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Foreign mutual funds = Passive Foreign Investment Companies (PFICs)?

We have had many clients with unreported foreign mutual funds. As a result, it is time to revisit the unfavorable topic of foreign mutual funds as  a “Passive Foreign Investment Companies” (PFICs), which is often a surprise to our clients.

U.S. persons who own foreign mutual funds can sometimes be in for an unpleasant surprise when it comes to filing their taxes. The tax treatment of overseas funds differs considerably from those of domestic funds under the Internal Revenue Code’s rules for “Passive Foreign Investment Companies” (PFICs). Passive income includes dividends, interest, gains from the disposition of stocks and securities, and gains from commodities trading. A foreign company is considered a PFIC if at least 75% of its gross income is passive income and/or if at least 50% of its assets produce passive income. Because most of the income of a mutual fund consists of items that can be defined as passive income, nearly all overseas mutual funds are PFICs. A foreign mutual fund might escape classification as a PFIC if a majority of its holdings consists of large shares of other corporations whose income would be classified as “active” and not passive income.

To avoid certain excise taxes, U.S. based mutual funds generally distribute earnings and capital gains to their shareholders. These amounts are then reported annually to the IRS on a Form 1099. Foreign investment companies are not subject to U.S. taxes or to these disclosure rules. As a result, prior to the passage of the PFIC rules as part of the Tax Reform Act of 1986, U.S. investors in overseas funds would only have taxable income when they sold their stock or received a dividend. This gave investors in overseas funds significant advantages over similarly situated investors in domestic funds. Such investors not only avoided current taxation, but income that would be defined as ordinary income if received currently also became characterized as capital gain income, and received favorable tax treatment as a result. The PFIC rules were designed to restrict the ability of U.S. persons to defer tax on income from foreign investments.

The taxation of PFICs is built on the idea of denying to United States persons – and hence capturing for the U.S. Treasury – the value of deferral of U.S. taxation on all passive investments channeled through foreign entities. The rules achieve this end in one of two ways: first, by directly taxing U.S. investors in PFICs, and second, by indirectly imposing an interest charge on the deferred distributions and gains of these investors.

U.S. investors report their PFIC holdings on Forms 8621 – Return by Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, which are filed with their annual return. A separate Form 8621 is filed for each PFIC investment required to be reported in a given year. If the aggregate value of a US shareholder’s PFIC stock is US$25,000 (US$50,000 for joint filers) or less, and if no MTM or QEF election has been made, the shareholder need not file an annual form 8621.

The PFIC tax regime includes THREE different alternative tax systems for PFIC shareholders:

(1) the excess distribution rules; Under the excess distribution rules, a US PFIC shareholder is generally taxable on receipt of an excess distribution: the total amount received in the year exceeds 125 percent of the actual average distribution to the shareholder in the preceding three years. An excess distribution includes a gain on the sale of PFIC stock. An excess distribution is taxed at the highest ordinary income tax rates for individuals, and interest is based on the allocation of the excess distribution to prior years.

(2) the qualified electing fund (QEF) rules; The QEF rules may mitigate the harsh consequences of the PFIC regime if a US PFIC shareholder timely elects to include in gross income each year his pro rata share of the PFIC’s ordinary income and capital gain; This is usually the best solution but very few mutual funds qualify as a QEF; and

(3) the mark-to-market (MTM) rules. A US PFIC shareholder may be able to elect to include MTM amounts in income and avoid the excess distribution rules. Under the MTM method, you compute tax at the end of each year on the difference between the fair market value (FMV) of the shares at the beginning of the year and the FMV at the end of the year.  The MTM election cannot be made retroactively. The deadline for making such an election is the due date, including extensions, of the electing person’s U.S. income tax return for the year.

U.S. taxpayers should be clear when purchasing foreign mutual funds given the potentially detrimental tax treatment they may face at the time of filing. Those who already own overseas funds would definitely benefit from professional counsel to determine their tax liability, which could be very high in many situations.

India and the US have agreed to collaborate on offshore tax evasion

India and the US have agreed to again enhance collaboration on tackling offshore tax evasion and increase cooperation in sharing of cross-border tax information after the United States Treasury and India’s Ministry of Finance met last week. Following the conclusion of the dialogue, India’s Ministry of Finance Minister Shri Jaitley and United States Treasury Secretary Mr Lew released the following Joint Statement:

“We were pleased to participate in the sixth annual ministerial meeting of the Economic and Financial Partnership and to welcome Federal Reserve Chair Janet Yellen, Reserve Bank of India Governor Raghuram Rajan and other participants.

The United States Treasury and India’s Ministry of Finance launched our Economic and Financial Partnership in 2010 as a framework commensurate with the growing importance of our economic relationship and the significant business and cultural ties that already exist between our two nations. At this meeting, the last for the Obama Administration, we took stock of the impressive efforts that have been undertaken by both sides to deepen mutual understanding, and to improve cooperation across a wide range of bilateral and multilateral issues. We reiterated that the U.S.-India partnership will be one of the defining relationships of the 21st century.

Contributing to our bilateral relationship, five work streams have been underway at the sub-cabinet level in India and the United States. Progress has been made on all fronts.

Over the past year, our tax authorities resolved a significant portion of bilateral tax disputes between the United States and India. In addition, our governments have begun to accept bilateral Advance Pricing Agreement applications by companies in both jurisdictions in an effort to enhance cross-border business processes and strengthen our commercial ties.

We have noted the progress in sharing of financial information between the two countries under the Inter-Governmental Agreement pursuant to Foreign Account Tax Compliance Act (FATCA). The two sides will continue to engage in discussions on full reciprocal arrangement on FATCA. We look forward to increased cooperation in sharing of cross-border tax-information.

We are committed to continued collaboration and sharing of experience in tackling offshore tax evasion and avoidance, including joint tax audits and tax examination abroad. We look forward to the Competent Authorities of the two countries engaging in bilateral dialogue to move forward cooperation in these areas.

Earlier this year, in India, the U.S.-India Financial Regulatory Dialogue brought together our respective financial regulators to discuss a range of issues pertinent to our domestic financial sectors and to financial stability, including banking sector reform and development of capital markets. In addition, expert staff from Treasury and the Ministry of Finance are having consultations on the United States experience and international perspectives on the regulatory design for India’s recently launched payment banks.

Under the U.S.-India Investment Initiative launched in January 2015, our governments have worked in collaboration with private sector to identify specific policies, regulatory reforms, and technical collaboration aimed at mobilizing capital from both domestic and foreign investors to build infrastructure and create jobs. We are working together to support India’s National Investment and Infrastructure Fund (NIIF) in order to increase financing options for India’s infrastructure growth. We look forward to continuing discussions in areas such as municipal finance under the future work of the Initiative. The next meeting of the Investment Initiative will be in the United States later in 2016.

Public debt management is an area of focus for India. India believes in continued efforts for more efficient debt and cash management, as well as the development of a deeper and more robust domestic debt market. It presents an opportunity for India’s Ministry of Finance and the U.S. Treasury’s Office of Technical Assistance to engage in knowledge and information sharing in India’s government debt management program. Accordingly, a Terms of Reference was signed between the two to collaborate on India’s government debt program.

We have enhanced our cooperation in tackling money laundering and combating the financing of terrorism through increased information sharing and cooperation, including a dialogue held recently in India. We both agree on the importance of fighting illicit finance in all forms as an important means of tackling global terrorism.

Finally, we are committed to further deepen our understanding of each other’s economies. As partners and peers, we are committed to working together to collaborate in multilateral fora, such as the G20, to steer our economies toward stronger, sustainable, and balanced growth. Under the aegis of our Economic and Financial Partnership, we held a sub-cabinet level discussion among our Deputies in India in early 2016.

We are encouraged with the developments that have taken place since the launch of the Economic and Financial Partnership and look forward to continued engagement in an effort to strengthen our relationship, our economies, and the global economy.”

The statement was issued after Jaitley and Lew co-chaired the 6th US-India Economic and Financial Partnership (EFP) here on the sidelines of the annual Spring Meeting of the International Monetary Fund and the World Bank.

Last year, India and the US signed an agreement to implement the Foreign Account Tax Compliance Act (FATCA) that will facilitate exchange of information between the two countries starting on October 1, 2015. Under the inter-governmental agreement, Indian financial institutions would have to reveal information about US tax payers to the revenue department which would be passed on to the US tax authorities.

The US has signed IGAs with more than 110 jurisdictions and is engaged in related discussions with many other nations. America had enacted FATCA in 2010 to obtain information on accounts held by US taxpayers in other countries. It requires US financial institutions to withhold a portion of payments made to foreign financial institutions (FFIs) who do not agree to identify and report information on US account holders. As per the IGA, FFIs in India will be required to report tax information about US account holders directly to the Indian government which will, in turn, relay that information to the IRS.

Under FATCA, financial institutions, including banks, deposit taking non-banking finance companies, mutual funds, private equity funds, custodians and life insurance companies, will have to maintain information about their customers, including name, address, tax identification number and in cases of individuals, even details such as place and date of birth.

Specifically in India, for example, many Indian banks and mutual funds have started warning customers who are believed to have foreign contacts for a FATCA Compliance Certificate.  Technically, there is no FATCA Compliance Certificate, per se.  Practically speaking, a FATCA Compliance Certificate simply refers to that indicates that the foreign account has been properly reported to US authorities.

FATCA requires financial institutions to carefully review the client records in order to identify foreign customers.  The bank review includes careful scrutiny of bank electronic databases, bank paper files of account records, and interviews of bank managers and relationship managers regarding customers’ foreign status.

If a customer is deemed foreign upon initial review, numerous other questions are to be raised by the financial institution and answered by the customer.  In addition, information and documentation may be required by the customer, such as self-certification forms stating residency and tax information of the customer.  Often, a foreign tax identification number, such as a US Social Security number, is solicited.

While the IRS has recently targeted Swiss, Israeli and Indian banks, India continues to be a focal point for the U.S.  government. While new criminal prosecutions start and continue, our law firm expects unabated aggressive enforcement of the U.S. tax laws, including increased criminal prosecutions and civil investigations. We have been advising our clients to expect the unexpected (and the worst) in their tax treatment and disclosure of offshore assets, particularly for Indian assets.

Patel Law Offices has consulted with hundreds of clients regarding their offshore asset compliance issues. Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign accounts.

Internal Revenue Service again issues annual reminder to US persons to report foreign accounts and foreign income

The Internal Revenue Service recently once again issued its annual reminder to US persons to report foreign accounts and foreign income.  The reminders issued because of the widespread confusion and misunderstanding that exists among most US persons with foreign assets.

Part of the confusion about reporting foreign assets arises from the fact there are two separate reporting regimes. One regime is under the Bank Secrecy Act, while the other regime was enacted within the Internal Revenue Code.

The first regime pertains to the Foreign Bank Account Report, sometimes referred to as the “FBAR.” The FBAR is same as the Financial Crimes Enforcement Network Form 114. The law requires U.S. citizens, business entities and permanent residents to submit Form 114 each year if the sum of their foreign bank and securities accounts exceeds $10,000 at any point in time during the tax year. The form is required to be submitted electronically by June 30 of each year for the preceding tax year, with no ability to extend the due date. Beginning in 2017, Calendar 2016 reports will be due April 15 with the chance of a six-month extension.

Failure to file the FBAR carries very high civil and/or criminal penalties. The civil penalties are determined by two factors: Did you report the income in your tax return and was the failure to file “willful.” The civil penalties range from the civil, non-willful penalty of $10,000 to as much as the civil willful penalty of 50 percent of the highest balance in all of your foreign accounts for each year of the most recent six tax years. The criminal penalties are above and beyond the civil penalties and a myriad of other penalties that may apply. The criminal penalties can include an additional fine up to $500,000 and up to 10 years imprisonment.

That second regime requires completion of IRS Form 8938 with your tax return in each year that the sum of your highest balances/values exceeds $50,000 at any point during the tax year. The good news about this regime is the penalty is only $10,000 for each year you fail to file the form. The penalty can run up to $50,000 if the IRS contacts you and you fail to respond.

The IRS reminder notice is provided below.

Foreign Account Filings Top 1 Million; Taxpayers Need to Know Their Filing Requirements

IR-2016-42, March 15, 2016

WASHINGTON — Strong and sustained growth of taxpayers complying with foreign financial account reporting reflects improving awareness and compliance of this important part of offshore tax rules, the Internal Revenue Service said today.

“Taxpayers here and abroad need to take their offshore tax and filing obligations seriously,” said IRS Commissioner John Koskinen. “Improving offshore compliance has been a top priority of the IRS for several years, and we are seeing very positive results.”

By law, many U.S. taxpayers with foreign accounts exceeding certain thresholds must file Form 114, Report of Foreign Bank and Financial Accounts, known as the “FBAR.” It is filed electronically with the Treasury Department’s Financial Crimes Enforcement Network (FinCen).

In 2015, FinCen received a record high 1,163,229 FBARs, up more than 8 percent from the prior year. In fact, FBAR filings have grown on average by 17 percent per year during the last five years, according to FinCen data.

Filings of IRS Form 8938, Statement of Specified Foreign Financial Assets, are another sign of growing awareness of foreign reporting requirements. Taxpayers filed more than 300,000 Forms 8938 with their tax returns for tax year 2014, roughly the same as the prior year and up from about 200,000 for tax year 2011, the first year of the form.

Form 8938 resulted from the Foreign Account Tax Compliance Act, known as “FATCA.” The filing thresholds are much higher for this form than for the FBAR.

Filing Requirements

Taxpayers with an interest in, or signature or other authority over, foreign financial accounts whose aggregate value exceeded $10,000 at any time during 2015 must file FBARs. It is due by June 30 and must be filed electronically through the BSA E-Filing System website.

Generally, U.S. citizens, resident aliens and certain non-resident aliens must report specified foreign financial assets on Form 8938 if the aggregate value of those assets exceeds certain thresholds. Reporting thresholds vary based on whether a taxpayer files a joint income tax return or lives abroad. The lowest reporting threshold for Form 8938 is $50,000 but varies by taxpayer. See the form’s instructions for more information.

IRS.gov provides the best starting place for international taxpayers to get answers to their important tax questions. The International Taxpayers page on IRS.gov is packed with information. The web site also features a directory that includes overseas tax preparers.

International taxpayers will find the online IRS Tax Map and the International Tax Topic Index to be valuable sources of answers. The IRS also has videos to assist international taxpayers. See IR-2016-03 for more.

By law, Americans living abroad, as well as many non-U.S. citizens, must file a U.S. income tax return. In addition, key tax benefits, such as the foreign earned income exclusion, are only available to those who file U.S. returns.

The law requires U.S. citizens and resident aliens to report worldwide income, including income from foreign trusts and foreign bank and securities accounts. In most cases, affected taxpayers need to complete and attach Schedule B to their tax return. Part III of Schedule B asks about the existence of foreign accounts, such as bank and securities accounts, and usually requires U.S. citizens to report the country in which each account is located.

More information on the tax rules that apply to U.S. citizens and resident aliens living abroad can be found in, Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

New Leak of Offshore Accountholders Highlights the Need to Clean Up

The U.S. Justice Department is reviewing reports about the offshore financial arrangements of global politicians and public figures based on 11.5 million leaked files from Panamanian law firm Mossack Fonseca, a department spokesman said yesterday. The department is determining whether the findings point to evidence of corruption and other violations of U.S. law.

“The U.S. Department of Justice takes very seriously all credible allegations of high level, foreign corruption that might have a link to the United States or the U.S. financial system,” said Peter Carr, spokesman for the Justice Department’s criminal division.

The International Consortium of Investigative Journalists published the investigation based on documents from the Panama-based Mossack Fonseca law firm, which specializes in creating offshore accounts. The “Panama Papers” revealed financial arrangements of tens of thousands of rich and powerful people, including friends of Russian President Vladimir Putin, relatives of the prime ministers of Britain, Iceland and Pakistan, and the president of Ukraine.

The news about the Panama Papers is emerging as the U.S. continues to ramp up efforts to thwart illegal practices involving offshore accounts. Agreements signed with other countries under the Foreign Account Tax Compliance Act (FATCA) have cracked open access to bank information previously held in secret in other countries. If a foreign bank refuses to disclose information about account holders required by FATCA, it may be assessed a 30% withholding tax on certain U.S. source payments, whether or not the recipient is a U.S. taxpayer.

In addition, U.S. taxpayers are required to report holdings in foreign banks and other financial institutions for any year in which their total assets exceed $10,000. The FBAR (Report of Financial Bank and Financial Accounts) for the 2015 tax year must be filed by June 30, 2016. Beginning with the 2016 tax year, FBARs must be filed by April 15 to coincide with the income tax filing deadline.

U.S. taxpayers are ALSO required to report holdings in foreign banks and other financial institutions for any year in which their total assets exceed generally $100,000 (there are many other applicable limits) on another Form 8938. The Form 8938 is filed with the normal income tax return filing.

Beware: Punitive penalties (including criminal prosecution) apply in cases of delinquent or non-filing of the aforementioned forms.

Taxpayers who desire to disclose to the US government a foreign account have a choice between the OVDP, and the newer streamlined procedures.  The OVDP remains the safest and most foolproof program, with amnesty even for willful acts. But for those with the right facts, the IRS Streamlined program for non-willful violations is far simpler and much less costly.  The Streamlined programs came with the 2014 improvements to the OVDP, which sparked and renewed interest in cleaning up offshore accounts.

The two programs are mutually exclusive, and a taxpayer must choose between them. The key difference in participating in the streamlined procedures requires a certification of non-willfulness. A false certification filed under the streamlined procedures could lead to possible criminal liability. Most US taxpayers who enter the IRS OVDP to resolve undeclared offshore accounts will pay a penalty equal to 27.5 percent of the high value of the accounts. The IRS updated its list of foreign banks where accounts trigger a 50% (rather than 27.5%) penalty in the IRS’s long-running Offshore Voluntary Disclosure Program (OVDP). This penalty is based on the highest account balance measured over up to eight years.

Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. Taxpayers with foreign accounts would be wise to retain experienced tax legal counsel, to better analyze the taxpayers’ position and recommend one of the two programs to clean up their mess. Most importantly, account holders become ineligible to enter the voluntary disclosure programs after the US government contacts them, which becomes more worrisome in light of leaks like the Panama Papers.

 

 

Streamlined Filing Compliance Procedure’s New Revisions to Streamlined Domestic Offshore Procedures (SDOP)

In the midst of tough tax season, many U.S taxpayers are unfortunately surprised to discover that they have a U.S. tax reporting obligation on financial accounts or assets held overseas. Once they discover their tax and reporting obligation, there are a number of programs through which they can become compliant. One option, if the taxpayers meet the requirements, is to file under the Streamlined Domestic Offshore Procedures (SDOP) or the Streamlined Foreign Offshore Procedures (SFOP).  This article focuses on the SDOP, which is for taxpayers who reside in the United States.

The Internal Revenue Service (IRS) recently modified the non-willfulness certification form that individual taxpayers must submit to enroll in the streamlined filing compliance procedures (SFCP).

The IRS introduced SFCP in June 2014 as an alternative to its existing Offshore Voluntary Disclosure Program (OVDP), which was designed more for taxpayers with evidence of willful failure to disclose foreign assets.  Specifically, SFCP is for taxpayers who non-willfully failed to disclose foreign assets. Under the SFCP, non-willful conduct is specifically 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”.

The most important first step in analyzing whether a taxpayer is eligible to participate in the streamlined procedures is to ascertain whether the taxpayer’s compliance failure, including the failure to file an FBAR, was actually non-willful. The IRS has defined “nonwillful conduct” 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.”  This definition is a little different from other legal cases. For failure to file FBARs, the IRS must establish knowledge of the law and evaluating indicators of willfulness (Internal Revenue Manual (IRM) §4.26.7).  Willfulness in criminal tax cases generally means a voluntary, intentional violation of a known legal duty (Cheek, 498 U.S. 192 (1991)). The taxpayer does not have to have an improper motive or a bad purpose. All that is required is that the taxpayer knew of the duty and intended to violate it (Pomponio, 429 U.S. 10 (1976)).

It is extremely important that a taxpayer’s eligibility is carefully analyzed because once the SFCP is elected and the taxpayer claims the violations were non-willful, the taxpayer will not be eligible for the OVDP any longer. There are possible risk factors that need to be considered and analyzed such as the evidence of willfulness including intent of laws, knowledge and violations. Although filing an SFCP does not automatically select the taxpayer for an IRS audit, the taxpayers is still subject to the possible normal audit selection. The taxpayer needs to be prepared to defend filing a SFCP and be able to demonstrate their non-willfulness.

The SDOP has numerous requirements.  Specifically, in addition to filing any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed, the taxpayer must submit: (1) amended tax returns, together with all required information returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date has passed); (2) the full amount of the tax and interest due in connection with the amended returns; (3) a completed and signed Certification by U.S. Person Residing In the U.S. (Form 14654); and (4) the Title 26 miscellaneous ONE TIME offshore penalty (which is equal to 5 percent of the highest aggregate year-end balance/value of the taxpayer’s foreign financial assets that are in the SFCP penalty base).  However, taxpayers who enter the SDOP are NOT subject to other various penalties (e.g., failure-to-file and failure-to-pay penalties, accuracy related penalties, information return penalties or FBAR penalties).

Taxpayers in the SDOP must submit Form 14654 (Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures).  As part of such certification, the taxpayer must provide specific facts and reasons (generally on a signed attachment) why their conduct was non-willful. In February 2016, the IRS revised Form 14654 to require more disclosure.  Now the IRS also instructs the taxpayer to:

Include the whole story including favorable and unfavorable facts.  Specific reasons, whether favorable or unfavorable to you, should include your personal background, financial background, and anything else you believe is relevant to your failure to report all income, pay all tax, and submit all required information returns, including FBARs.  Additionally, explain the source of funds in all of your foreign financial accounts/assets.  For example, explain whether you inherited the account/asset, whether you opened it while residing in a foreign country, or whether you had a business reason to open or use it.  And explain your contact with the account/asset including withdrawals, deposits, and investment/management decisions.  Provide a complete story about your foreign financial account/asset.   If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice. (italics added)

This is the third revision to this form in the last 18 months. The revision indicates that the IRS is receiving many incomplete disclosures. In fact, our law firm has cleaned up many rejected incomplete or inadequate SFCP nonwillful certifications. As a result of the revision, the IRS is requesting the “whole story” in exhaustive detail.  The revision poses a very delicate balance for our advocacy for our clients:  we need to share enough information in order to persuasively demonstrate non-willfulness, including unfavorable facts and circumstances; however excessive unnecessary disclosure(s) could lead to new questions and complications.

Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. While the streamlined program offers a welcome option for many taxpayers with undeclared accounts, other ways to address past noncompliance remain viable, including the OVDP program and Delinquent FBAR Submission Procedures and Delinquent International Information Return Submission Procedures. The analysis to enter the one program versus other alternative options is complex and requires full legal analysis by a competent experienced tax attorney.

Our firm presented an informational webinar on the Streamlined Filing Compliance Procedures. Materials from the webinar can be downloaded here: Game Changer Streamline.

Patel Law Offices has consulted with hundreds of clients regarding their offshore asset and income compliance issues. Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign assets.

Streamlined Filing Compliance Procedure’s New Revisions to Streamlined Foreign Offshore Procedures (SFOP)

In the midst of tough tax season, many U.S taxpayers are unfortunately surprised to discover that they have a U.S. tax reporting obligation on financial accounts or assets held overseas. Once they discover their tax and reporting obligation, there are a number of programs through which they can become compliant. One option, if the taxpayers meet the requirements, is to file under the Streamlined Domestic Offshore Procedures (SDOP) or the Streamlined Foreign Offshore Procedures (SFOP).  This article focuses on the SFOP.

The Internal Revenue Service (IRS) recently modified the non-willfulness certification form that individual taxpayers must submit to enroll in the streamlined filing compliance procedures (SFCP).  SFCP is a program offered by the IRS to individuals who have not previously disclosed foreign assets to the U.S. government.

The IRS introduced SFCP in June 2014 as an alternative to its existing Offshore Voluntary Disclosure Program (OVDP), which was designed more for taxpayers with evidence of willful failure to disclose foreign assets.  Specifically, SFCP is for taxpayers who non-willfully failed to disclose foreign assets. Under the SFCP, non-willful conduct is specifically 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”.

The most important first step in analyzing whether a taxpayer is eligible to participate in the streamlined procedures is to ascertain whether the taxpayer’s compliance failure, including the failure to file an FBAR, was actually non-willful. The IRS has defined “nonwillful conduct” 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.”   For failure to file FBARs, the IRS must establish knowledge of the law and evaluating indicators of willfulness (Internal Revenue Manual (IRM) §4.26.7).  Willfulness in criminal tax cases generally means a voluntary, intentional violation of a known legal duty (Cheek, 498 U.S. 192 (1991)). The taxpayer does not have to have an improper motive or a bad purpose. All that is required is that the taxpayer knew of the duty and intended to violate it (Pomponio, 429 U.S. 10 (1976)).

It is extremely important that a taxpayer’s eligibility is carefully analyzed because once the SFCP is elected and the taxpayer claims the violations were non-willful, the taxpayer will not be eligible for the OVDP any longer. There are possible risk factors that need to be considered and analyzed such as the evidence of willfulness including intent of laws, knowledge and violations. Although filing an SFCP does not automatically select the taxpayer for an IRS audit, the taxpayers is still subject to the possible normal audit selection. The taxpayer needs to be prepared to defend filing a SFCP and be able to demonstrate their non-willfulness.

The IRS has two separate tracks for taxpayers wishing to enter in the SFCP: one track for taxpayers who reside in the United States (hereinafter “Streamline Domestic Offshore Procedure (SDOP)”) and another track for taxpayers who reside outside the United States (hereinafter “Streamline Foreign Offshore Procedure (SFOP)”).

The eligibility requirements for the separate tracks have some notable variations.  The threshold eligibility inquiry is the taxpayer’s residency.  A taxpayer will be treated as not residing in the United States if, in any one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the taxpayer did not have a U.S. abode and the taxpayer was physically outside the United States for at least 330 full days.

If the taxpayer meets the non-residency test, then the taxpayer may enter the Streamline Foreign Offshore Procedure (SFOP), provided the taxpayer can certify that: (1) he or she failed to report income from a foreign financial asset and pay tax as required by U.S. law [and may have failed to file a report of foreign bank and financial accounts (FBAR)]; and (2) such failures resulted from non-willful conduct.

If a taxpayer can certify that he or she meets the eligibility requirements, then the taxpayer may make a voluntary disclosure as part of the SFCP program.  The SFOP requires the taxpayer to submit, in addition to filing any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed: (1) delinquent or amended or new tax returns, together with all required information returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date has passed); (2) the full amount of the tax and interest due in connection with the delinquent or amended returns; and (3) a completed and signed Certification by U.S. Person Residing Outside of the U.S. (Form 14653).  Taxpayers who enter the SFOP are NOT subject to any penalties (i.e., failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, FBAR penalties, or a Title 26 miscellaneous offshore penalty).  There simply is no penalty, which is a great uncommon result for non-compliant taxpayers.

Taxpayers in the SFOP must submit Form 14653 (Certification by U.S. Person Residing Outside the United States for Streamlined Foreign Offshore Procedures).  As part of such certification, the taxpayer must provide specific facts and reasons (generally on a signed attachment) why their conduct was non-willful.

In February 2016, the IRS revised Form 14653 and added a section to Form 14653 requesting detailed information regarding presence outside the U.S. during the streamlined procedures submission period.  The IRS now requires that U.S. citizens or lawful permanent residents indicate whether they were physically outside the United States for each year in the covered three-year period. Also, for joint submissions, the IRS states that both spouses filing a joint certification must meet the non-residency requirement. If the number of days physically outside of the United States differs for each spouse, then each spouse needs to disclose that on the chart on the Form 14653 or in an attachment thereto.

Also in February 2016, the IRS revised Form 14653 to require more disclosure.  Now the IRS also instructs the taxpayer to:

Include the whole story including favorable and unfavorable facts.  Specific reasons, whether favorable or unfavorable to you, should include your personal background, financial background, and anything else you believe is relevant to your failure to report all income, pay all tax, and submit all required information returns, including FBARs.  Additionally, explain the source of funds in all of your foreign financial accounts/assets.  For example, explain whether you inherited the account/asset, whether you opened it while residing in a foreign country, or whether you had a business reason to open or use it.  And explain your contact with the account/asset including withdrawals, deposits, and investment/management decisions.  Provide a complete story about your foreign financial account/asset.   If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice. (italics added)

This is the third revision to this form in the last 18 months. The revision indicates that the IRS is receiving many incomplete disclosures. In fact, our law firm has cleaned up many rejected incomplete or inadequate SFCP non-willful certifications. As a result of the revision, the IRS is requesting the “whole story” in exhaustive detail.  The revision poses a very delicate balance for our advocacy for our clients:  we need to share enough information in order to persuasively demonstrate non-willfulness, including unfavorable facts and circumstances, however excessive disclosure could lead to new questions and complications.

Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. While the streamlined program offers a welcome option for many taxpayers with undeclared accounts, other ways to address past noncompliance remain viable, including the OVDP program and Delinquent FBAR Submission Procedures and Delinquent International Information Return Submission Procedures. The analysis to enter the one program versus other alternative options is complex and requires full legal analysis by a competent experienced tax attorney.

Our firm presented an informational webinar on the Streamlined Filing Compliance Procedures. Materials from the webinar can be downloaded here: Game Changer Streamline.

Patel Law Offices has consulted with hundreds of clients regarding their offshore asset and income compliance issues. Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign assets.

 

 

New Trust Law Enacted in New Jersey

On January 19, 2016, the New Jersey Uniform Trust Code (NJUTC) was enacted into law.  The new law will take effect on July 17, 2016.  The new law, based in part on model legislation prepared by the Uniform Law Commission, supplements and revises New Jersey’s existing laws concerning trusts.  Many of the provisions of the new Uniform Trust Code are default rules that will only apply if the provisions of the trust instrument fail to adequately address a particular issue.

Below are a few significant provisions of what the NJUTC does:

  • Establishes new specific rules of trusts that are not subject to override in the trust’s terms.
  • Establishes that upon reaching the age of 35, if a beneficiary becomes aware of the trust, the trustee must provide the beneficiary both the trust instrument and information regarding the investment and management of the trust if requested by the beneficiary.
  • Establishes rules concerning trust modification and termination which allow greater flexibility and special rules relating to revocable trusts.
  • Clarifies and affirms the ability to establish Special Needs Trusts for individuals with disabilities and strengthens the protection against creditors’ attempts to reach the assets held in a Special Needs Trust.
  • Establishes a means of determining which jurisdiction’s law governs a trust and location of a trust’s principal place of administration.
  • Enables the non-judicial settlement of trust accounts and other matters related to trust administration; provided, such action is not contrary to a material purpose of the trust or public policy. This eliminates the need to go through the cost and delay of seeking court approval for action such as (a) interpreting the terms of a trust; (b) approving a trustee’s accounting; (c) approving or restraining an action of a trustee; (d) approving the resignation or appointment of a trustee and determining a trustee’s compensation; (e) transferring the principal place of administration of a trust; and (f) establishing trustee liability for an action related to a trust.
  • Defines who may represent and legally bind another individual in matters related to the administration of a trust.
  • Establishes the method for creating, modifying or terminating a trust, including, but not limited to allowing for the modification or termination of a trust even if the trust has a spend thrift clause (limiting creditor access to trust assets) and allowing for the modification or termination of a trust if the trustee and beneficiaries agree (the settlor does not have to agree).
  • Establishes detailed rules in connection with the representation of beneficiaries.
  • Establishes the duties of a trustee and how a trustee is appointed, declines appointment or is removed. For the most part, the NJUTC restates current law. However, it does make a few changes. For example, it clarifies the relationship between a trustee and investment advisor and the responsibilities of each to direct and manage the trust assets.

The NJUTC applies retroactively, with some limited exceptions, to trusts created before, on or after the effective date. As a best practice, many trusts drafted by our law firm have already addressed many of the benefits provided by the NJUTC. The new law may necessitate a review of an old estate plan.

US Entities with foreign assets have more information reporting

The US Treasury has issued long-awaited regulations specifying the domestic taxpayers who have to disclose substantial foreign financial assets to the Internal Revenue Service (IRS) every year.

The new rules, effective immediately, are linked to the Foreign Account Tax Compliance Act (FATCA). When FATCA was enacted in 2010, the new Section 6083D was added to the Internal Revenue Code requiring certain domestic US taxpayers to make annual reports to the IRS on their ‘specified foreign financial assets’. These reports, to be submitted on Form 8938, would be mandatory if the aggregate value of the foreign assets was above USD50,000 on the last day or the year, or above USD75,000 at any time during the year.

Form 8938 and associated draft instructions have been available since 2012 for use by non-resident US persons, but agreement had, at that stage, not been reached on exactly what types of ‘domestic entity’ would also be required to report assets. The US Treasury published a draft regulation addressing this issue in 2011, but later changed its mind and deferred reporting by domestic entities until final regulations had been published.

The final rule sets out exactly which domestic entities must file Form 8938 reports. It includes any domestic corporation, a domestic partnership, or a domestic trust ‘formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets’. For corporations or partnerships, this means entities that are closely held by a specified individual, and whose main activity is to generate passive income. The rule gives a definition of ‘closely held’ and ‘passive income’, designed to catch entities that ‘have a high risk of being used for tax evasion’ while reducing compliance burdens for active entities.

Domestic trusts are exempt if the trustee is a regulated financial institution or public corporation that files annual returns on behalf of the trust. Domestic grantor trusts owned by one or more ‘specified persons’ are also exempt.

Reports are required from all entities whose tax years start after 31 December 2015. There is a USD10,000 penalty for failure to file the form, which overlaps heavily with the existing FBAR form.

 

The Tax Heat is On

At the recent American Bar Association meeting held on January 29, 2016, the acting Attorney General for the tax division disclosed that the IRS and US Department of Justice are now focusing bank investigations in Belize, the British Virgin Islands, Cayman Islands, the Cook Islands, India, Israel, Liechtenstein, Luxemburg, the Marshall Islands and Panama, to name a few. The heat is on and the US government is pursuing both civil and criminal enforcement efforts to pursue taxpayers who continue to conceal foreign accounts and assets and evade their US tax obligations. The government has encouraged financial institutions and individuals who have engaged in criminal conduct to contact the US Department of Justice to discuss their options.

In September, the US District Court for the Southern District of Florida authorized the issuance of “John Doe” summonses to Citibank and Bank of America to produce records identifying US taxpayers with offshore bank accounts in Belize. The “John Doe” Summonses sought information regarding US persons who hold offshore accounts at Belize Bank International Limited and Belize Bank Limited (the “Belize Banks”). These summonses permit the IRS to seek records of the Belize Banks’ correspondent accounts at Bank of America, N.A. and Citibank, N.A.

Pursuant to the summonses, Bank of America and Citibank have been directed to produce records which identify US taxpayers with accounts at the Belize Banks. The court also granted permission to the IRS to seek records of Corporate Services’ correspondent accounts at Bank of America and Citibank, as well as information related to Corporate Service’s deposit account at Bank of America. The “John Doe” class includes US taxpayers, who at any time from 2006 through 2014 had interests in, or authority with respect to, any financial accounts maintained at, monitored by, or managed through the Belize Entities. The IRS believes that these John Doe summonses will enable it to ascertain the identity of US taxpayers that it believes are using the Belize Entities and correspondent accounts to avoid their obligation to report and remit associated taxable income to the United States.

Taxpayers who desire to disclose to the Service a foreign account have a choice between the OVDP, the latest iteration of which is an open-ended program that began in January 2012 (modified in 2014), and the newer streamlined procedures, offered beginning in 2012 and also modified in 2014 to accommodate a broader group of US taxpayers.  The OVDP remains the safest and most foolproof program, with amnesty even for willful acts. But for those with the right facts, the IRS Streamlined program for non-willful violations is far simpler and much less costly.  The Streamlined programs came with the 2014 improvements to the OVDP, which sparked and renewed interest in cleaning up offshore accounts.

The two programs have been very successful: Since commencement, the U.S. has collected more than $13.5 billion from individuals and financial firms in taxes and penalties due on offshore accounts.

The two programs are mutually exclusive, and a taxpayer must choose between them. The key difference in participating in the streamlined procedures requires a certification of non-willfulness. A false certification filed under the streamlined procedures could lead to possible criminal liability. Most US taxpayers who enter the IRS OVDP to resolve undeclared offshore accounts will pay a penalty equal to 27.5 percent of the high value of the accounts. The IRS updated its list of foreign banks where accounts trigger a 50% (rather than 27.5%) penalty in the IRS’s long-running Offshore Voluntary Disclosure Program (OVDP). This penalty is based on the highest account balance measured over up to eight years.

Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. Taxpayers with foreign accounts would be wise to retain experienced tax legal counsel, to better analyze the taxpayers’ position and recommend one of the two programs.