IRS’s Foreign Filing Requirements and Disclosure Programs: A Summary
Globalization has made an increasing number of individuals and businesses subject to foreign filings, requiring them to report foreign assets and income. The following filings are mandatory for U.S. citizens, lawful permanent residents, and individuals who have income from foreign sources or have an interest in foreign financial accounts or assets.
FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR) (formerly TD F 90-22.1), reports a financial interest in, or signature authority over, one or more financial accounts in a foreign country with an aggregate value of more than $10,000 at any time during a particular year.
Form 8938, Statement of Specified Foreign Financial Assets, is used if the taxpayer holds specified foreign assets above certain thresholds.
Form 5471, Information Return of US Persons with Respect to Certain Foreign Corporations, is used to report specific information for US persons who are officers, directors, or shareholders in certain foreign corporations based on varying criteria.
Schedule B, Interest and Ordinary Dividends, of Form 1040, U.S. Individual Income Tax Return, reports and taxes income earned from foreign financial accounts where there was a financial interest in or signature authority over said financial account (such as a bank account, securities account, or brokerage account) located in a foreign country.
Taxpayers who fail to report foreign-source income and/or fail to report foreign financial assets may face civil penalties and possibly a criminal investigation. The Internal Revenue Service has recently made major changes to its offshore disclosure procedures to encourage U.S. taxpayers with foreign financial assets to comply with their tax obligations.
The two main routes the IRS offers for disclosure are the Offshore Voluntary Disclosure Program (OVDP), and the
filing compliance procedures of the Streamlined Domestic Offshore Programs (SDOP) and the Streamlined Foreign Offshore Programs (SFOP).
Taxpayers who wish to utilize the OVDP will generally be granted protection from criminal liability. However, they are required to amend or file the most recent eight tax years for which the due date has already passed. Penalties are levied at 27.5 percent of the highest aggregate value of OVDP assets during the period covered by the voluntary disclosure. This penalty increases to 50 percent if the taxpayer has an account at a bank identified by the IRS as being one that has helped facilitate tax evasion. There are many details the taxpayer needs to be aware of when going through this process and should consult a reputable tax advisor.
In comparison, the streamlined filing procedures require that the taxpayer non-willfully failed to file one of the forms listed above. For purposes of the streamlined procedures, non-willful conduct is defined as conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law. Taxpayers are required to amend or file the most recent three years for which the U.S. tax return due date has passed, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621), six years in case of FBARs.
Taxpayers are required to pay a five-percent penalty on the highest aggregate balance/value of the taxpayer’s foreign financial assets and they are required to complete and sign a statement certifying that the taxpayer is eligible for the program; that all required FBARs have been filed; that the failure to report all income, pay all tax, and submit all required information returns was non-willful; and that the penalty amount included with the filing is accurate. All tax due on the tax returns plus statutory interest for each of the late payment amounts must be paid with the filing.
While the streamlined procedures may result in a significant reduction in penalties, the risks involved are very high, and in the event that the IRS rejects your application, it has all the ammunition it needs to assess extremely high civil penalties or even recommend criminal prosecution to the Department of Justice. Taxpayers with unfiled foreign bank account reports or unreported income from offshore accounts would be wise to seek professional advice to evaluate their case, explain the options, and develop a defense strategy.
Fred Bara has been a CPA for over 15 years, nine at WeiserMazars. Fred has extensive knowledge of the tax issues small business owners face.
Rachana Mody has over six years’ experience in public accounting, providing services to closely-held IT consulting and professional services businesses and law firms.
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