Streamlined filing procedures for disclosing foreign assets and income.

• Author: Williamson, Donald T.

EXECUTIVE SUMMARY

* Streamlined filing compliance procedures, introduced in 2012 for individuals residing outside the United States and in 2014 revised and expanded to also apply to taxpayers inside the United States, offer a potentially easier and less expensive alternative to the Offshore Voluntary Disclosure Program (OVDP) for qualifying taxpayers who wish to disclose unreported foreign assets and income and file related delinquent information returns.

* The streamlined procedures are available only to taxpayers whose failure to report assets and income and file required information returns was due to nonwillful conduct. Under the procedures, taxpayers residing In the United States are subject to a 5% miscellaneous offshore penalty, and taxpayers residing outside the United States are not subject to the penalty.

* Whether a taxpayer is considered a resident of the United States is determined under rules specific to the streamlined procedures. Some taxpayers that are residents for income tax purposes may be nonresidents for purposes of the streamlined procedures.

* Despite the advantages of the streamlined procedures, some taxpayers may nonetheless want to proceed under the OVDP because the OVDP Is not available if the IRS rejects a taxpayer's disclosure request under the streamlined procedures. In particular, taxpayers who may have difficulty proving that their conduct was nonwillful should consider using the OVDP.

PREVIEW

* The IRS's revised "streamlined" filing compliance procedures offer taxpayers an alternative to the Offshore Voluntary Disclosure Program for disclosing unreported foreign assets and income.

* Learn the requirements taxpayers must meet to use the streamlined procedures and what forms and information must be submitted under them.

* Practical issues to consider before applying to use the streamlined procedures are discussed, including whether a taxpayer's failure to file returns or report assets or income was willful.

In June 2014 the IRS announced revised "streamlined" procedures for individuals who unintentionally fail to report foreign-source income or foreign assets, generally, foreign bank accounts. (1) In part, the revised procedures address concerns of taxpayers and their professional advisers that the traditional offshore voluntary disclosure programs (OVDPs) often resulted in unduly harsh penalties for inadvertent conduct. (2) Under the revised procedures, in addition to avoiding criminal prosecution, qualifying taxpayers enjoy significantly reduced penalties, and in the case of certain nonresidents, penalties may be excused entirely.

However, to take advantage of these new procedures, individuals must demonstrate to the satisfaction of the IRS that their conduct was not "willful." (3) As discussed below, such a burden calls for careful consideration whether to disclose income and/or assets under the new streamlined procedures or whether the traditional OVDP remains the preferable option. (4)

Background

Since 1970, individuals have been required to report their ownership of and/ or signature authority over foreign financial accounts, (5) but not until 1976 did the IRS ask individuals if they had such accounts. Specifically, Schedule B, Interest and Ordinary Dividends, line 7a, of the current Form 1040, U.S. Individual Income Tax Return, asks, "At any time during [the tax year] did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country?" If the answer is "yes," the form next asks, "[A]re you required to file FinCen Form 114, Report of Foreign Bank and Financial Accounts (FBAR), to report that financial interest or signature authority?"

These questions are intended to make individuals aware of their responsibility to file an FBAR whenever the total of their foreign accounts exceeds $10,000 at any time during a tax year. (6) For tax years beginning after Dec. 31, 2015, the form is due April 15, with a maximum six-month extension to Oct. 15. (7) In certain circumstances, failing to file an FBAR can result in criminal and/or civil exposure. Civil penalties of $10,000 per account are imposed on any person who fails to timely file the report. (8) Where a person willfully fails to file the FBAR, the penalty may be up to $100,000 or 50% of the balance in the account at the time of the violation. (9) However, the IRS has recently clarified that in most willful-violation cases the total penalty for all years under consideration will not exceed 50% of the highest aggregate balance for all unreported foreign accounts during the years under examination; and for nonwillful violations, the penalty will generally not exceed $10,000 per year, regardless of the number of unreported accounts. (10)

In an effort to encourage individuals to report their offshore accounts, from March 2009 to October 2009, the IRS conducted an OVDP for reporting those accounts and paying related income tax without fraud penalties or possible criminal prosecution (2009 OVDP). (11) This program was followed in February 2011 by another "amnesty" that closed in September 2011 (2011 OVDP). (12) Finally, in June 2012, the IRS announced an OVDP without a specific closure date but made clear it could be closed or changed at any time (2012 OVDP). (13) As a result of the OVDPs, as of June 2014, the IRS had collected almost $6.5 billion of tax and penalties from more than 45,000 taxpayers. (14)

The 2012 OVDP, like its predecessors, excuses taxpayers from criminal prosecution and fraud penalties but requires the assessment of substantial understatement penalties under Sec. 6662 as well as interest on any deficiency. Under each iteration of the OVDP, taxpayers were required to file amended returns for a period of six to eight years (depending on the program), file all delinquent FBARs, and submit any information returns or schedules required in connection with the taxpayer's overseas assets.

In lieu of all other penalties attributable to the undisclosed foreign accounts, assets, and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, participating taxpayers pay a "miscellaneous offshore penalty" calculated on the highest aggregate balance of the taxpayer's assets during any single year covered by the disclosure period. Regardless of the taxpayer's culpability, this penalty started at 20% under the 2009 OVDP and escalated to 27.5% under the 2012 OVDP, subject to certain rare exceptions.

In September 2012, the IRS supplemented the 2012 OVDP with a "streamlined" disclosure procedure for individuals who had failed to file income tax returns and had resided outside the United States since Jan. 1, 2009.15 In those cases, an individual needed to file three years of back tax returns rather than eight, as generally required by the 2012 OVDP. But to avoid penalties under the streamlined procedures, individuals had to show themselves to be a "low compliance risk," based upon factors such as their not conducting business in the United States, reporting income in their country of residence, and a lack of "sophisticated tax planning or avoidance." (16) Most important, if an individual was rejected for the streamlined option because he or she was found to be a "high compliance risk," the general OVDP alternative with its protections against criminal prosecution was unavailable. (17)

Eligibility for Revised Streamlined Procedure

In June 2014, the IRS made sweeping changes to its offshore initiative to allow most taxpayers who had not willfully failed to disclose foreign accounts and income to use the streamlined procedures and mitigate the penalties for making a disclosure. The Service jettisoned the streamlined procedures in the traditional OVDP, replacing them with a set of revised streamlined procedures, the Streamlined Domestic Offshore Procedures (domestic streamlined procedures) available to individuals living in the United States and Streamlined Foreign Offshore Procedures (foreign streamlined procedures) available to individuals living outside the country. (18) In lieu of an analysis of whether the individual is a high or low compliance risk, the revised streamlined procedures call for the individual to declare under penalties of perjury that the failure to report income...