The IRS has begun receiving information regarding tax year 2014 from nations around the world who have agreed to comply with FATCA. Some of those countries negotiated reciprocal agreements to also receive information from the US regarding their taxpayers with U.S. accounts.
According to IRS pronouncements, the IRS has said that the following 34 countries, including most developed countries, have already met all the requirements to receive information from the IRS:
- Czech Republic
- Isle of Man
- New Zealand
- South Africa
- United Kingdom
International families with U.S. connections are exposed to the legal risk of being involuntarily discovered by the US were their own local government.
U.S. citizens and tax residents, living in the U.S. or abroad, who have accidentally or intentionally failed to report income, bank accounts, corporations, trusts or other assets outside the U.S. are increasingly at risk of being detected, fined and in some cases prosecuted.
It is strongly recommended that you speak with a tax attorney with experience in international tax planning in the context of an attorney client privileged conversation.
IR-2015-111, Oct. 2, 2015
WASHINGTON — The Internal Revenue Service today announced the exchange of financial account information with certain foreign tax administrations, meeting a key Sept. 30 milestone related to FATCA, the Foreign Account Tax Compliance Act.
To achieve this, the IRS successfully and timely developed the information system infrastructure, procedures, and data use and confidentiality safeguards to protect taxpayer data while facilitating reciprocal automatic exchange of tax information with certain foreign jurisdiction tax administrators as specified under the intergovernmental agreements (IGAs) implementing FATCA.
“Meeting the Sept. 30 deadline is a major milestone in IRS efforts to combat offshore tax evasion through FATCA and the intergovernmental agreements,” said IRS Commissioner John Koskinen. “FATCA is an important tool against offshore tax evasion, and this is a significant step in the process. The IRS appreciates the assistance of our counterparts in other jurisdictions who have helped to make this possible.”
This information exchange is part of the IRS’s overall efforts to implement FATCA, enacted in 2010 by Congress to target non-compliance by U.S. taxpayers using foreign accounts or foreign entities. FATCA generally requires withholding agents to withhold on certain payments made to foreign financial institutions (FFIs) unless such FFIs agree to report to the IRS information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
In response to the enactment of FATCA and other jurisdictions’ interest in facilitating and participating in the exchange of financial account information, the U.S. government entered into a number of bilateral IGAs that set the groundwork for cooperation between the jurisdictions in this area. Certain IGAs not only enable the IRS to receive this information from FFIs, but enable more efficient exchange by allowing a foreign jurisdiction tax administration to gather the specified information and provide it to the IRS. And some IGAs also require the IRS to reciprocally exchange certain information about accounts maintained by residents of foreign jurisdictions in U.S. financial institutions with their jurisdictions’ tax authorities.
Under these reciprocal IGAs, the first exchange had to take place by September 30, giving the IRS a deadline to put in place a process to facilitate this data exchange.
The information now available provides the United States and partner jurisdictions an improved means of verifying the tax compliance of taxpayers using offshore banking and investment facilities, and improves detection of those who may attempt to evade reporting the existence of offshore accounts and the income attributable to those accounts.
The IRS will only engage in reciprocal exchange with foreign jurisdictions that, among other requirements, meet the IRS’s stringent safeguard, privacy, and technical standards. Before exchanging with a particular jurisdiction, the United States conducted detailed reviews of that jurisdiction’s laws and infrastructure concerning the use and protection of taxpayer data, cyber-security capabilities, as well as security practices and procedures.
“This groundbreaking effort has fundamentally altered our relationship with tax authorities around the world, giving us all a much stronger hand in fighting illegal tax avoidance and leveling the playing field,” Koskinen said.
Meeting this deadline reflects a significant international collaboration and partnership with dozens of jurisdictions around the world. The capacity for reciprocal automatic exchange builds on numerous accomplishments including the following:
- Development of a consistent data reporting format, or schema, and the agreement to use this format by all jurisdictions;
- Establishment of the details and procedures required to assure data confidentiality;
- Creation of a data transmission system to meet high standards for encryption and security; and
- Cooperation with foreign jurisdiction tax administrations to achieve the timely implementation of this exchange.
Koskinen noted the risks of hiding money offshore are growing and the potential rewards are shrinking.
Since 2009, tens of thousands of individuals have come forward voluntarily to disclose their foreign financial accounts, taking advantage of special opportunities to comply with the U.S. tax system and resolve their tax obligations. At the beginning of 2012, the IRS reopened the Offshore Voluntary Disclosure Program (OVDP), which is open until otherwise announced.
If you are an American entrepreneur with a foreign business interest or operating abroad then you should be aware of U.S. tax reporting obligations on non-U.S. businesses. If a U.S. taxable person (U.S. citizens or U.S. green card holders) owns a controlling stake in a foreign business, that business is likely a Controlled Foreign Corporation (CFC) for U.S. tax purposes. CFCs are subject to potentially complex U.S. tax reporting requirements and, at a minimum, must file U.S. tax Form 5471 every year, whether or not the business is profitable. Even if no tax is due, failure to file a Form 5471 can result in large penalties.
CFC income reporting requirements (most importantly, the so-called “subpart F income” and “passive foreign investment income” rules) are designed to prevent Americans from using foreign businesses to shelter income from U.S. taxation. On the other hand, many American expat entrepreneurs have an often overlooked opportunity to employ conventional U.S. qualified retirement plans to significantly mitigate tax due on foreign sourced income and build retirement account assets.
American entrepreneurs abroad who partner with non-U.S. persons may find that their U.S. connection brings unwanted U.S. reporting requirements and scrutiny. Aside from the CFC rules discussed above, the new FATCA (Foreign Account Tax Compliance Act) requires ownership stakes in non-U.S. private business to be reported on Form 8938. Effectively, these reporting requirements force any business with U.S. partners to prepare financial statements to U.S. standards and submit that information to the IRS so that the U.S. partners’ tax liability can be determined. Enforcement of such onerous rules has significantly ratcheted up with the introduction of FATCA and has resulted in many cases of U.S. partners being shunned from foreign business ventures.
It should also be noted that where a U.S. partner (or even a U.S. employee) has signing authority over a business-related financial account, a Foreign Bank Account Report (FBAR) must be filed annually to disclose the account to the U.S. Treasury Department. Failure to properly make FBAR disclosures can result in extraordinarily high U.S. penalties, even when no tax is due.
Finally, self-employed Americans abroad are normally required to pay 15.3% U.S. self-employment tax (Social Security and Medicare) on self-employment income. Social Security Totalization agreements maintained by the U.S. with other countries may exempt the entrepreneur from paying U.S. self-employment tax when similar taxes are being paid locally.
On July 31, 2015, President Obama signed into law P.L. 114-41, which included a number of tax provisions, one of which changes the deadline for filing the Report of Foreign Bank and Financial Accounts (FinCEN Form 114) (the FBAR) for 2016 and future years.
The FBAR must be filed by a U.S. person (i.e., an individual who is a U.S. citizen or resident, and a U.S. entity, including a trust or estate formed under the laws of the United States) with a financial interest in one or more non-U.S. bank and financial accounts, the highest balances of which, in the aggregate, equal or exceed $10,000 during the year. Since it was introduced in the 1970s, the FBAR, which is filed separate and apart from all U.S. income tax returns, has been due on or before June 30 of the following year (with no extension of that deadline available), which differed from all U.S. income tax return filing deadlines. The deadline for U.S. residents to timely file a U.S. Individual Income Tax Return is April 15, and the deadline for non-U.S. residents is June 15; both deadlines can be automatically extended to October 15 by filing IRS Form 4868 on or before the original deadline.
The Act directed the Treasury Department to modify the appropriate regulations to change the due date of the FBAR for U.S. residents from June 30 of the following year to April 15 and to change the due date of the FBAR for non-U.S. residents to June 15. The Act also directed the Treasury to provide for a maximum extension for filing the FBAR to October 15 for both U.S. residents and nonresidents. The IRS will likely create a form for requesting an automatic extension of time to file the FBAR by October 15 or will modify IRS Form 4868 or IRS Form 7004 to incorporate the FBAR.
The Act is effective for tax years beginning after December 31, 2015, so the new filing deadlines will not take effect until the FBAR for the 2016 year is due in 2017.
Hence, the 2015 FBAR is still due on June 30, 2016. However, the 2016 FBAR and subsequent years will be due on April 15th.
The Act also instructs the Treasury to waive any penalty for a first time FBAR filer’s “failure to timely request for, or file, an extension” of time to file. Although that wording is less than clear, presumably a first-time filer must file the first FBAR by the would-be extended (October 15) due date to be eligible for the penalty relief.
The change in the due date of the FBAR makes its filing deadline more logical by aligning it with the U.S. Individual Income Tax Return filing deadlines, but it also means that taxpayers and tax-return preparers have additional work to do by those tax return filing deadlines and that the FBAR deadline for U.S. residents will be accelerated by more than two months.
The ability to extend the FBAR filing deadline to October 15, is certainly a welcome change to tax professionals.
Many of our tax-noncompliant clients are fearful of being involuntary discovered through the impending FATCA disclosures of their foreign accounts by their foreign banks. The Internal Revenue Service has issued a notice extending the time under which certain transitional rules for the Foreign Account Tax Compliance Act will apply.
FATCA was included as part of the HIRE Act of 2010 and requires foreign financial institutions to report on the assets of U.S. taxpayers to the IRS, or else face penalties of up to 30 percent on their income from U.S. sources. The law has provoked controversy abroad, and as the US Treasury Department has delayed a number of the requirements to give banks time to adjust while also negotiating a series of intergovernmental agreements with tax authorities in foreign countries, most of which allow them to act as intermediaries before the information is given to the IRS.
IRS Notice 2015-66, issued Friday, announces that the Treasury and the IRS intend to amend regulations under Sections 1471-1474 of the Tax Code to extend the time that certain FATCA transitional rules will apply. The notice also provides information on the exchange of information by Model 1 IGA jurisdictions with respect to 2014. Under the Model 1 intergovernmental agreement, which is the more typical kind, foreign financial institutions report the account information to their own countries’ tax authorities, which then pass the information to the IRS. Under the Model 2 IGA, the foreign banks report the information directly to the IRS.
In new Notice 2015-66 the IRS said it plans to amend FATCA regulations to reduce certain collateral restrictions on grandfathered obligations and extend the following transition rules:
(1) the date for when withholding on gross proceeds and foreign passthrough payments will begin;
(2) the use of limited branches and limited foreign financial institutions (limited FFIs); and
(3) the deadline for a sponsoring entity to register its sponsored entities and redocument such entities with withholding agents.
Separately, IRS Notice 2014-33 states that calendar years 2014 and 2015 are regarded as a transition period for purposes of IRS enforcement and administration of the due diligence, reporting, and withholding provisions of FATCA. Consistent with treating 2014 and 2015 as a transition period, the US Treasury and the IRS will treat foreign banks covered by an IGA as complying with, and not subject to withholding under, FATCA even if the relevant partner jurisdiction has not exchanged 2014 information by September 30, 2015, as long as the partner jurisdiction notifies the U.S. competent authority before September 30, 2015, of the delay and provides assurance that the jurisdiction is making good faith efforts to exchange the information as soon as possible. This notice does not affect the timing of when FFIs should report information to a partner jurisdiction, which remains governed by local law.
This means that as long as the foreign government notifies the US Treasury of the delay then there will be no adverse effects under FACTA.
It is good to see that some of the impending transition dates have been pushed back.
FATCA is not the only new way foreign account information is being shared among different countries’ tax authorities. The Organization for Economic Cooperation and Development has been pushing for a Common Reporting Standard to address the issue of offshore tax evasion by creating a globally coordinated, consistent approach to the disclosure of financial accounts held by non-residents and the automatic exchange of that information by governments. The OECD standard builds upon FATCA, which obligates foreign financial institutions to provide the U.S. government with information about accounts held by U.S. taxpayers. In total, almost 100 jurisdictions have committed to implement the CRS by January 1, 2017.
Last spring, the IRS revised its program for delinquent FBAR returns. The IRS offers a new “delinquent FBAR submission procedure”. See below excerpt from the IRS website.The program is available if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
You must include “a statement explaining why you are filing the FBARs late”, which many people interpret as a “reasonable cause” excuse explanation. Taxpayers are warned to carefully craft the statement to persuasively demonstrate reasonable cause.
In such case, many longstanding authorities regarding what constitutes reasonable cause continue to apply, and existing procedures concerning establishing reasonable cause, including requirements to provide a statement of facts made under the penalties of perjury, continue to apply. See, for example, Treas. Reg. § 1.6038-2(k)(3), Treas. Reg. § 1.6038A-4(b), and Treas. Reg. § 301.6679-1(a)(3).
Taxpayers may wish to seek legal counsel in filing the delinquent FBAR submission procedure.
Delinquent FBAR Submission Procedures
Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:
- have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1),
- are not under a civil examination or a criminal investigation by the IRS, and
- have not already been contacted by the IRS about the delinquent FBARs
should file the delinquent FBARs according to the FBAR instructions.
Follow these steps to resolve delinquent FBARS
- Review the instructions
- Include a statement explaining why you are filing the FBARs late
- File all FBARs electronically at FinCEN
- On the cover page of the electronic form, select a reason for filing late
- If you are unable to file electronically, contact FinCEN’s Regulatory Help line at 1-800-949-2732 or 1-703-905-3975 (if calling from outside the United States) to determine possible alternatives to electronic filing.
The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
FBARs will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.
If you invest internationally a Passive Foreign Investment Company (PFIC) could be a nightmare that could become a reality if you happen to invest in what the IRS deems a PFIC, which are taxed at exorbitant rates and have highly complex reporting rules. Most foreign mutual funds are PFICs, as are certain foreign stocks.
It is not illegal to invest in a PFIC, but practically speaking, the costs of doing it are so incredibly onerous that it’s prohibitively expensive in the vast majority of cases.
What Is a PFIC Investment?
If a foreign corporation or investment vehicle meets either of the two conditions below, it will be deemed to be a PFIC.
1) If passive income accounts for 75% or more of gross income (passive income includes income from interest, dividends, annuities, and certain rents and royalties) or
2) 50% or more of its assets are assets that produce passive income.
If you own a foreign mutual fund it probably (and unfortunately) qualifies as a PFIC. An offshore investment entity that makes an election (which is rare) to be classified as a disregarded entity or a partnership is not a PFIC.
What Are the Implications of the PFIC Rules?
The consequences of owning a PFIC are severe. The IRS estimates it takes up to 30 hours of tax preparation time to complete Form 8621, which needs to be filed for each PFIC every year. As a result, the benefit of holding a PFIC often outweighs even the cost of reporting it.
Aside from the aforementioned complexity, unless a PFIC investor makes one of the elections explained below, he suffers the following punitive tax rates and special rules:
- For any year in which you receive a dividend or sell any PFIC shares, you face a complex calculation that involves prorating the PFIC’s return over your entire holding period and applying an interest charge.
- Most capital gains are taxed at a top federal rate of 20%, plus the Obamacare surcharge of 3.8%, for a total of 23.8%, which is favorable compared to the top ordinary federal income tax rate of 39.6%. Capital gains in PFICs, however, are effectively taxed at the highest ordinary income rate plus the interest charge mentioned above. The tax and interest due can eat up 70% or more of your gain.
- A capital loss on a PFIC cannot be used to offset capital gains on other investments.
Due to the Foreign Account Tax Compliance Act (FATCA), which forces every single financial institution to submit information on their American clients to the IRS, PFIC rules will be enforced.
Fortunately, there are a few solutions out of PFIC status:
- First, if the PFIC meets certain accounting and reporting requirements (which is rare), the US investor can elect to treat the PFIC as a Qualified Electing Fund (QEF), which eliminates the punitive tax rates.
- Second, generally speaking, there is an exemption from PFIC reporting if PFIC holdings do not exceed $25,000 ($50,000 for married couples filing jointly).
- Third, if you hold a PFIC through an IRA or other certain retirement accounts, you may be exempt from Form 8621 filing requirements.
With the complexity and unfavorable tax rates that come with them, it is clearly better to avoid owning PFICs when investing offshore.
The most common FBAR reporting mistake is simply failing to file. Some U.S. persons continue to deliberately conceal assets in secret offshore bank accounts in the hope of evading U.S. tax authorities. In many other cases, however, Americans living and working outside the U.S., recent immigrants, foreign citizens who are resident in the U.S., and U.S. children who received gifts or bequests from their foreign parents are simply unaware of their FBAR filing obligations. Despite well-publicized enforcement actions against financial institutions and individual account holders, as well as corresponding amnesty programs, many U.S. persons with foreign financial accounts remain unaware of the FBAR reporting obligations.
U.S. persons with ownership or signature authority over foreign financial accounts should obtain complete copies of their account records and fully educate themselves regarding FBAR reporting obligations and, when necessary, seek advice from U.S. tax professionals in advance of the June 30 filing deadline.
Those who fail to resolve prior reporting errors can expect harsh treatment from U.S. tax authorities and remain exposed to substantial penalties and possible criminal prosecution. Similarly, U.S. courts have not been sympathetic to uninformed foreign account.holders who failed (deliberately or otherwise) to investigate their reporting obligations. In some cases, U.S. courts have imposed a penalty equal to 50 percent of the highest account balance for each year that remained open under the statute of limitations. Many who deliberately concealed offshore bank accounts have been prosecuted and received prison terms.
The IRS offers four options to fix FBAR mistakes. Participation in the two formal disclosure programs is permitted only if the funds held in the foreign financial account(s) are from a legal source (and not the proceeds of an illegal activity) and if the IRS is not already in a position to know of the person’s noncompliance.
1. File an Amended FBAR
According to the FBAR instructions, a person who previously filed an FBAR but mistakenly provided incomplete or inaccurate information on the form is required to file an amended FBAR. FinCEN Form 114 includes a box for providing a brief explanation of the error. Because of the six-year statute of limitations, a filer need not correct an error on an FBAR filed more than six years ago.
Filing an amended or delinquent FBAR outside one of the IRS’s penalty relief programs does not afford any penalty protection and therefore requires careful consideration. The IRS may impose penalties if it later determines that the FBAR error was willful or due to negligence. On the other hand, no penalties may be imposed under the law if the error was due to reasonable cause (i.e., an innocent mistake). Even if the error was not due to reasonable cause, under the IRS’s penalty mitigation guidelines, the IRS has discretion to determine that a penalty would be inappropriate and may instead issue an FBAR warning letter.
2. File Pursuant to the IRS’s Delinquent FBAR Submission Procedures
A person who has not previously filed an FBAR, but who has properly filed federal income tax returns that fully reported the income from any foreign account(s), may be eligible for the IRS’s Delinquent FBAR Submission Procedures. Under the Delinquent FBAR Submission Procedures, “[t]he IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.”
The U.S. person should e-file the delinquent FBAR and include a statement that explains why the FBAR is being filed late. Although not required by the procedures, the explanation should also reference that the FBAR is being filed pursuant to the “IRS’s Delinquent FBAR Submission Procedures.”
3. File Pursuant to the IRS’s Streamlined Filing Compliance Procedures
The IRS’s Streamlined Filing Compliance Procedures (commonly referred to as the “Streamlined Offshore Program”) are available for a resident or nonresident U.S. person who mistakenly failed to file an FBAR and/or failed to report on a U.S. tax return income related to foreign financial account(s). These procedures are also available for a nonresident U.S. taxpayer who failed to file a federal income tax return (i.e., Form 1040).
In general, a taxpayer is eligible to participate in the streamlined program if his or her failure to file a U.S. tax return and/or FBAR was not willful. The streamlined program requires a participant to file federal income tax returns (or amended returns) for three prior years and FBARs for six prior years, along with a declaration (signed under penalties of perjury) attesting that his or her failure to file was not willful. A false certification could expose a disclosing taxpayer to potential civil fraud, FBAR and information return penalties, as well as criminal liability.
In general, under the terms of the streamlined program, the IRS will not impose any penalties on a participating nonresident taxpayer. For a taxpayer resident in the U.S., the IRS will impose (1) accuracy penalties (20 percent) on the unreported tax, and (2) an FBAR-type penalty equal to 5 percent of the maximum aggregate balance in the unreported foreign financial account(s) during the six-year period. The streamlined procedures are fully described on the IRS’s website.
4. Apply to Participate in the IRS’s Offshore Voluntary Disclosure Program
The current iteration of the OVDP program is intended to help those taxpayers who knowingly violated the tax laws to come back into compliance and avoid criminal prosecution. In general, this program requires a taxpayer to file eight prior years’ tax returns and FBARs, provide detailed information regarding any unreported foreign financial account(s), and pay all taxes, accuracy penalties, delinquency penalties, and interest due for the eight-year period. In addition, the IRS imposes an FBAR-type civil penalty equal to 27.5 percent of the single maximum aggregate balance in the unreported foreign financial accounts during the eight-year period. The penalty is increased to 50 percent if the IRS or DOJ has initiated an investigation of the financial institution in which the accounts are held. Nevertheless, this program remains a potentially attractive option for a U.S. person otherwise exposed to even greater civil penalties or potential criminal prosecution.