Overview of IRS Penalties for Individuals with Foreign Bank Accounts and Investments
Earlier this spring, the Internal Revenue Service ("IRS") Large Business and International Division identified several "campaigns" or areas where it plans to focus its audit resources. One campaign involved taxpayers who opted out of the Offshore Voluntary Disclosure Program ("OVDP").
IRS Campaign Background
The OVDP is a program whereby U.S. persons who have offshore assets may voluntarily disclose unreported income and/or offshore assets to the IRS. Under the program, taxpayers apply for pre-clearance, meaning that the IRS will cross-check applicants’ names with a list of individuals who are under audit, subjects of criminal investigations, or in other situations. Applicants for whom the cross-checks reveal that there are no such open audits, criminal investigations, or other situations are then pre-cleared to make a voluntary disclosure, while applicants who are the subject of an open audit, criminal investigation, or other situations are denied pre-clearance. Taxpayers who receive pre-clearance then file, among other documents (which may be voluminous), amended tax returns (or original tax returns); pay the requisite tax, interest, and accuracy-related penalties; and in addition, pay a miscellaneous penalty equal to 27.5 percent (or in some cases, 50 percent) of the balance of the undisclosed offshore assets. Taxpayers who do not have unreported income and do not owe back taxes may enter into other compliance programs with less significant penalties.
In some cases, taxpayers, after being accepted into the OVDP, have second thoughts about resolving their matter through such a program, and instead withdraw from the OVDP. In such a case, the taxpayer is simply attempting to resolve their outstanding tax issues outside of the OVDP (which typically involves a formal audit). The IRS campaign suggests that these individuals, as well as individuals who are denied pre-clearance from the outset, will be subject to heightened scrutiny.
IRS Forms and Penalties Likely to Be the Focus of the IRS Campaign
As part of the campaign, it is likely that the IRS will be focusing on the assertion of penalties for failing to file certain information returns with respect to foreign assets, including the forms that are set forth below. An audit that focuses on the failure to file, or incomplete filing, of these returns can result in draconian civil and criminal penalties. Further, the IRS may be able to assert that the statute of limitations with respect to a tax return (i.e., the period of time during which the IRS is legally permitted to assess additional tax or assert penalties with respect to a filed tax return) continues to remain open until these forms are filed.
Here are some of the most common forms likely to be the subject of the IRS campaign, a description of the taxpayers required to file them, and a general overview of the penalties that may be asserted.
- FinCEN Form 114. Foreign Bank Account Report ("FBAR") Form. U.S. persons are required to file a FinCEN Form 114 if (1) the U.S. person had a financial interest in or signature authority over at least one financial account located outside of the United States; and (2) the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year reported. The term "financial account" includes bank accounts such as savings accounts, checking accounts, and time deposits; securities accounts such as brokerage accounts; commodity futures accounts; insurance policies with a cash value (such as a whole life insurance policy); and mutual funds or similar pooled funds. "Financial interest" includes the owner of record, as well as agents, nominees, closely held corporations, and "owners" of trusts. Thus, if an individual has a power of attorney over a foreign account held in the name of a parent, that individual would have a FBAR filing requirement. Similarly, the FinCEN Form requires that an individual with a 50-percent ownership in an entity report that company’s foreign bank accounts.
The penalty for failure to file a FBAR is $10,000, if the failure to file was non-willful. However, if the IRS deems the taxpayer’s failure to file to be willful, it may impose a penalty of up to 50 percent of the balance of the account (or, if higher, $100,000 for such an account).
- IRS Form 8938. Statement of Specified Foreign Financial Assets. The IRS requires that "specified individuals" who file tax returns also file a Form 8938, if they have foreign assets with an aggregate balance of more than $50,000. The Form 8938 is filed in addition to the FinCEN Form 114, even though both forms collect similar (or, in many cases, identical) information. The Form 8938 looks at a broader category of assets, including foreign stock and partnership interests. However, the taxpayer does not need to report bank accounts for which he simply possesses signatory authority. The penalty for failing to file a Form 8938 is up to $10,000, with an additional $10,000 for each 30 days of non-filing after the IRS notice, for a potential maximum penalty of $60,000. But, perhaps most importantly, the taxpayer’s entire tax return remains subject to audit, irrespective of any statute of limitations, until a Form 8938 is filed—only then does the three-year statute of limitations begin to run.
- IRS Forms 3520 and 3520-A. Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts and Annual Information Return of Foreign Trust with a U.S. Owner. These forms generally apply to taxpayers who receive foreign gifts or who have an interest in an offshore trust. First, the Form 3520 must be filed by any U.S. person who receives either $100,000 from a foreign individual or a foreign trust, or a gift from a foreign corporation or partnership over $15,671. A Form 3520 must be filed even if the gifts are not taxable. Failure to file the form can trigger a penalty of up to 35 percent of the value of the transfer. If a U.S. person is deemed to be the owner of a foreign trust, then the foreign trust must file a Form 3520-A. If the foreign trust fails to file the Form 3520-A, then the IRS can assess a penalty of up to five percent of the value of the foreign trust’s corpus. There is no statute of limitations for the IRS to assess penalties on unfiled Forms 3520 and 3520-A. Thus, a trust that has not filed for many years could be assessed with multiple five-percent penalties.
- IRS Form 5471. Information Return of U.S. Persons with Respect to Certain Foreign Corporations. There are a number of scenarios in which a U.S. person is required to file this return. Generally, the filing requirement is triggered if the U.S. person owns 10 percent or more of stock in a foreign company. The form is required to be filed irrespective of any tax liability. The penalty regime is the same as the Form 8398. The taxpayer’s entire tax return potentially remains subject to audit, irrespective of any statute of limitations, until a Form 5471 is filed—only then does the three-year statute of limitations begin to run.
The aforementioned forms are just a sample of some of the most commonly filed forms for reporting foreign assets, but there are several others that may be applicable, depending on the facts and circumstances. Often, due to the complexity of the foreign reporting rules, there will be situations where either a taxpayer is non-compliant with respect to foreign asset reporting or needs an analysis as to the scope of the full reporting requirement related to a particular foreign asset or transaction. In these cases, sophisticated counsel should be retained in order to navigate this complex area of the tax law. Blank Rome has handled hundreds of matters concerning foreign asset reporting and has significant experience in this area. — ©2017 BLANK ROME LLP
© 2017, Blank Rome LLP. All rights reserved. Please contact Blank Rome for permission to reprint. Notice: The purpose of this update is to identify select developments that may be of interest to readers. The information contained herein is abridged and summarized from various sources, the accuracy and completeness of which cannot be assured. This update should not be construed as legal advice or opinion, and is not a substitute for the advice of counsel.