Posts by MarkNestmann:
- You must disclose any “reportable” foreign accounts on Schedule B of Form 1040. This is a simple “yes or no” declaration, along with a list of the countries in which you hold foreign accounts.
- You must file Form 8938 to report “specified foreign financial assets” you hold outside the US with a total aggregate value of more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
A Ceasefire in the IRS’ War on US Citizens
July 16th, 2014By Mark Nestmann.
Around 10 years ago, the US declared war on a select group of Americans – the nearly 8 million US persons (citizens and green card holders) living abroad.
The IRS quietly and stealthily conducted this war. Its campaign consisted of extortion and intimidation, in an effort to force expats to comply with their US tax obligations.
In my adopted country of Panama, IRS agents fanned out across the country, seeking out non-compliant US taxpayers. At least some of the agents carried firearms in open view. How would you feel if an SUV full of armed men pulled into your driveway and started walking toward your front door?
You may be scratching your head at this point and thinking, “You mean US persons who don’t actually live in the US have to pay US taxes?”
Yes, that’s right. The US is the only major country with this policy. And US persons living abroad also have the same reporting responsibilities as “homelanders.” For instance, US persons – no matter where they live – who have signature or “other” authority over any non-US bank, securities, or “other” financial accounts must report them if their aggregate value exceeds $10,000.
The penalties for failing to file some of these forms far exceed those for merely failing to file a tax return. For instance, the civil penalty for “willfully” failing to file this “foreign bank accounts report” (FBAR) is the greater of $100,000 or 50% of the total balance of the foreign account. Criminal penalties may also apply for willful violations. Non-willful violations are subject to a $10,000 penalty per account per year.
That’s just the beginning. US persons who create or fund a foreign trust or any foreign business entity, such as an offshore corporation, must make extensive disclosures. Once again, penalties for failing to do so are draconian.
Recently, I estimated that if the IRS were to impose the maximum civil penalty against US expats for failing to file just the FBAR, it could raise nearly $300 billion… nearly half of the estimated US budget deficit for 2014.
Millions of expats were caught in the crossfire – even those who thought they understood these rules. For instance, a US citizen who had lived in Canada for many years contacted me after receiving a bill from the IRS for $20,000. He thought he was 100% compliant with all US tax and reporting obligations. He’d even hired a big-name US accounting firm to prepare his tax returns each year, at a cost of more than $5,000 annually. He never owed any US tax, because taxes in Canada are higher than in the US, but he still got screwed.
A Canadian educational savings plan account he’d set up for his daughter was the problem. According to US tax rules, he must report the savings plan on the FBAR. Mercifully, the IRS didn’t impose a penalty for “willful” FBAR violations. It merely fined him $10,000 for two years of negligently failing to include the savings plan on the reporting form.
Until June 18, there were only a couple of ways that you could avoid these penalties. If you had no underreported tax liabilities, you could file delinquent FBARs and other reporting forms with no penalty at all. And about a year ago, the IRS decided that non-resident taxpayers that it determined were a “low compliance risk” would also be eligible for more favorable treatment. To qualify for this status, you had to live outside the US and owe less than $1,500 per year in income tax. The IRS waived all reporting penalties, but you still had to pay all taxes and interest going back for three years.
Otherwise, the best you could hope for would be to come forward under the IRS’s “Offshore Voluntary Disclosure Program” (OVDP). In exchange for signing up for this program, the IRS promised not to prosecute you for criminal tax evasion or to impose its most severe civil penalties. Instead, you had to pay 27.5% of the highest aggregate account values for eight years prior to the disclosure.
This calculation method significantly increased the severity of the penalty. For instance, thanks to the global economic downturn in 2008-2009, an unreported international account worth $1 million in 2007 might have been worth only $600,000 at the end of 2012. Yet the 27.5% penalty would be assessed against the entire $1 million for 2007, increasing the effective sanction to nearly 50% ($275,000 of $600,000). And this is in addition to the penalties for subsequent years.
The Newest Offshore Voluntary Disclosure Program
Early last month, IRS commissioner John Koskinen made a speech in which he hinted that the IRS might “enhance” the OVDP. Koskinen told his audience that the IRS might have been too hard on non-resident US persons. He distinguished these citizens – many of whom have lived abroad for decades – from US-resident taxpayers who willfully hide their international investments overseas from IRS scrutiny. In other words, the IRS finally recognized that not every expat with an unreported foreign account is a criminal.
On June 18, the IRS followed through on Koskinen’s promise. Effective immediately, expats who agree to disclose their foreign accounts and pay US taxes for the previous three years won’t need to pay any penalties. They’ll owe just back taxes and interest (if any). The IRS even extended an olive branch to resident Americans. They’ll be able to come forward and disclose their offshore accounts for the previous three years and pay only a 5% penalty, not 27.5%.
To take advantage of the “kinder and gentler” IRS approach to international compliance, you’ll need to certify that the “the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non-willful conduct. ” The certification forms for US residents and non-residents, respectively, are here and here.
If the IRS decides your failure to comply with these obligations was willful, you could be socked with a 50% penalty, calculated in the same way as the 27.5% penalty under the earlier OVDP. In addition, a recent US court decision made it clear that the 50% penalty could be imposed for each year you had an undisclosed international account. In other words, you could be liable for a penalty far exceeding the amount of money you ever had in the account. As the IRS makes clear in its FAQs for the revised program, that’s just the tip of the iceberg in terms of possible penalties you could face. (See FAQs 5 and 6.) And while it’s far from clear, the act of making a false certification could itself be considered a crime.
Proving “willfulness,” incidentally, is much easier for the IRS than you might think, as I described in this essay.
In addition, there’s an important – and not well-understood – “stinger” in these rules. US persons who held accounts at a number of Swiss banks and other companies already under investigation by the IRS aren’t eligible. They’ll also be socked with a 50% penalty.
Don’t Forget FATCA!
Today – July 1, 2014 – key information disclosure provisions of the Foreign Account Tax Compliance Act (FATCA) come into effect. “Foreign financial institutions” (FFIs) – i.e., foreign banks and other financial institutions – must be either FATCA compliant or in the process of becoming FATCA compliant. If they’re not, interest, dividends, rents, and similar payments leaving the US directed to those institutions will be subject to a 30% withholding tax.
Part of FATCA compliance requires banks to make the IRS aware of any accounts that are owned directly or indirectly by US taxpayers. The IRS has been asking many banks to review their accounts retroactively for at least one year – sometimes longer – to identify US persons who closed accounts during that time. If the IRS thinks you closed your account to avoid FATCA, the possibility of a “willful” violation increases substantially.
And one requirement to enroll in the OVDP is that the IRS doesn’t already know about the unreported offshore accounts or income you wish to disclose. Yet once FFIs begin automatically turning over the account details of their US clients to the IRS, it will have all the information it needs to enforce the draconian penalties Congress has imposed for offshore non-compliance.
Do you have unreported offshore income or accounts? If you do and would like to take advantage of the OVDP, consult with a qualified attorney (not an accountant). This arrangement provides attorney-client privilege to keep your discussions private. The attorney can then retain an accountant to prepare the necessary returns and decide whether you should participate in the program
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Why You Shouldn’t Gamble With Uncle Sam
June 18th, 2014
By Mark Nestmann.
If you think June 30, 2014, is just another lazy, hazy summer day, think again. If you’re a US citizen or permanent resident, this may be a date to remember. It’s the deadline to report signatory or “other” authority over, or financial interest in, any “foreign bank, securities, or ‘other’ financial accounts” if the aggregate value of those accounts exceeded US$10,000 at any time in 2013. This is done with an FBAR (Report of Foreign Bank and Financial Accounts).
There’s even a shiny new form for the FBAR that you must file electronically: FinCEN Report 114. The old paper form – FinCEN Form TD F 90-22.1 – will no longer be accepted. (FinCEN, the “Financial Crimes Enforcement Network,” is the Treasury bureau responsible for collecting FBARs.)
And you might be surprised to discover what Uncle Sam considers a reportable account. If you have a foreign bank account or securities account, it’s clear you must file. But there are other offshore relationships that may need to be reported.
The IRS answers some questions about reporting foreign accounts here. But traps remain for the unwary.
And sometimes the IRS changes its mind… with catastrophic results for taxpayers.
A case in point is online poker accounts.
Since online gambling is (mostly) illegal in the US, websites catering to gamblers operate internationally. Until 2008, FinCEN advised that online poker accounts didn’t need to be reported on the FBAR. In 2009, it shifted gears and declared these accounts to be reportable. Then, in 2011, FinCEN reversed itself again. Online poker accounts were once again non-reportable.
This written guidance, though, didn’t help John Hom, who gambled online and set up accounts at two online poker companies. He used a third online company to facilitate the transfer of funds to the poker accounts. All three companies were organized outside the US.
The IRS charged Hom with not reporting the accounts on the FBAR. It assessed civil penalties of $30,000 for the three unreported accounts for 2006 ($10,000 for each account) and $10,000 for a single unreported account in 2007. With interest, Hom owes more than $45,000.
Hom appealed the penalty to a federal district court. But on June 4, 2014, a judge ruled that all three accounts were reportable on the FBAR.
Perhaps Hom’s biggest problem was that he represented himself before the court. Still, he made some good points. He argued that since many of the actual accounts maintained by these companies were in the US, the IRS had no proof that he had any “foreign accounts.” He also pointed to the FBAR instructions for support, which state:
… the geographic location of the account, not the nationality of the financial institution in which the account is found, determines whether it is an account in a foreign country.
The district court disagreed. It ruled an account’s location is determined by its host institution, not where the physical money might be stored after it is sent to a bank. And to add insult to injury, the court held that instructions for the FBAR form aren’t legally binding, because:
… interpretation by taxpayers of the language used in government pamphlets cannot act as an estoppel on the government, nor change the meaning of taxing statutes.
An “estoppel” is a rule of evidence that prevents someone from denying the truth of a statement of facts that person previously asserted. In other words, when it comes to the FBAR, normal rules of evidence simply don’t apply.
In some respects, Hom was lucky. The IRS didn’t accuse him of “willfully” failing to file FBARs. That capped the civil penalty at $10,000 per account per year.
Still, the Hom decision is scary, because it ignores FinCEN’s written guidance, not to mention its arrogant dismissal of the plain wording of the FBAR instructions.
June 30 is rapidly approaching. If you have any kind of non-US financial relationships, no matter how far removed they are from the ordinary meaning of an “account,” ask a tax professional for help. Find one who is experienced with FBAR filings (many aren’t).
Finally: The FBAR isn’t the only form you need to file to disclose investments or financial relationships you have outside the US…
Both Schedule B and Form 8938 must be filed with your tax return.
I realize that these forms telegraph information you’d probably rather not share with your benevolent Uncle Sam. My advice is to file them even in borderline situations. The consequences of NOT filing are severe, should you get caught.
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