what is a noncompliant US taxpayer to do?
Since 2003, the Internal Revenue Service has conducted a number of special voluntary compliance programmes designed for United States taxpayers who have not reported all of their non-US income or who have not complied with all of the various reporting requirements applicable to non-US income and assets.
Although these programmes are sometimes referred to as “amnesty” programmes, they do not provide much, if any, relief from tax, interest and/or penalties. Certain programmes do, however, provide protection against the possibility of criminal prosecution.
Several of these compliance programs are currently available. Before they provide us with any information regarding their case, potential clients often ask, “Which program is best for me?”
The answer is always that each case must be considered separately and there are no “one-size-fits-all” solutions. An appropriate strategy cannot be determined until all of the relevant facts and circumstances are considered. Because of the potential criminal consequences of noncompliance, the decision as to which program to pursue should be made only after consultation with an attorney.
The options currently available include: Filing compliance procedures for non-resident US taxpayers
This programme, often referred to as the “low-risk taxpayer programme” or the “streamlined programme”, is applicable only to non-resident US taxpayers who meet the following three requirements:
- they have lived outside the US since 1 January, 2009,
- they have not filed US income tax returns during that period and
- their income tax returns submitted in the programme show less than $1,500 in tax due in each of the years included in the programme. These taxpayers must also present a low level of compliance risk. The list of factors that may increase the risk level is broad with the unfortunate result that only a very limited number of client situations will fall squarely within the definition of “low compliance risk”.
The main advantages of this programme are that it requires preparation of fewer returns and taxpayers may not be subject to any penalties.
Taxpayers are required to submit only three years of income tax returns (with all applicable information returns), six years of foreign bank account reports (Treasury Department Form TD F 90-22.1 or FBAR) and a short questionnaire. Taxpayers will be subject to income tax and interest. The IRS may impose penalties for late filing and/or late payment, but will not impose penalties for failure to file the information returns.
The disadvantages are that there is no protection from criminal prosecution, there is less certainty with regard to penalties, which may include criminal penalties, and once application to this programme is made the taxpayer no longer has the option of participating in a voluntary disclosure.
The determination of who is a “low-risk taxpayer” is very limited. Any factor that raises the risk level may result in full examination that would not be limited to the three years submitted and may result in imposition of all civil and criminal penalties available under the Internal Revenue Code.
1. Filing under FAQ 17 and/or 18
The IRS issues guidance for participation in the offshore voluntary disclosure programmes in the form of frequently asked questions and answers (FAQs). FAQ 17 for the current offshore voluntary disclosure program provides that taxpayers who reported and paid tax on all their taxable income for prior years, but who failed to file FBARs may file the delinquent FBARs directly with the Department of the Treasury.
The IRS will not impose a penalty for the failure to file the forms if a statement is attached explaining why the report is being filed late and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.
FAQ 18 provides a similar rule for taxpayers who reported and paid tax on all their taxable income with respect to all transactions related to a foreign corporation or foreign trust, but who failed to file information returns such as Form 5471, Information Return of US Persons With Respect to Certain Foreign Corporations, or Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.
Taxpayers may file the delinquent information returns directly with the appropriate service centre. In the case of Form 5471, the information returns should be attached to an amended income tax return. As with the FBARs discussed above, the IRS will not impose a penalty for failure to file these information returns if a statement is attached explaining why the form is being filed late and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.
There is no guidance provided on how many years of delinquent FBARs and/or information returns should be filed. We normally recommend that taxpayers file for the last six years.
2. The Offshore Voluntary Disclosure Programme
In January of 2012, the IRS announced that it would continue to offer taxpayers an opportunity to come forward voluntarily to disclosure their offshore income and assets with the potential for reduced information reporting penalties by participating in the Offshore Voluntary Disclosure Programme (OVDP). Anyone may apply to participate in the OVDP, but taxpayers must first be cleared through the Criminal Investigation division.
Taxpayers who participate in the OVDP are required to file eight years of amended or original income tax returns, including all required information returns, and eight years of FBARs. They will be subject to income tax, interest and penalties (accuracy, late filing and/or late payment) and to a one-time OVDP penalty currently equal to 27.5 per cent of the value of the taxpayers foreign accounts and certain other foreign assets for the year during the eight-year period where the aggregate value of such assets was the highest.
Unlike prior offshore voluntary disclosure programmes, there is no filing deadline for the current programme. The IRS reserves the right, however, to increase the voluntary disclosure penalty or to cancel the programme at any time.
The advantages of this programme are that taxpayers are protected from criminal prosecution, as long as they cooperate completely, taxpayers are provided with peace of mind in the form of a closing agreement that concludes the matter once and for all, and taxpayers have more certainty with respect to penalties, which may be less then what would be imposed under the Code.
The disadvantages of this programme are that it requires eight years of income tax returns and FBARs, the programme is very rigid and IRS agents have little flexibility in regard to penalties, taxpayers may be required to provide account statements for all foreign accounts for all eight years, which may be difficult to obtain, and the process is very time consuming.
Taxpayers who have entered OVDP who disagree with the application of the offshore penalty given the facts and circumstances of their case may elect to opt out of the programme. In such situations, the IRS may conduct a full examination of the submitted returns and may determine whether a reduction in penalties is warranted, for example, if the taxpayer had reasonable cause for their failure to timely comply.
3. Service Centre filings
Some taxpayers will not meet the strict requirements of the low-risk programme, but may feel that they do not have offshore income and/or assets substantial enough to justify a voluntary disclosure or they may feel that there were extenuating circumstances that justified their failure to properly file. Such taxpayers are left without any suitable alternatives. These taxpayers may wish to simply file original and/or amended income tax returns with the information returns and a reasonable cause statement and hope for the best.
This is a risky strategy but it may be appropriate in certain cases. Taxpayers deciding to pursue this route should do so very carefully and only after consultation with an attorney who is knowledgeable about offshore reporting matters and all of the available programmes.