International Tax and Law for the International Family

FBAR, OVDI, and FATCA - What’s Next – 2012 and Beyond

As we enter into 2012 two amnesty programs have now expired, and it is clear that thousands of US taxpayers remain out of FBAR compliance.  On January 9, 2012 the IRS announced that it is reopening the Offshore Voluntary Disclosure Program (OVDP).   The standard penalty has increased from 25 percent to 27.5 percent.  The lower rate options, for those eligible, remain the same.  More details will be forthcoming.

In December 2011 the IRS issued FS-2011-13 (the “Fact Sheet”) that seemed to soften their tone and provided that “penalties will not be imposed in all cases”.  But these are cases not caught in the OVDI regime. The Fact Sheet talks in part about “reasonable cause” for both regular income tax penalties and FBAR penalties.  “Reasonable cause” is discussed further below.

With the approach of  FATCA legislation taxpayers that remain out of compliance will likely pop up on the IRS radar screen.  Once that happens, the ability to deal with penalties in favorable manner will likely disappear.   These individuals need to develop a strategy to come into compliance as soon as possible..

In addition, there remains the question as to how those who filed late or corrected tax returns and FBARs through normal channels (“quiet disclosure”) will fare.   Will the IRS target them?  If audited how will penalties be applied?  

Finally, there are those who went through the OVDI program but are considering “opting out” rather than write large checks for penalties. Given the lengthy look back period, penalties are often based upon inflated asset values that no longer exist in a deleveraging world and consequently are outright penal in nature especially for those who are in retirement or approaching it.

Innocent Taxpayers with Compliance Problems

My office has come across US taxpayers with offshore compliance problems who come from a variety of backgrounds and ages.  Few fit the profile of the millionaire tax frauds with hidden offshore (Swiss) accounts.  Many live in Anglo or common law (United  Kingdom,  Canada, Australia, New Zealand ) countries and are at, or close to retirement age.  Others are younger “techies” who became US tax residents but who continue to fund family obligations abroad with offshore accounts.  Computer professionals from India are the most common example here.

Most of our clients do not face any exposure to criminal tax issues.  Criminal tax problems typically involve intentional actions to hide the ownership of assets and income such as offshore trusts and shell companies. Many of our clients have simply failed to file FBARs, some have not filed tax returns for many years and many of these taxpayers do not owe any US tax due to foreign tax credits as they pay higher rate foreign tax.  The unreported accounts are standard bank or investment accounts in their names and all fully reported to local tax authorities.  The source of funds is typically savings from fully taxed earnings (as opposed to illegal activities). Often they are family accounts and represent transfers in gift.

Where is reasonable cause and relief from penalties headed?

Reasonable cause in the traditional domestic context will have a narrower field of fact patterns and will often relate to complex law or receiving poor advice.   The acceptable “excuses“ will be somewhat well worn.  The international expatriate context opens up a wide (and probably less familiar) array of fact patterns for the IRS examiner.  In addition the law becomes very complex at best and in many scenarios there is simply an absence of guidance. Simply put, life for the international family with a US connection is extremely complex, even for those of moderate means.

Finally, given the political nature of all this and the fact that the IRS has already collected $4.4 billion will “reasonable cause” in practice become a very narrow escape hatch in order for the IRS to waive large numbers in front of Congress and the public.

The IRS Manual states that penalties should only be asserted to promote compliance with FBAR requirements.   Elsewhere in the IRM it states that the “sole” purpose of FBAR penalties is to promote compliance. The vast majority of FBAR filing problems result from lack of knowledge, bad advice, or at worst simply being too busy dealing with an international family to deal with the complexity of the US reporting system. How does one square that statement with coming in from the cold and getting all your compliance in order (hiring costly professionals), under these circumstances it is highly unlikely that one would fall out of compliance again.  .

IRS guidelines set out four threshold mitigation conditions:  No history of FBAR assessments (repeat offenders); no illegal source for money; cooperation with the examining agent; and no civil fraud penalty assessed with respect to unreported foreign source income.

Penalties have an upper limit but no floor.  These are mitigation guidelines but they are intended only as an aid.  Examiners are expected to exercise discretion taking into account the facts and circumstances. 

Quiet Disclosure or Procedurally – What Do I do?

Quiet Disclosure is not really a formal term; it was intended to mean filing amended returns (typically 3 years and in some cases 6 years) through traditional reporting channels to report previously unreported income with the hope that the IRS would not audit and  apply serious civil or criminal fraud penalties.  Its meaning seems to have broadened to include simply filing late or amended returns.

FBAR Enforcement Backlash?

Perhaps, but do not count on it.  There has been an increasing amount of negative foreign press about the FBAR and OVDI penalty regime.   The reason it is found in the “foreign press” is that these USCs’ are paying full tax in the country where they reside.   This is a case of typical bureaucratic overreach.  The original target was millionaire tax frauds with hidden Swiss accounts, but the current widely cast net is pulling in middle class retirees, young professionals just starting their careers, and countless other fact patterns that are far removed from the intended target.  These individuals are by and large compliant with the tax law where they reside.  They are international families with complicated lives who have lost sight of the full panoply of US internationally oriented tax filings.  One would think that there would be a strong negative reaction from foreign tax authorities and there may yet be, but at present it appears that their lobbying efforts are on behalf of foreign financial institutions that are not happy with the pending FATCA laws.

The Cost of Tax and Legal Advice.

The crackdown has become a bit of boom for tax professionals but few have international expertise. My office has come across too many cases of abusive professional fees.  Many firms have little international experience and are charging their clients for their “learning curve”.  Taxpayers are also being taken advantage of when the threat of criminal prosecution is put on the table.  The vast majority of taxpayers with offshore compliance problems have not done anything remotely criminal.  It is simply a matter of bringing them into compliance with the least pain.  While in some cases there may be complex international tax issues, for most it is simply a matter of getting the proper forms filled and tax paid (if there are not sufficient foreign tax credits), and if one is outside OVDI or OVDP putting forth the best case for reasonable cause relief from penalties.

Renunciation of US Citizenship

Many USC who live abroad and have eliminated most ties to the US will consider renunciation of their US citizenship to simplify their lives.  As a consequence, many consulates have developed waiting lists and some require two appointments.   These individuals may want to contact their consulates to determine time frames.  They will also have to get their US tax affairs in order as they and their advisors have to make certifications of US tax compliance on Form 8854 under penalties of perjury.  Planning is typically required here.

The Special Case of Green Cards (LPRs).

The December 2011 Fact Sheet only refers to USC but LPRs outside the US fall under the shadow of FBAR/FATCA as well.  LPR’s are a special case because they are subject to the full range of FBAR issues but may have lost all US legal rights incident to their green cards due to a “deemed abandonment” of that status simply by staying outside the US on an  indefinite basis.  Notwithstanding abandonment, they remain caught in the US tax system until they formally relinquish their green cards by filing Form I-407.

Foreign Pensions

Interests in non-US tax favored retirement schemes present special problems in context of OVDI penalties and FBAR reporting.  First off, the rules regarding taxation of non-US retirement schemes are complex and in many cases there is a total absence of guidance.  Unreported income is always a possibility which in turn makes “reasonable cause” arguments much more difficult.  Foreign pensions clearly require reporting under Form 8938 but FBAR reporting is not particularly clear.  There is also the question of whether a retirement scheme held in trust needs reporting on Form 3520 and Form 3520A.  The conservative view is yes.   These plans are highly regulated by the relevant tax authorities; they have none of the characteristics of the abusive secretive Swiss bank accounts that started this offshore witch hunt.  To have a regulated retirement scheme added to the total of unreported offshore financial accounts that is the basis of the OVDI penalty calculation is punitive to say the least.

The topic of foreign retirement schemes will be discussed in greater detail in future updates to this website.

Conclusion

If your offshore affairs are out of compliance, you must come into compliance, with the new reporting regimes are looming – you will get caught.  It really comes down to whether you can accept the relevant voluntary disclosure penalty or put yourself in a position to argue relief from tax return and/or FBAR penalties outside of OVDI or OVDP.  You should not attempt to “roll the dice” here and play the “audit lottery”.  Move ahead and prepare your work as if you will be audited.  The government has recouped billions here and they will continue to dedicate resource.