It is common knowledge that U.S. persons (i.e., U.S. citizens or green card holders) must report their U.S. income on a U.S. income tax return. It is not as common, however, that U.S. persons know that they need to report their worldwide income on a U.S. income tax return. Moreover, it is even less common that U.S. persons know about all of the foreign informational forms that may be applicable in connection with reporting a foreign financial asset (e.g., foreign bank account, foreign stock, foreign partnership interest, etc.) on an FBAR form and/or Form 8938, or that a gift from a foreign person (or inheritance from a foreign estate) may need to be reported on a Form 3520.
When U.S. persons learn that they should have filed certain foreign informational forms and didn’t, and that there may be considerable penalties for not filing, panic usually sets in, and the worst-case scenario is envisioned. The logical question is, what can I do to resolve my situation?
It is important to note that the Internal Revenue Service (IRS) has several programs, including the Delinquent International Information Return Submission Procedures and the Streamlined Filing Compliance Procedures, that can be utilized to minimize or potentially eliminate all penalties. In order to determine the best program to utilize, it is imperative to examine whether the failure to file the foreign informational form(s) was due to reasonable cause or was non-willful.
According to the IRS, “reasonable cause” means that, based on all of the facts and circumstances, a taxpayer used all ordinary business care and prudence to meet his/her tax obligations but were nevertheless unable to do so (e.g., due to fire, death, serious injury, reliance on a tax professional, etc.). On the other hand, “non-willful” conduct (according to the IRS) means conduct due to negligence, inadvertence, or mistake or conduct that is the result of a good-faith misunderstanding of the requirements of the law. The best way to illustrate the difference is with examples.
Example of Reasonable Cause: Sam, a green card holder, has a $100,000 foreign bank account in England, the country where he was born. Sam uses Sally, a CPA, to prepare his U.S. income tax return. Sam has used Sally for several years, and Sally advertises that she has experience in international tax. During a meeting between Sam and Sally, Sam mentions to Sally that he has a foreign bank account and is curious whether he needs to report it for U.S. income tax purposes, given that the account does not generate any interest income. Sally tells Sam (incorrectly) that because the foreign account does not generate any income, he does not need to report the account to the U.S. government. Sam, not knowing any better, follows this advice and does not report the account for U.S. tax purposes. Several years later, Sam uses a different CPA, Beth, to prepare his income tax return, and Sam informs Beth of the foreign bank account. Unlike Sally, Beth tells Sam that because of the value of the foreign account, Sam needs to report the account on an FBAR form and a Form 8938. Moreover, Beth informs Sam that he should have reported the foreign bank account in prior years on an FBAR form and a Form 8938, and that he may be subject to penalties for failing to report the account.
Under this scenario, Sam should qualify for reasonable cause because he properly informed Sally, a CPA with international tax experience, of his foreign bank account and reasonably relied on her advice of not filing any foreign informational forms. Accordingly, Sam should not be subject to any penalties for failing to file the FBAR and 8938 forms.
Example of Non-willful: Same facts as above, except Sam does not inform Sally of his foreign bank account, nor does Sally ask Sam (through a tax organizer or verbally) whether he has any foreign accounts or assets. When Sam meets with Beth years later, he is provided a tax organizer that asks whether he has any foreign accounts, for which Sam marks “Yes.” Beth informs Sam that because of the value of the foreign account, he needs to report the account on an FBAR form and a Form 8938. Moreover, Beth tells Sam that he should have reported the foreign bank account in prior years on an FBAR form and a Form 8938, and that he may be subject to penalties for failing to report the account.
Under this scenario, Sam’s failure to file FBAR and 8938 forms in prior years should be considered non-willful because he did not know about the filing requirements. Accordingly, Sam may be eligible to resolve his situation under the Streamlined Filing Compliance Procedures and have reduced penalties. That being said, since Sam did not inform Sally of the existence of the foreign account, it is unlikely that the IRS would deem this situation to rise to the level of reasonable cause, which is a higher standard than establishing that one was non-willful.
It is worth noting that, oftentimes, it is difficult to determine whether someone’s situation rises to the level of reasonable cause, or even whether the situation is non-willful. In that regard, when we analyze foreign reporting issues, we provide a detailed questionnaire that is tailored to each client’s situation to help determine the best way to resolve a foreign reporting matter. This attention to detail is needed given the large penalties that may be applicable for failing to file timely foreign informational forms.
Aaron Valenti is a partner in the Tax Law department at Berliner Cohen, LLP. He can be reached at aaron.valenti@berliner.com.
This article is not intended to and does not constitute legal advice or a solicitation for the formation of an attorney-client relationship. Anyone with questions about this topic should consult an attorney.