Offshore Tax Compliance
Offshore Tax Compliance: In recent years, the IRS has significantly increased the enforcement of offshore tax compliance. With the introduction of FATCA (Foreign Account Tax Compliance Act), renewed interest in FBAR FinCEN Form 114 (Foreign Bank and Financial Account Reporting), and the introduction of automatic assessed penalties for international reporting forms 3520, 3520-A and 5471 — the Internal Revenue Service is aggressively pursuing offshore fines and penalties.
While getting into compliance can be a scary undertaking, it is an important step to take. If the IRS catches a taxpayer who is noncompliant before the taxpayer has an opportunity to get into compliance through one of the approved tax amnesty programs, it prevents the taxpayer from qualifying for IRS amnesty.
Let’s review offshore tax compliance and the top 10 current IRS international enforcement priorities.
FBAR
FBAR (FinCEN Form 114) has been heavily enforced for the past 5 – 10 years.
In 2018, the IRS ended OVDP (Offshore Voluntary Disclosure Program) and expanded VDP (Voluntary Disclosure Program) to include both domestic and offshore.
When OVDP ended, the standard FBAR and offshore asset penalty was 27.5% (unless a bad bank or facilitator was involved). Under VDP, the general guidelines result in 50% FBAR penalties — or minimum of $100,000 (adjusts for inflation).
While the streamlined program and delinquency procedures are still available — and allow for a reduced penalty or even a penalty waiver — the IRS has indicated that these programs are temporary and will be soon be closed.
FATCA
FATCA is the Foreign Account Tax Compliance Act. It was first introduced as a reporting requirement for U.S. taxpayers in 2012 on their 2011 tax return, IRS Form 8938.
Over the past year, we have found that significantly more taxpayers have been hit with Form 8938 non-compliance penalties.
The penalties start at $10,000, with a continuing penalty upwards of $50,000.
Form 3520 Gift
When a US person receives a gift from a nonresident alien (foreign person), the US person may have to report the gift when the threshold requirements for reporting are met.
In a common scenario, a US person receives a gift from a foreign person such as a parent for several hundred thousands dollars.
If the gift is not reported timely (or late with a reasonable cause statement), then the IRS will issue 25% penalties against the value of the gift, which can often result in penalties reaching the hundreds of thousands of dollars.
Form 3520-A
Form 3520-A is used to report foreign trusts.
There are different levels to the 3520-A penalties depending on the type of noncompliance, value of the trust, etc. Oftentimes the penalties can reach into the hundreds of thousands of dollars, if not more — depending on the value of the trust.
Form 5471
Form 5471 is used to report ownership in a foreign business and is a very important aspect of offshore tax compliance.
The penalty for noncompliance starts at $10,000 per form. Many taxpayers — especially entrepreneurs — may have multiple LLC equivalents outside the United States, and if they are considered per se corporations, then the entity cannot be disregarded.
For example, a foreign entity such as Sociedad Anonima (which is very common in many Latin countries) cannot be disregarded.
As a result, an unsuspecting taxpayer who hadn’t filed Form 5471s for several years may end up with several hundreds of thousands of dollars’ worth of offshore penalties.
Rental Real Estate for Nonresident Aliens
When a foreign citizen/nonresident alien owns US real estate that generates rental income, that rental income is taxable.
It is considered FDAP (Fixed Determinable, Annual, Periodical) and the the tenant is required to withhold 30% and submit directly to the IRS — unless the foreign person applies for various certificates and files an annual tax return, transmuting the income to ECI (Effectively Connected Income).
Post-Voluntary Disclosure Offshore Tax Compliance
Once a person has been brought into compliance with the IRS by using one of the voluntary disclosure programs, they are required to continue their compliance.
The IRS is finding that many individuals who had become compliant, have since not remained in compliance.
The IRS frowns heavily upon this and issues soft letters to taxpayers reminding them that they must remain compliant.
Expatriation & Offshore Tax Compliance
In recent years, the number of people who have expatriated have increased significantly.
The IRS has determined that many taxpayers have shirked their exit tax duty and misrepresented their assets and income on their final tax return and Form 8854.
For example, this gentleman was recently indicted by the IRS for being caught having allegedly artificially reduced his income to avoid the exit tax.
IRC 965
Internal Revenue Code section 965 was a one-time repatriation tax on certain retained earnings for post-1986 income retained abroad in foreign companies owned by US persons.
For many people, it was not that they did not want to comply with the law, but rather they never heard of the law — or could not figure out how to prepare the computation.
The IRS created a special enforcement group related to this specific type of compliance.
J-5, Coinbase, Cryptocurrency
J5 is an initiative created to reduce global offshore tax fraud and evasion, with an emphasis on cryptocurrency-related matters.
Moreover, the IRS was successful in its quest to obtain a summons against Coinbase for more than 13,000 account holders.
When these facts are coupled with the fact that the IRS just recently issued a new round of 6173 and 6174 letters — and still has not provided concrete guidance about reporting overseas cryptocurrency — international cryptocurrency is ripe for enforcement.
In conclusion, the IRS has significantly increased enforcement of international tax and offshore reporting compliance. Not all taxpayers who are noncompliant will get hit with offshore fines and penalties, but for those who do, the penalties can be extremely harsh. For taxpayers who are noncompliant, they may want to consider offshore voluntary disclosure.