Important IRS voluntary disclosure initiative updates
By Robert A. Green, CPA with assistance from Mark Feldman, JD
Updates include 90-day extension, lower penalties for smaller problems, and opt-out opportunities.
The IRS updated its offshore voluntary disclosure initiative FAQ page on June 2, 2011.
Webinar: Click here for our June 30, 2011 Webinar recording on FBAR, the IRS voluntary disclosure initiative and other alternatives too.
The IRS seems to be pulling out the stops to encourage more taxpayers to come clean and join its 2011 offshore voluntary disclosure initiative by the Aug. 31, 2011 deadline. (See our original blog detailing the program.)These filings are very complex and have many unintended consequences. For some, joining the program means accepting huge tax bills — a hard thing to swallow. As the clock ticks, many taxpayers might not have sufficient time to get their affairs and filings in order to meet this deadline. Gathering years of offshore information isn’t an easy task. Rather than scare these taxpayers away, the IRS made these important changes to make its initiative more attractive to join. First, the IRS will grant a 90-day extension providing the taxpayer makes a good faith attempt to file on time. Second, penalties for various less problematic scenarios have been lowered, including smaller accounts, inadvertent omissions, and inherited foreign accounts. Last, it provides various ways to opt out of the initiative if the taxpayer could do better with other filing options.
90-day extension: According to the IRS, “A taxpayer may request an extension of the deadline to complete his or her submission if the taxpayer can demonstrate a good faith attempt to fully comply with FAQ 25 on or before Aug. 31, 2011. The good faith attempt to fully comply must include the properly completed and signed agreements to extend the period of time to assess tax (including tax penalties) and to assess FBAR penalties. Requests for up to a 90-day extension must include a statement of those items that are missing, the reasons why they are not included, and the steps taken to secure them.”
Lower penalties under certain conditions: New FAQ 52 & 53 state, “Taxpayers making voluntary disclosures who fall into one of the three categories … will qualify for 5-percent or 12-percent offshore penalties, respectively.” Read these sections to see if you qualify for the lower penalties.
Consequences of opting out: New FAQ 51 shows why some taxpayers may want to opt out of the initiative and how they can do so. These escape hatches are helpful to many who are weighing their options to join the program in the first place. Rather than dither and miss the deadline, the IRS encourages you to join and allows you to opt out later. For example, suppose you join the program and realize you actually would not owe any income tax due to foreign tax credits or losses. The update states: "Electing to opt out might subject the taxpayer to a much smaller FBAR penalty than the penalty that would be due under the 2011 OVDI (or possibly no penalty at all, if the taxpayer's violation was due to reasonable cause)."
This offshore disclosure full-court press is a nightmare for many, but the IRS seems to be improving its customer service with the extension, opt out, and lower penalty regime. The IRS motto may be "join first and opt out later." The lower penalties are a good incentive for those who qualify to come clean. Why should they risk the same major problems as the purposeful tax cheats do? Skipping the program entirely might be the costliest and more problematic option, especially when you consider the possibility of criminal charges.
Update on June 22, 2011:
Information reporting suspended for foreign financial asset holders & PFIC shareholders. Notice 2011-55 http://www.irs.gov/pub/irs-drop/n-11-55.pdf
Per RIA, "A new Notice suspends information reporting required under the Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147 ), for certain individuals with an interest in a “specified foreign financial asset,” as well as for shareholders of a passive foreign investment company (PFIC). The information reporting is suspended until IRS issues the forms necessary to report the requisite information."
June 2, 2011
Foreign Bank Account Report (FBAR) problems
By Robert A. Green, CPA with assistance from Mark Feldman, JD and Deborah King, CPA.
Note: Click here for an important update on the IRS voluntary disclosure initiative.
Webinar: Click here for our June 30, 2011 Webinar recording on FBAR, the IRS voluntary disclosure initiative and other alternatives too.
If you have unreported foreign accounts of more than $10,000 and unreported income, you better come clean with the IRS or you could be in a heap of tax trouble — the type that can cost you hundreds of thousands of dollars and even land you in jail.
Two trends are not necessarily your friend. While trading has gone global, the IRS is becoming xenophobic over reporting foreign income and accounts.
Americans are trading different types of instruments all around the world. Some trade from U.S. brokerage and bank accounts, but others trade directly through foreign brokers and banks. The U.S. taxes all income, which means it taxes foreign accounts too.
The IRS is getting very tough on so-called “tax cheats,” — U.S. taxpayers hiding income and assets in offshore accounts. These include, but are not limited to, foreign-based banks, brokerage firms, and some retirement funds, entities and trusts.
Hiding offshore income or just didn’t know to report it?
While some Americans set up offshore bank accounts in clandestine ways to purposely cheat the IRS and others including creditors, investors, customers, and spouses, others inadvertently omit reporting offshore bank and brokerage accounts, even though they report this foreign annual income on their income tax returns. These taxpayers don’t even realize they have to file a separate Reports of Foreign Bank and Financial Accounts (FBARs) to the Treasury.
In many cases, the group that has reported all income can comply by filing late FBARs and thereby avoid tax penalties. But those taxpayers with both hidden foreign income and foreign accounts face a much greater burden with the IRS. Keep in mind the IRS figures that if you report foreign income, you probably will report the foreign accounts and vice versa.
Unfortunately, it’s not easy for the IRS to distinguish between purposely cheating the IRS or inadvertently omitting forms and income. Generally, if a taxpayer hides large amounts of income and related assets offshore over many years, he is likely trying to cheat the IRS.
Consider reporting hidden offshore income and accounts under a new IRS program
The IRS is offering a second voluntary compliance FBAR reporting program, which ends on Aug. 31, 2011. Its first program ended Oct. 15, 2009 and it drew out many more taxpayers than envisioned. It’s a complex filing and many of those taxpayers are still being sought out, even though they filed by the deadline. It’s a gamble to assume there may be a third program, so it’s wise to consider coming clean and joining this second program before it ends.
FBAR reporting includes obvious foreign accounts like bank and brokerage accounts, and the less-obvious ones like foreign mutual funds, foreign pension plans and life insurance. This applies also to individuals with signature or other authority over, but no financial interest in, such accounts/plans (e.g., offshore mutual fund managers). IRS and the Treasury just announced that certain individuals with only signature authority over foreign accounts have a one-year extension to file the FBAR, after the upcoming June 30, 2011 filing deadline. Offshore entities and trusts require special tax reporting too.
Don’t put your head in the sand on these tax issues because the consequences are beyond your wildest imagination — possible jail time for willful and very serious cases, plus big payments for all sorts of penalties, interest, and back taxes. That’s why I say xenophobia, because it’s that scary and attacking.
Congress and the administration are backing the IRS here to “close the tax gap.” They agree they should first improve the current rates and rules before resorting to raising tax rates, which is viewed as a third-rail of politics for Republicans.
Forget about trying to sneak in amended income tax returns to report hidden foreign income with late FBARs. The IRS made it clear that “quiet disclosure” of hidden offshore income won’t work. The IRS crafted its voluntary compliance program as a “my way or the highway” program.
It’s not a big problem if you are only late with the FBAR report itself
Again, if you reported all your annual foreign income in connection with these foreign accounts correctly, and only inadvertently omitted your FBAR annual reports to the Treasury, you are permitted to file the FBAR forms late without penalties and without a need to enter the IRS voluntary compliance program. In fact, the later would be a mistake in that instance. If the IRS catches you first, the late $10,000 penalty applies. For this reason, it’s wise to file all late year FBAR reports soon and just be sure you have not omitted reporting any income related to those accounts.
Voluntary disclosure of hidden income comes with risks
Don’t confuse the IRS voluntary disclosure program with an “amnesty” program. You don’t get off scot-free — there are huge bills to pay. The allure of the program is the avoidance of criminal prosecution. If you owe the IRS hundreds of thousands on unreported hidden offshore income, keep in mind other taxpayers have gotten jail time for less! You have every incentive to join this IRS voluntary disclosure program on time.
If you’re in danger of criminal prosecution, you should hire a tax attorney (such as our outside attorney, Mark Feldman). Have your attorney hire a CPA as well to iron out the income tax matters. That way you can extend your attorney-client privilege in the IRS voluntary disclosure program. If you have hidden an offshore account and its underlying income - earned on the account, and/or earned from other hidden sources and deposited to the account - you should discuss it in confidence with an attorney first.
Time does not expire on these problems, and there is no place to hide
You can’t just cross your fingers for three years and figure your tax year closes, as is the case on regular income tax matters. As in fraud cases, your tax years may remain open for FBAR reporting omissions. For civil penalties, tax years remain open for six years. If you want to sleep well at night, come clean on FBAR.
The IRS is also after the banks to boot. Read the nasty UBS tax bust cases in the U.S. and Europe and you will see this is a losing proposition. The IRS compelled UBS to turn over a portion of their U.S. client lists. Other American taxpayers were turned in by whistle blowers, including some who worked at these banks.
Penalties can be huge
The penalty for failing to file an FBAR is $10,000 for each non-willful violation. If you willfully did not file an FBAR, the penalty can be much higher: the greater of $100,000 or 50 percent of the amount in the account for each willful violation. Plus, each year is treated separately. The $10,000 threshold for FBAR reporting is in the aggregate, not per account.
The IRS FBAR “voluntary disclosure initiative” has changed recently. The penalty under the new FBAR initiative is 25 percent of the highest combined balances plus substantial understatement of tax penalties of 20 percent if applicable too. The 25 percent FBAR penalty is lower than the usual penalty, but higher than the 20 percent from the last initiative.
Notice that penalties under the voluntary disclosure initiative (25 percent) can be significantly less than the regular FBAR penalties (50 percent).
FBAR only is late, and taxpayer is compliant already on income tax reporting
A taxpayer can file late FBARs without going through the IRS voluntary disclosure initiative and without paying penalties if they have reported all their foreign income on their annual income tax returns, and only neglected to file the FBAR report with the Treasury. Such a taxpayer should NOT file under the IRS voluntary disclosure process; otherwise they may get charged with a higher penalty regime intended for taxpayers who did not report all their income. Learn more on the "2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers" page IRS FAQ # 17 .
When we recommend the IRS voluntary disclosure program throughout this article, it’s intended for taxpayers who have not reported BOTH foreign income and assets (accounts).
FBAR issues for forex traders
Over the past few years, many forex traders went offshore, not to cheat on income taxes, but to get higher leverage than in the U.S. and to avoid the NFA’s 2009 hedging rule requiring first-in/first-out trading (FIFO).
New CFTC regulations (effective October 2010) over the off-exchange retail forex marketplace reversed this trend. The CFTC blocks foreign banks and brokers from doing business with Americans unless they follow the U.S. regulations and register with the appropriate US regulator.
Some Americans insist on keeping a foreign broker to retain 200:1 leverage and spread betting, rather than succumb to CFTC rules capping leverage at 50:1 on majors and 20:1 on minors plus FIFO. Some are tempted to set up dummy corporations or hide the accounts — a big mistake!
Others may move back to U.S. registered forex brokers now, but they still may have open FBAR reports from prior years, which is a tax problem that won’t go away. File the late FBARs before the IRS catches you and avoid penalties. An FBAR form is easy to fill out — it includes the bank’s name, address, your account number, contact information, and type of account.
It’s not always clear how to handle FBAR issues with foreign affiliates. For example, many forex traders had accounts with U.S.-based forex brokers first, and moved their funds to the foreign affiliates of their U.S. brokers in order to get higher leverage and avoid the hedging rule.
Most of these traders reported their annual income and loss on these accounts, but did not file an FBAR annual report with the Treasury. Under the new FBAR regime, these traders should file late FBAR reports as soon as possible. Because they reported their offshore income, they should be in the clear on bigger problems.
If the client funds are reported on a foreign brokerage statement, we consider this a foreign bank account to be reported under FBAR. In order to get 200:1 leverage and spread betting in the UK, you generally have to have an account housed with a UK broker, regulated by the UK regulator.
Many of these traders have not filed foreign bank account forms and might not be complying with FBAR rules. In some cases, they may argue their funds never left the U.S. brokerage affiliate and FBAR was not required. This matter is confusing and you should discuss your facts and circumstances with a tax attorney if you are unsure.
Some foreign forex brokers mistakenly told their U.S. clients they did not have to report foreign trading gains until the income was repatriated back into the U.S. That’s clearly very wrong and these clients now need to consider the IRS voluntary-disclosure program.
Securities and futures traders are different
Many securities and futures traders have access to global instruments and exchanges through a U.S.-based broker. Some online brokers differentiate themselves over this global reach.
As long as the taxpayer’s brokerage account statements are in the name of a U.S.-based broker and all the transactions are reported on their 1099-Bs or substitutes (no 1099s for forex), the taxpayer can probably figure he doesn’t have to file an FBAR in connection with that account. Conversely, funds moved to another country to be housed in a foreign affiliate may trigger FBAR concerns.
U.S. vs. foreign?
Many international banks and brokers have headquarters outside the U.S. and affiliates in the U.S. registered with U.S. regulators. An account with an international bank’s U.S. affiliate is treated like any other U.S.-based account.
A history of offshore tax cheating
In the late 1980s I was a CEO of a French company. I was surprised to learn that many French businessmen had offshore bank accounts and openly tried to structure their contracts to pay some income offshore and the rest onshore. I balked at these practices as an American CEO.
It seemed morally acceptable in Europe for these tax-cheating practices. Using tax havens has been less acceptable in America, yet many have done it anyway. The IRS is leading the charge against busting tax cheating through Swiss banks and the EU has followed suit. Read the landmark cases of U.S. tax man vs. UBS, HSBC and other banks too.
HSBC provided a new type of tax scheme with offshore accounts
Tax cheating is not the domain of wealthy Europeans and Americans only. The IRS busted HSBC recently for providing tax-cheating schemes to Americans. Many were Indian-Americans seeking hidden offshore accounts denominated in Indian currency.
In some cases, HSBC was not clear about moving money abroad to a certificate of deposit denominated in rupees issued and housed with a foreign affiliate. Some taxpayers busted by the IRS have argued they figured they still had a U.S.-based account, not a foreign account. When the IRS asked why they didn’t report the annual income on the CD, some have argued it was non-taxable since it was only accrued and not paid.
In some cases, they traded and lost money on stocks as well as the rupee. Had they reported the income and loss each year, it would have been net tax losses. Now these taxpayers are embroiled in a maximum penalty regime. Others who have not yet been busted by the IRS should consider the IRS voluntary disclosure program since in involves both non-reported (hidden) income and accounts.
Foreign pension plans
The IRS often treats foreign pension plans as regular taxable accounts, denying tax-deferral. That means the IRS will not allow a tax deduction for annual retirement plan contributions, and the annual income is subject to income tax too. In some cases, based on tax treaties, or an election filed on time, taxpayers may obtain tax-deferral treatment, similar to U.S.-based retirement plans.
If you missed filing your election (e.g., Canadian retirement plans), our firm can probably prepare a private letter ruling to submit to the IRS, asking to file a late election providing retroactive relief from inception of the foreign retirement plan. That could save you from owing income taxes on income from inception of the plan, plus related penalties and interest.
Here’s the problem with these foreign pension plans. If the IRS says your plan doesn’t qualify, annual income inside the plan is therefore taxable. This means you probably haven’t reported some foreign income each year. You inadvertently triggered the need for the IRS voluntary disclosure compliance program. That regime of penalties is very stiff and to be avoided whenever possible.
In special cases of inadvertent and odd triggering of income, you should consider other potential strategies, which are beyond the scope of this article.
A foreign accounting quagmire
Deciding to come clean and enter the IRS voluntary compliance program isn’t easy, but it may be the easier part. It can be a nightmare to figure out the accounting and tax treatment when reporting the hidden income, gains and losses.
Some tax attorneys have come to our firm because their clients entered the program and they need to quickly figure out what income or loss to report to the IRS.
Some clients had a foreign bank account trading forex, stocks and futures, and held some money in interest-bearing vehicles, plus some alternative investments. They need to calculate the annual income and loss and figure the tax treatment breakdowns, often many years later. One challenge is currency appreciation — while embedded in stock trades — is part of capital gain or loss treatment, whereas appreciation of the underlying physical currency while not invested may be ordinary gain or loss.
We have ideas for cutting through the maze on this accounting, so check with us in these complicated cases.
For more information on FBAR, see the irs.gov Website and there are plenty of other resources on the Internet too. Try this irs.gov link for Report of Foreign Bank and Financial Accounts (FBAR). Here are a few key points that stand out.
• The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.
Observation: Notice they mention “all accounts” and not per account. If you have several accounts, each under $10,000, but over in the aggregate, you need to file the TDF 90.22-1 and report all these accounts.
• Exception for:
o IRA owners and beneficiaries;
o Participants in and beneficiaries of tax-qualified retirement plans;
Observation: We point out above that the IRS may treat your foreign retirement plan as “non-tax” qualified, meaning this exception would not apply.
If you invest in an offshore hedge fund, you may have Passive Foreign Investment Company (PFIC) issues, but it’s not an account for purposes of FBAR reporting. Some clients omit reporting PFIC income and that’s another problem.
Even though this article focuses solely on FBARs, there are a bevy of other tax forms to consider with foreign transactions, companies, trusts and more. Other tax forms include but are not limited to:
1) Form 5471 — Information Return of U.S. Persons With Respect To Certain Foreign Corporations
2) Form 8621 — Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund;
3) Form 3520 — Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts
Other useful links:
IRS FBAR article
2011 Offshore Voluntary Disclosure Initiative (OVDI)
Foreign wine and clothes are great, but foreign accounts can be a pain. Promoters may promise easy tax cheating, but it’s anything but that. The IRS has modern tools and a mandate from Congress to rein in what it views as rampant offshore tax cheating. Although, the government is focused on the big fish and big banks, they will catch, fry and make an example of small fish too. It’s time to come clean.
If you haven’t reported both foreign accounts and income deposited or earned in those accounts, consider joining the IRS voluntary compliance program. By doing so you may get to keep a small or large fraction of your offshore money and avoid criminal prosecution. Plus, you will sleep better at night.
You are welcome to contact our tax attorney Mark Feldman, JD (firstname.lastname@example.org) to set up a time to speak in confidence about your FBAR situation. Your communication with Mr. Feldman will be protected under attorney-client privilege.