New Filing Compliance Procedures for Non-Resident U.S. Taxpayers
The IRS recently announced a Streamlined Filing Procedure (SFP), that became effective September 1, 2012, intended to entice current non-residents and dual citizens who have not filed U.S. income tax and information returns to file their delinquent returns back into filing and reporting compliance. Since 2009, many non-residents began participating in various IRS offshore voluntary disclosure programs providing a reduced penalty structure and certainty that criminal prosecution will not occur for previous tax indiscretions. The current Offshore Voluntary Disclosure Program (OVDP) was announced in IR-2012-5 on January 9, 2012 and generally requires submission of income tax returns and Reports of Foreign Bank and Financial Accounts (FBARs), Form TD F 90-22.1, for eight tax years.
The 2012 OVDP is patterned after the 2011 Offshore Voluntary Disclosure Initiative but increases the maximum “FBAR-related” penalty from 25% to 27.5% of the highest account value at any time during the previous eight tax years. The 2012 OVDP does not have a stated expiration date but can be terminated by the IRS at any time as to specific classes of taxpayers or as to all taxpayers. In all, the IRS has seen 33,000+ voluntary disclosures from the 2009 and 2011 offshore initiatives. Outside of these programs, numerous U.S. taxpayers have continued to make voluntary disclosures or otherwise come into compliance with the filing and reporting requirements. Others have waited for what they perceive to be a better opportunity to come into compliance.
U.S. Citizens and Resident Aliens Living Abroad. The U.S. remains one of the few countries that tax their citizens and residents on a worldwide basis, as opposed to a determination based on the source of the income related items. U.S. citizen and resident aliens (Green Card holders) are subject to substantially the same rules for filing income, estate, and gift tax returns and paying estimated tax whether living in the United States or abroad – their worldwide income is subject to U.S. income tax and reporting requirements, regardless of where they reside. However, numerous U.S. taxpayers living abroad have failed to timely file U.S. federal income tax returns or FBARs and have tended to avoid the offshore initiatives due to the applicable penalty regime associated with their foreign accounts and assets which, given their residence in a foreign country, are often located in their chosen country of residence. Perhaps foreign by U.S. standards but most often located in the country of their residence.
Streamlined Filing Compliance Procedures for Current Non-Resident, Non-Filer Taxpayers. The Streamlined Filing Procedure(SFP)is available for non-resident U.S. taxpayers who, since January 1, 2009, have resided outside of the U.S. and have not filed a U.S. tax return. It is designed for taxpayers that otherwise present a low compliance risk and requires current, non-resident, non-filer taxpayers to file delinquent tax returns, with appropriate related information returns, for the previous three years and to file delinquent FBARs for the previous six years. All submissions will be reviewed by the IRS to determine the appropriate level of compliance risk represented by the submission. For low compliance risk taxpayers, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. Submissions that present higher compliance risks will be notified they are not eligible for the SFP and might be subjected to a more thorough review and possibly a full examination, which might expand beyond three tax years, in a manner similar to opting out of the Offshore Voluntary Disclosure Program.
Tax, interest and penalties, if appropriate, will be imposed in accordance with U.S. federal tax laws based on a review of the submission. For a summary of information about federal income tax return and FBAR filing requirements and potential penalties, see IRS Fact Sheet FS-2011-13 (December 2011). In addition, retroactive relief is available through the SFP for a failure to timely elect income deferral on Form 8891 regarding certain retirement and savings plans where deferral is permitted by relevant treaty (this relief is also available under the 2012 OVDP). The proper deferral elections with respect to such arrangements are to be made with the submission.
Compliance risk determination. Based on information contained in the SFP submissions and additional information that may be required, the IRS will determine the level of compliance risk presented by the submission. Low risk will be predicated on simple returns with little or no U.S. tax liabilities. Absent high risk factors, if the submitted returns and SFP submission reflect less than $1,500 in tax due in each of the years, they will automatically be treated as low risk.
Generally, the risk level will increase as the income and assets of the taxpayer rise; if there are indications of sophisticated tax planning or avoidance; if there is material economic activity in the U.S.; if any of the returns submitted under the SFP claim a refund; if the taxpayer has not declared all of their income in their country of residence; if the taxpayer is under audit or investigation by the IRS; if FBAR penalties have previously been assessed against the taxpayer or if the taxpayer has previously received an FBAR warning letter; if, since January 1, 2006, the taxpayer has held a financial interest or authority over a financial account(s) located outside their country of residence or in an entity or entities located outside their country of residence; if employed by a U.S. based entity or if there is U.S. source income. Look for the IRS to continue releasing additional information regarding the specific factors the IRS used to assess the level of compliance risk and how information regarding those factors should be presented in the submission.
Participating in the SFP. Taxpayers wishing to use the new procedure will be required to submit: (1) delinquent income tax returns marked “Streamlined”, with appropriate related information returns, for the previous three tax years, (2) delinquent FBARs for the previous six years, and (3) any additional information regarding compliance risk factors required by future instructions. Taxpayers will also be required to submit a Questionnaire ( https://www.irs.gov/pub/irs-utl/non-resident_questionnaire.pdf ) that should accelerate the IRS review process .Payment of any federal tax and interest due must accompany the SFP submission.
Failure to file and failure to pay penalties may be imposed in accordance with U.S. federal tax laws and FBAR penalties may be imposed in accordance with U.S. law for returns determined to be high risk. Reasonable cause statements may be requested during review or examination of SFP submissions that are determined to be high risk. Taxpayers claiming reasonable cause for failure to file tax returns, information returns, or FBARs will be required to submit a dated statement, signed under penalties of perjury, explaining why there is reasonable cause for previous failures to file. See IRS Fact Sheet FS-2011-13 (December 2011) for examples of reasonable cause.
Taxpayers seeking relief for failure to timely elect deferral of income from certain retirement or savings plans where deferral is permitted by relevant treaty will be required to submit a statement requesting an extension of time to make an election to defer income tax and identifying the pertinent treaty position; for relevant Canadian plans, a Form 8891 for each tax year and description of the type of plan covered by the submission; and a statement describing the events that led to the failure to make the election, the events that led to the discovery of the failure, and if the taxpayer relied on a professional advisor, the nature of the advisor’s engagement and responsibilities.
The SFP does not provide protection from criminal prosecution if the IRS and Department of Justice determine that the taxpayer’s particular circumstances warrant such prosecution. Taxpayers concerned about criminal prosecution because of their particular circumstances should be aware of and consult their legal advisers about the 2012 OVDP, which offers another means by which taxpayers with undisclosed offshore accounts may become compliant. However, the IRS has announced that once a taxpayer makes a submission under the SFP, participation in the 2012 OVDP is no longer available. It should also be noted that taxpayers who are ineligible to participate in the OVDP are also ineligible to participate in the SFP.
Options Remaining for Taxpayers With Offshore Interests. The ongoing IRS focus on offshore enforcement efforts and related disclosure programs has significantly raised awareness regarding tax filing and information reporting obligations among U.S. taxpayers. The IRS has prepared several documents explaining these requirements, including the U.S. Citizens and Resident Aliens Abroad page on IRS.gov (https://www.irs.gov/Individuals/International-Taxpayers/U.S.-Citizens-and-Resident-Aliens-Abroad ). Taxpayers should consult with their professional legal and tax advisors in determining which of the following options might be the most appropriate given their facts and circumstance.
(1). Taxpayers who have properly reported all taxable income but recently discovered that they should have been filing FBARs in prior years to report a personal foreign bank account or to report signature authority over bank accounts owned by an employer – Taxpayers who reported, and paid tax on, all their taxable income for prior years but did not file FBARs, should file the delinquent FBAR reports according to the instructions (send to Department of Treasury, Post Office Box 32621, Detroit, MI 48232-0621) and attach a statement explaining why the reports are filed late. The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.
(2). Taxpayers who only have certain delinquent information returns, but no tax due. A taxpayer who has failed to file tax information returns, such as Form 5471 for controlled foreign corporations (CFCs) or Form 3520 for foreign trusts but who has reported, and paid tax on, all their taxable income with respect to all transactions related to the CFCs or foreign trusts, should file delinquent information returns with the appropriate IRS Service Center according to the instructions for the form and attach a statement explaining why the information returns are filed late. (The Form 5471 should be submitted with an amended return showing no change to income or tax liability.) The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.
(3). Non-resident U.S. taxpayers with delinquent returns with low risk factors (including tax owed less than $1,500/year). Non-resident U.S. taxpayers should review the Streamlined Compliance Procedures above and consider filing delinquent tax returns, including delinquent information returns, for the past three years; delinquent FBARs for the past six years; and additional required information regarding compliance risk. Payment of any federal tax and interest due must accompany the submission.
(4). Taxpayers with undisclosed foreign accounts and unreported income. The 2012 OVDP offers a civil settlement structure in which taxpayers pay an offshore penalty in lieu of a number of other penalties that may be assessed in cases of offshore noncompliance. The OVDP also offers protection from criminal prosecution. In order to participate in the OVDP, taxpayers must first request acceptance into the program from IRS Criminal Investigation. Once pre-cleared for acceptance, taxpayers must submit certain information including eight years of amended tax returns, FBARs, and information returns as well as information about their offshore accounts. In addition, taxpayers must submit full payment of the tax and interest due, and certain penalties. Taxpayers who have entered OVDP who disagree with the application of the offshore penalty given the unique facts and circumstances of their case may elect to opt out of the civil settlement structure of the program. In such situations, the IRS can be expected to conduct an examination to determine if the potential offshore related penalty or some other resolution is appropriate.
The SFP review factors discussed above will likely have differing impacts on the degree of risk involved and the resolution of each submission. Hopefully, there will be a positive recognition of the act of participation in the SFP that will result in a fair and reasonable resolution of each submission. Encouraging non-compliant taxpayers to come forward enhances future compliance. Fair treatment of those coming forward encourages others to follow the same or a similar path into compliance. Efforts to enhance overall future compliance should forever be a guiding principle of our system of tax administration.
U.S. taxpayers having undisclosed interests in foreign financial accounts and assets must consult competent professionals before deciding to participate in the SFP, the 2012 OVDP, or some other action designed to come into compliance with their filing and reporting requirements. We do not live in a perfect world and, for the most part, the foregoing options are not perceived as perfectly fair resolutions by everyone involved but each provides an opportunity to get back into the system. Some will come into compliance. Others may decide to risk detection by the IRS and the imposition of substantial penalties, including the civil fraud penalty, numerous foreign information return penalties, and the potential risk of criminal prosecution. Others may be prosecuted for non-compliance. All should exercise their best efforts to fully understand the various options and potential consequences before making any decision regarding the disclosure (or not) of interests in foreign financial accounts and assets.