Tax Reporting Obligations for Foreigners

FBAR Flowchart

As a U.S. citizen or resident alien, you have several reporting obligations to the Internal Revenue Service regarding your foreign assets and accounts that you must be aware of. Failing to comply with these requirements can lead to severe penalties, additional taxes, and even civil and/or criminal penalties. Here is what you need to know:

Reporting Foreign Income:

U.S. taxpayers must report both their domestic and foreign income earned during the year on their annual tax returns, regardless of whether that income is also taxed in a foreign country.  If you fail to report your foreign income on your U.S. tax return, you could be facing a penalty for failing to pay taxes on that income equal to 0.5% of the tax per month, up to 25%.  Additionally, an accuracy-related penalty equal to 20% of the amount not reported could apply if the reason why you did not report the foreign income is due to your negligence, disregard of the rules or regulations, or a substantial understatement of income tax – this penalty could be higher if the violation was willful or fraudulent.

Reporting Foreign Assets and Financial Interests – FBAR:

Under the Bank Secrecy Act, a U.S. person with “a financial interest in, or signature or authority over, a bank, securities, or other financial account in a foreign country” is required to report such interest” to the IRS under FinCEN Form 114, Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR.” This requirement only applies if the aggregate value of the accounts exceeded $10,000 at any point during the calendar year.  The deadline to file an FBAR for 2016 is April 15, 2017.

Generally, the civil penalty for willfully failing to file can be the greater of $100,000 or 50% of the total balance in the foreign account at the time of the violation.  The penalty for a non-willful violation can be up to $10,000 per violation.  In addition to civil penalties, the willful failure to file an FBAR when due can result in criminal sanctions of up to $500,000 and/or 10 years imprisonment.  The penalty for knowing and willfully filing a false FBAR is punishable by up to $10,000 and 5 years imprisonment.

Reporting Foreign Assets and Financial Interests – Form 8938:

The Foreign Account Tax Compliance Act (FATCA) also imposes an additional reporting requirement to U.S. taxpayers holding certain assets abroad. A U.S. taxpayer holding any interest in a “specified foreign financial asset” (SFFA) during the taxable year must include Form 8938, Statement of Specified Foreign Financial Assets, with his or her annual tax return.  This requirement is only imposed if the value of the assets exceeds $50,000 on the last day of the taxable year, or $75,000 at any time during the taxable year.  The thresholds increase to $100,000 and $150,000, respectively, for married taxpayers.

A specified foreign financial asset, or SFFA, include the following assets:

  • Bank accounts;
  • Foreign partnership interests;
  • Foreign stock or securities; and
  • Foreign hedge funds and private equity funds.

 

The penalty for failing to disclose information required on Form 8938 is up to $10,000 for the initial failure, and an additional $10,000 for each 30-day period after receiving notice from the IRS of the failure.  The maximum civil penalty for failing to disclose SFFAs on Form 8938 is $60,000, although criminal penalties may also apply.

Other Information Returns and Disclosures:

The FBAR and Form 8938 are not the only forms that you may need to complete to report your foreign assets.  Other information returns, most of which provide for civil and/or criminal fines for failing to file, include the following:

  • Form 3250
  • Form 3520-A
  • Form 5471
  • Form 5472
  • Form 926
  • Form 8865
  • Form 8621

Voluntary Disclosure Options:

Under FATCA, a Foreign Financial Institution is required to report to the IRS information about financial accounts held by U.S. taxpayers or by foreign entities in which U.S. taxpayers hold substantial ownership interests. FATCA also allows the U.S. Treasury with authority to negotiate special intergovernmental agreements (FATCA IGAs) with respect to the exchange of information on U.S. taxpayers. Currently, the U.S. has information exchange agreements in place with 86 nations, and has FATCA IGAs in effect with more than 100 countries. In other words, FATCA requires these foreign financial to report to the IRS the names, taxpayer identification numbers, addresses, account numbers, and account balances of all U.S. account holders.

The appropriate method of disclosing your foreign assets depends on the facts and circumstances of each case. Generally, disclosure cases are grouped into one of two categories – “willful” and “non-willful”.

Under the Offshore Voluntary Disclosure Program (OVDP), taxpayers pay an offshore penalty in lieu of a number of other penalties that may be assessed due to the noncompliance.  OVDP also offers protection from criminal prosecution. Under this program, the IRS imposes a miscellaneous offshore penalty equal to 27.5% of the highest aggregate balance in the foreign assets held during any year in the eight-year period covered by the voluntary disclosure.  Disclosure through OVDP is generally appropriate only for taxpayers whose noncompliance was “willful” and have significant exposure and risk of criminal prosecution.

Streamlined procedures are available for taxpayers who were non-willful in their failure to report foreign income and assets. To be eligible for the Streamlined Domestic Offshore Procedures (SDOP), taxpayers must have previously filed a U.S. tax return for each of the past three years, failed to report income from a foreign asset and pay the applicable tax on the income, and acted non-willfully in failing to report. Eligible taxpayers who disclose under SDOP must file amended returns and any applicable information returns for the past three tax years, file any delinquent or incomplete FBARs for each of the last six years, and submit a statement certifying they acted non-willfully. In exchange, taxpayers disclosing under SDOP face only a 5% miscellaneous penalty on the highest aggregate year-end balances for the covered years.

The Streamlined Foreign Offshore Procedures (SFOP) is offered for U.S. taxpayers residing abroad. To be eligible, the taxpayer generally must have resided abroad, must have been physically outside the U.S. for 330 days in any one of the most recent three years, and must have also been non-willful in their failure to report income from a foreign asset.  Eligible taxpayers who disclose under SFOP must file income tax returns and any applicable information returns for the past three tax years, file any delinquent or incomplete FBARs for each of the last six years, and submit a statement certifying they acted non-willfully and meet the requirements for the program. In exchange, taxpayers disclosing under SFOP will not face any penalties, but will be required to pay any tax due and accrued interest at the time of their submission.

“Quiet disclosure” is another method of disclosing your failure to report income from foreign assets to the IRS by filing amended tax returns, FBARs and other delinquent information returns, and paying any back taxes owed, with the hopes that the IRS does will not flag you or examination or will simply assess a reduced penalty. Quiet disclosures may be appropriate where the taxpayer has minimal income ($1,000 or less in the aggregate) from their undisclosed assets. However, quiet disclosures are disfavored by the IRS and carry the risk of heavy penalties if examined.

If you find yourself doubting whether you have met the requirements of Foreign Bank Account Reporting, we’re here to assist you. Reporting your foreign income is important and there are penalties for not doing so. EPGD Business Law is here to help.