program, there is no way of accurately predicting how the IRS will differentiate “low risk” (and therefore eligible) from “high risk.” Once you elect to proceed with the new streamlined simplified program, it doesn’t appear you can change your mind and later get into the amnesty program. That means taxpayers and their advisers need to be sure of what they are doing when they make the election.
So what defines a low risk taxpayer?
Thus far we know that if a taxpayer that has less than $1500 in tax due in each of the years, they may be eligible. That means if your unreported accounts generated $10,000 in interest income which yielded $1400 in tax, you are okay. With interest rates very low in recent years, it is possible to have a fairly large interest bearing account and still meet the tax thresholds.
If the only requirement were a tax threshold, the decision to file through the new program would be pretty straightforward. As with many IRS programs, there are requirements and a fair amount of gray area. This is where things get tricky. Vey tricky.
The IRS looks at a number of other factors to determine eligibility. They include:
- The overall income of the taxpayer
- Evidence of “sophisticated tax planning or avoidance”
- “Material economic activity within the United States”
- “Amount and type of United States source income”
- History of noncompliance with U.S. tax law
- Present audit activity
- Any of the newly filed returns seeks a refund
- Offshore income not reported to country of residence
- Offshore account not located in taxpayer’s country of residence
Additional guidance is forthcoming. If it resembles anything like the way the IRS handled unreported foreign retirement accounts, there could be several hiccups along the way until consistent guidance and standardized rules are available. Unfortunately, with foreign banks poised to begin reporting under the new FATCA law, taxpayers really can’t wait.
One thing we do know is that participation in the new low risk program does not guarantee a “get out of jail free” card like the full OVDI amnesty program. If the government disagrees with you and believes you are high risk or intentionally evaded your tax obligations, they can prosecute.
We also know that the new program does not eliminate an audit like OVDI does. The IRS is free to examine returns and ask questions.
Is the new program worth it? Tomorrow the program begins (it commenced over a holiday weekend) so it will be some time to see how the IRS puts the program into practice.
Many of our clients are dual nationals or foreign born Americans who simply send home money to family. The program unfortunately will not be a good fit for people earning money here in the U.S. but may be a great option for those living and earning overseas.
The risks under the new program are higher but the IRS is not interested in prosecuting holders of small foreign accounts and people living outside the United States. Of course, people whose foreign accounts never exceeded $75,000 may be able to take advantage of the small account rules under the existing OVDI amnesty program.
Announcement of the new plan has made the decision as to which program to choose more difficult. All the experts agree, however, that you must do something. If the IRS finds you first, all bets are off. Whatever program you decide, hire a competent lawyer or CPA well versed in offshore reporting requirements.
The tax lawyers at Mahany & Ertl have helped many foreign born Americans, dual nationals, American expats and Americans with foreign accounts navigate the complex waters of offshore reporting. OVDI, FBARs, amnesty, opt-outs, offshore partnerships and trusts, and foreign gifts… we can help. In most instances, are services are available for a reasonable flat fee and we stand behind our work. All the way to the United States Tax Court if need be.
For more information, contact attorney Bethany Kroes at or by telephone at (414) 223-0464. All inquiries are protected by the attorney – client privilege and kept in strict confidence, even if you never hire us.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; Minneapolis, Minnesota & coming soon, San Francisco, California (tax only). IRS services available anywhere in the U.S. and worldwide.