Options Available for Taxpayers with Undisclosed Foreign Accounts and/or Unreported Foreign Income

Foreign information reporting (i.e., reporting the existence of certain foreign/overseas assets) may be required for any “United Sates person.”  The term “United States person” is broadly defined, and includes United States citizens, United States residents (such as green card holders and those deemed a resident alien under the substantial presence test), and domestic entities (including corporations, partnerships, LLCs, and trusts).  If you have been told that you are required to file an income tax return in the United States, then, generally, you are a “United States person.”  A “United States person’s” foreign information reporting obligations may include, among other forms, the requirement to file FinCEN Form 114 (FBAR), Form 8938, Form 3520, Form 5471, and Form 8865. 

Failing to file any of the above-mentioned forms can lead to large penalties.  For example, if a taxpayer fails to file FBAR forms (or files them late), the taxpayer could be subject to a $10,000 penalty per account, per year (for a non-willful violation) or, if deemed willful, a penalty in the amount of the greater of $100,000 or 50% of the account balance, per year.[1]  In the case of the willful failure to file FBAR forms, criminal prosecution is also possible. 

These penalties are enough to cause anyone with unreported foreign financial assets considerable consternation.  Fortunately, for taxpayers with unfiled foreign information returns and/or unreported foreign income, the IRS has established several programs that may reduce (or eliminate) the penalties that might otherwise apply.

The purpose of the remainder of this article is to provide a primer on the programs which the IRS has established to assist non-compliant taxpayers in coming into compliance and reducing (or eliminating) the penalties that would otherwise be associated with their non-compliance.  Please note: The rules and requirements regarding international information reporting obligations are complex, and taxpayers with unreported foreign income, or unreported foreign financial assets, are strongly encouraged to speak with a tax attorney.

Option 1: Delinquent FBAR Submission Procedures

In order to be eligible for the Delinquent FBAR Submission Procedures, a taxpayer:

  1. Must not have filed an FBAR (or FBARs);
  2. Must not be under a civil examination or a criminal investigation by the IRS;
  3. Must not have already been contacted by the IRS about the delinquent FBARs; and
  4. Must properly have reported on a U.S. tax return, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs.

Assuming a taxpayer is eligible for this program, then the taxpayer must file delinquent FBARs and include a statement explaining why the FBARs are being filed late. 

If an eligible taxpayer follows the proper procedures, then the IRS will not impose any penalties in connection with the late-filed FBARs.

Option 2: Delinquent International Information Return Submission Procedures

In order to be eligible for the Delinquent International Information Return Submission Procedures, a taxpayer:

  1. Must not have filed one or more required foreign information returns (e.g., Forms 8938, 3520, 5471, etc.);
  2. Must have reasonable cause for not timely filing the information returns;
  3. Must not be under a civil examination or a criminal investigation by the IRS; and
  4. Must not have already been contacted by the IRS about the delinquent information returns.

Assuming a taxpayer is eligible for this program, then the taxpayer must file delinquent foreign information forms (with amended income tax returns) with a statement of all facts establishing reasonable cause for the failure to file.

Similar to Option 1, if an eligible taxpayer follows the proper procedures, then the IRS will not impose any penalties in connection with the late-filed foreign information returns.

Option 3: Streamlined Filing Compliance Procedures

Under this option, there are actually two different programs that a taxpayer needs to consider: the Streamlined Domestic Offshore Procedures and the Streamlined Foreign Offshore Procedures. 

Streamlined Domestic Offshore Procedures

In order to be eligible for the Streamlined Domestic Offshore Procedures, a taxpayer:

  1. Must be an individual or an estate of an individual;
  2. Must not be under a civil examination or a criminal investigation by the IRS;
  3. Must have previously filed a U.S. tax return (if required) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed;
  4. Must have failed to report gross income from a foreign financial asset and pay tax, and/or have failed to file an FBAR and/or one or more foreign information returns; and
  5. Must prove that he/she was non-willful in failing to report income and failing to file an FBAR and/or foreign information returns.

Assuming a taxpayer is eligible for this program, then the taxpayer:

  1. Must file 3 years of amended income tax returns, together with any required foreign information returns (as applicable);
  2. Must pay the additional taxes and associated interest;
  3. Must file 6 years of FBARs (as applicable);
  4. Must complete and sign (under penalties of perjury) Form 14654 (Certification by U.S. Person Residing in the U.S.), which includes a non-willful statement; and
  5. Must pay an offshore penalty equal to 5% of the highest year-end aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the offshore penalty during the years in the covered tax return period and the covered FBAR period.

Streamlined Foreign Offshore Procedures

In order to be eligible for the Streamlined Foreign Offshore Procedures, a taxpayer:

  1. Must be an individual or an estate of an individual;
  2. Must not be under a civil examination or a criminal investigation by the IRS;
  3. Must meet the applicable non-residency requirement (meaning that in any one or more of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the individual did not have a U.S. abode (home), and the individual was physically outside the U.S. for at least 330 full days).
  4. Must have failed to report the income from a foreign financial asset and pay tax, and/or have failed to file an FBAR and/or foreign information returns; and
  5. Must prove that he/she was non-willful in failing to report income and failing to file an FBAR and/or foreign information returns.

Assuming a taxpayer is eligible for this program, then the taxpayer:

  1. Must file 3 years of original income tax returns (if returns have not been previously filed) or amended income tax returns, together with any required foreign information returns (as applicable);
  2. Must pay the additional taxes and associated interest;
  3. Must file 6 years of FBARs (as applicable); and
  4. Must complete and sign (under penalties of perjury) Form 14653 (Certification by U.S. Person Residing Outside of the U.S.), which includes a non-willful statement.

If an eligible taxpayer follows the proper procedures, then the IRS will not impose any penalties.

Option 4: Updated Voluntary Disclosure Procedures 

This program replaced the 2014 Offshore Voluntary Disclosure Program that ended on September 28, 2018.  Due to the harsh penalties associated with this program, it is mainly beneficial to those taxpayers that are attempting to avoid criminal prosecution.    

In order to be eligible for the Updated Voluntary Disclosure Procedures, a taxpayer:

  1. Must not be under a civil examination or a criminal investigation by the IRS; and
  2. Must not have unreported income from an illegal activity (e.g., selling illegal drugs).

Assuming a taxpayer is eligible for this program, then the taxpayer:

  1. Must submit a preclearance request (with background information) on Form 14457 (Rev. 3-2019) (Part I);
  2. Must submit all required additional information, as requested in Form 14457 (Rev. 3-2019) (Part II).  (This includes a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance);
  3. Must submit at least 6 years of tax returns (or amended tax returns), together with any required foreign information returns (as applicable); and
  4. Must submit at least 6 years of FBARs (as applicable).

If an eligible taxpayer follows the proper procedures, then a taxpayer:

  1. Will not be recommended for criminal prosecution if he/she cooperates throughout the process;
  2. Likely will be subject to a civil fraud penalty (75% of the tax);
  3. Likely will be subject to a willful FBAR penalty (minimum of $100,000);
  4. May be subject to other penalties associated with failing to file foreign information returns;
  5. Will have the ability to attempt to negotiate lower penalties (but will likely be difficult to accomplish); and
  6. Will have the right to request an appeal with IRS Appeals.

The rules and requirements regarding foreign information reporting are complex, and taxpayers who have learned that they have undisclosed foreign financial assets, or unreported foreign income may feel scared and overwhelmed when they learn that they have been delinquent in these reporting obligations, especially in light of the steep penalties that the IRS can impose for non-compliance.  The tax attorneys at Berliner Cohen, LLP have assisted hundreds of taxpayers in navigating the programs which the IRS has established to enable non-compliant taxpayers to voluntarily come into compliance.  We have experience working with clients from a variety of home countries and with a wide range of individual facts and circumstances.

[1] Note: Penalties are indexed for inflation.  The current maximum non-willful penalty is $12,921 per account.  The current willful violation penalty is the greater of $129,210, or 50% of the account balance.

For more information on this topic, please contact Aaron Valenti or David Bellumori at Berliner Cohen, LLP at 408.286.5800 or by e-mail at aaron.valenti@berliner.com.