IRS, in friendly gesture, makes disclosure of oversees assets easy

Rajesh Dhruva
Rajesh Dhruva

As elaborated earlier US citizens, Green Card Holders, H1B Visa holders and all USA tax residents are required to report global income in their Federal tax return and Federal tax on such global income is payable subject to credit being granted for tax paid overseas.

US tax residents are also required to report maximum value of specified foreign financial assets to the US treasury on or before 30th June every year and since 2011 reporting of overseas financial assets has become mandatory if the maximum value of overseas assets exceeds US$ 50,000 as on 31st December or US$ 75,000 during the tax year and in case of married couple tax-payers filing US$ 100,000 and US$ 150,000 respectively in Form 8938 together with Federal Tax return in Form 1040.

Out of ignorance great majority of US tax residents had not disclosed their foreign income or assets but unfortunately ignorance of law not being an excuse such defaults were subject to civil and criminal penalties.

To mitigate this difficulty IRS had offered Offshore Voluntary Disclosure Initiative (OVDI) and Offshore Voluntary Disclosure Program (OVDP) requiring tax residents to pay taxes for 8 years and file Foreign Bank Account Report (FBAR) returns for 8 years and also pay penalty of 25% / 27.5% penalty of maximum value of overseas assets during last 8 years.

The Internal Revenue Service of USA probably sensed that this penalty of 27.5% was a hurdle for defaulting US tax residents to opt for OVDP and therefore the IRS has extended a friendly gesture to the defaulting taxpayers by forgiving them for their genuine and bonafide negligence of not paying federal tax on such overseas income and not declaring overseas financial assets to the Treasury by reducing the penalty to a token 5% of the peak year end balance of the preceding six years and federal tax for previous three years only under the Streamlined Filing Compliance Procedures ” (SFCP) being introduced recently on 18th June, 2014.

For availing the benefits of SFCP the tax payer should not be under audit or criminal investigation by the IRS. The tax payer is also required to certify under penalty of perjury that non compliance of US tax and reporting of Foreign Assets were “non willful”.

Each case will be reviewed independently by the IRS and if the Financial Institutions is under investigation by IRS where in the US resident is maintaining a financial account offshore penalty will be 50% of maximum value of overseas financial assets. For such Financial Institutions wherein IRS is already investigating tax payers will have the option of buying peace of mind by paying miscellaneous offshore penalty of 50% of the value of overseas assets.

US tax payers residing outside USA have been granted exemption from the token 5% penalty too. As such they are required only to pay federal tax for preceding 3 years and file delinquent Foreign Bank Account Report (FBAR) returns for preceding 6 years together with appropriate applications.

The IRS has shown extreme leniency and granted total immunity from civil and criminal penalties by requiring innocent non-willful defaulter US tax payers to pay a token penalty and minimal tax. A back-of-the envelope calculation shows that the IRS leniency results in tax savings bonanza for a tax payer who could have skipped tax payment on overseas income for a period of 20 years and also results in substantial tax savings for tax payer defaulting for 10 years or more.

Calculations for a US$ 1 mn deposit in an overseas account in 1994 show interesting results of interesting tax savings.
Over 20 years US$ 1 mn would have grown to US$ 2 mn at nominal interest of 4% per year resulting in an income of US$ 1 mn. This overseas income of US$ 1 mn would have attracted tax liability of say US$ 0.30 mn.

Now under SFCP, only 5% penalty will be applicable to maximum balance over last 6 years say US$ 2 mn which amounts to US$ US$ 0.10 mn only. And the tax payer will be required to pay tax for previous three years – say US$ 40000 being 30% tax of US $ 0.135 mn. So the total payment will amount to US$ 0.14 mn and the SFCP results in tax savings of US$ 0.16 mn.

The relief from penalties is extended in case of non filing of FBAR returns too as even civil penalty for failure of FBAR filing is catastrophic. Penalty for non-willful FBAR filing failure is $10,000 for each year whereas if proved willful the penalties can be as high as $100,000 or 50% of the amount in the account for each violation.

A taxpayer in Florida was penalized recently with 150% of his overseas account balance. Now under the SFCP a defaulting tax payer is required just to file FBAR returns for previous six years and the 5% penalty takes care of FBAR failures too.

Salient features of the SFCP are:

.01 Only individual US tax payers are eligible to opt for SFCP.
.02 This would include US citizens, Green Card Holders, H1B visa holders covered by the definition of US tax residents and any of such tax residents residing abroad can also opt for SFCP.
.03 The tax payer must have filed tax returns for most recent preceding 3 years. i.e. Year 2011, 2012 and 2013
.04 If the tax payer has sought extension for filing tax returns for the year 2013 then most recent preceding 3 years are year 2010, 2011 and 2012.

.01 Tax payers in whose cases IRS has initiated civil examination of tax returns for any taxable year.
.02 It is not necessary that the examination results in undisclosed overseas assets or income.
.03 Tax payers under criminal investigation by IRS are also not eligible.
.04 Tax payers who have submitted applications under Overseas Voluntary Disclosure Program (OVDP) can also opt for SFCP.

.01 Penalty will be computed at 5% of amount of highest value of overseas assets during the period over last 6 years.
.02 Federal Tax of hitherto undisclosed overseas income for last 3 years is to be paid.

.01 Failure of reporting overseas income and pay tax thereon under US tax laws.
.02 Failure to file FBAR reports. Earlier FBAR reporting was required to file on form TD F 90- 22.1 which is now replaced from the current year by form FIN CEN 114 which be filed online and
.03 Failure to file in specified information regarding such overseas assets in various forms e.g. Form 3520 ; 8938 etc.
.04 Such failure of filing should be by way of ” Non-willful conduct ” which is defined to mean any 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.”

.01 Tax payers opting for SFCP declaration should be a tax payer who has failed to fulfill statutory obligations as a result of “non willful conduct”.
.02 Non willful conducts has been explained as. “Non-willful conduct is 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.”
.03 Taxpayers who do not qualify for SFCP may opt for OVDP and pay 27.5 percent offshore penalty on the highest balance held during previous eight years.
.05 However if the taxpayer has an undisclosed account at a bank listed on the IRS posted list the penalty is 50 percent.
.06 The SFCP does not guarantee that the IRS will not recommend criminal prosecution if rejected.

.01 Tax payers must file amended US Tax Returns together with all required information for last 3 years.
.02 One should file delinquent FBAR (New Form FinCEN 114) of last 6 years for which due date has passed.
.03 One is required to pay tax, interest and 5% offshore penalty on aggregated highest balance of all foreign financial assets as at end of last 6 years.
.04 “Streamline Domestic Offshore Procedures” should be read in red at the top of the page of amended tax returns.

.01 Procedural compliance should be strictly adhered to by filing specified documents together with receipts of tax and penalty payment which are required to be physically submitted to the IRS office Austin, Texas. The tax payer will be free to opt for SFCP till the IRS declares closure of said scheme
.02 The SFCP is once in a life time opportunity for defaulting tax payers who have not paid taxes on overseas income or not filed appropriate forms or provided information about overseas Financial assets.
.03 Besides the advantage of peace of mind and exemption from civil and criminal liabilities the tax payers actually saves on tax.
.04 Post SFCP tax payers can freely repatriate his overseas wealth into USA and enjoy the liquidity in USA.
.05 One can freely and legally enjoy the income and corpus of overseas financial assets in any place across the world too.
Society is structured around rules and regulations and citizens are expected to abide by the same. For easy enforcement of rules statutes provide for strict civil and criminal penalties for the law-breakers laws the rules. But when the law breaking is across the board and that too more out of ignorance it is pragmatic for a Government to offer immunity and give one time opportunity to citizens to revert back on the legal ways with lenient penalties. IRS has chosen to take this path breaking step of one time amnesty and it would therefore be appropriate for defaulting taxpayers to approach and take advice of an experienced Certified Public Accountant and also a Law Attorney and proceed ASAP.
Rajesh H Dhruva is Chief Executive,

Rajesh Dhruva

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