• ‘Cause I’m The Taxman, Yeah
  • May 18, 2017 | Author: Michael J. Fellerman
  • Law Firm: Shulman, Rogers, Gandal, Pordy & Ecker, P.A. - Potomac Office
  • Unlike the income tax systems of most countries, the United States requires all U.S. citizens and resident aliens (i.e., green card holders) to report on U.S. income tax returns all income, even if earned or otherwise received outside of the United States. Even though U.S. income tax on foreign-sourced income may be reduced, or even eliminated, by credits for income tax paid to foreign countries, it is critical that the foreign-sourced income be properly reported on U.S. income tax returns. Not only do U.S. taxpayers with foreign income have to report that income on their U.S. income tax returns, they also must answer in the affirmative a question on Schedule B that asks whether the taxpayer “had a financial interest in or signature authority over a financial account (such as bank account, securities account, or brokerage account) located in a foreign country.” This question must be answered in the affirmative even if the account generated no income. If the balance in the foreign accounts exceeded $10,000 at any time during the year, the taxpayer must also file a Foreign Bank Account Report (FBAR).

    In the past, banks and investment advisers in some foreign countries encouraged U.S. taxpayers to set up accounts that were designed to remain undisclosed to U.S. tax authorities. Because of the scope of this problem, U.S. tax authorities instituted a program in 2009 to aggressively locate and pursue penalties against U.S. taxpayers with undisclosed foreign income. If the failure to comply with U.S. tax laws was willful, criminal as well as civil penalties could be imposed on the offending taxpayer, with the penalty amount being far in excess of the value of the foreign accounts.

    At the same time that it began to take more aggressive enforcement action, the Internal Revenue Service (IRS) instituted the Offshore Voluntary Disclosure Program (OVDP), which allowed taxpayers to make voluntary disclosures of unreported income and avoid exposure to criminal prosecution and reduced potential civil penalties. Under the OVDP, all income taxes on undisclosed income over the prior six to eight years have to be paid together with a nonpayment penalty and a FBAR penalty equal to a specified percentage of the highest balance in the taxpayer’s foreign bank accounts (ranging from 20% in 2009 to 27.5% currently). This program treated taxpayers who acted willfully and those who were not willful the same, although taxpayers who believed they acted nonwillfully could seek reduced penalties. The IRS has generally taken a very broad view of what constitutes willfulness; simply filing a return without paying sufficient attention to the disclosure requirements could well be seen as willful action.

    In June of 2014, the IRS announced an expanded program for U.S. taxpayers whose failure to report foreign income was not willful. Taxpayers filing under the Streamlined Filing Compliance Procedures must file returns (or amended returns) for the prior three years for which foreign source income had not been reported and pay any tax due on the unreported income, as well as file any FBARs that had not been filed for the prior six years. In a dramatic change from the OVDP, penalties were eliminated for taxpayers residing outside of the U.S. and were reduced to 5% of the highest foreign account balance for taxpayers residing in the U.S. The Streamlined Procedures require far less documentation and delay than the OVDP and do not subject taxpayers to increased chance of audit. Perhaps even more significantly, the Procedures employ a much more lenient definition of willfulness, which should enable most U.S. taxpayers who had previously failed to comply with foreign income and account reporting obligations to bring themselves into compliance without being subject to harsh penalties.