IRS Undeclared Foreign Bank Accounts, Trusts, Corporations, Overseas Income and the FBAR Penalties
Under the 2009 Voluntary Disclosure Program, for which the deadline has passed, in lieu of all the penalties that the IRS could wield against the voluntary disclosing taxpayer, including the FBAR penalties, the IRS would assess an accuracy or delinquency penalty of 20% of the tax owed plus interest on the tax, and a penalty of 20% of the largest balance in the foreign bank account or entity during the previous six years. This was the price one paid for a taxpayers one way ticket out of the mess they found themselves in.
The program was a good deal for the taxpayer willing to part with some of his or her long-hidden account assets. Penalties at the disposal of the IRS include those for failing to report the foreign bank account, the yearly FBAR penalty of 50% of the account each year, the 75% civil fraud penalty for failing to report income, and additional penalties for failing to file informational returns such as those described below. However, the taxpayer was required to submit amended returns for the prior six years.
Because there is no statute of limitations whatsoever for the 75% civil fraud penalty, a taxpayer being audited is generally fearful that should the IRS agent find evidence of fraud, the taxpayer may be referred to the Criminal Investigation Division of the IRS where a thorough fraud investigation may be conducted well beyond any six-year criminal statute of limitations.
Penalties just for failing to file the FBAR, Report of Foreign Bank and Financial Accounts by June 30th each year, can be the greater of 50% of the total balance of the foreign account or $100,000.00, and there is no cap on the amount that can be penalized. An account with one million dollars in assets can thus incur penalties for the taxpayer who fails to report it for six years of three million dollars.
The civil statute of limitations for failing to file the FBAR yearly, is six years. And if that isn't enough to keep a taxpayer up at night, the statute of limitations for criminal prosecution for failing to file FBARs is five years. The criminal penalties for failure to file an FBAR are up to $250,000 and five years imprisonment and $500,000 and ten years imprisonment if in tandem with violation of any other U.S. law.
The statute of limitations on prosecution for tax evasion with respect to income from an offshore account is six years, starting from the date the tax return is due, or if later, the last affirmative act of evasion by the taxpayer. In the event the Criminal Investigation Division makes a referral to the U.S. Department of Justice for a felony indictment of a taxpayer, the taxpayer can face five years in prison and fines of up to $250,000. A person who fails to file a tax return at all is subject to a prison term of up to one year and a fine of up to $100,000. Penalties and fines vary.
In addition to the yearly requirement of taxpayers to file a FBAR by June 30th each year, a taxpayer must also report their worldwide income on their Form 1040, mark the box indicating they have a foreign account, and complete Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. This form requires the taxpayer to disclose transactions which include the creation of a foreign trust, transfers of property or assets to the foreign trust, and receipts of distributions from foreign trusts or other such entities. The penalty for failing to file this form, is 35% of the reportable amount, i.e. 35% of the gross value transferred to or received from the foreign trust.
A taxpayer with a foreign trust must also file form 3520-A, Annual Information Return of Foreign Trust with a U.S. Owner if the taxpayer has an ownership interest in or authority over a foreign trust. The penalty for failing to file this form is 5% of the value of the trust.
The failure to file a complete and correct Form 3520 or 3520-A can result in an additional penalty of $10,000 for every 30-day period the taxpayer fails to comply after 90 days have passed since notification by the IRS that the information return has not been filed, up to the amount of the assets transferred.
A person receiving a gift from a foreign trust may also be subject to a penalty of 5% per month up to 25 % of the value of the gift.
In addition to the FBAR yearly reporting requirements, many taxpayers are unaware that their reporting obligations begin as soon as they create a foreign trust. IRC Section 6048(a) requires the responsible party to provide written notice of any reportable event on or before the 90th day. These reporting requirements include the amount of money or other property transferred to the trust and the identity of the trust and each trustee and beneficiary. A reportable event includes the creation of any foreign trust, the transfer of any money or property to it by a U.S. person, and the death of a citizen or resident of the U.S. if he or she was treated as the owner of any part of it, or if any portion of the trust was included in the decedent's gross estate.
The penalty for failing to comply with IRC Section 6048(a) is 35% of the gross value of the property transferred. An additional penalty of $10,000 is assessed for each 30 day period after the 90th day, up to the value of the gross reportable amount.
Beneficiaries must also report any distributions from a foreign trust, the name of the trust, the amount of the distributions and any other information prescribed by the IRS. Separate filings must be made for each foreign trust from which the beneficiary receives a distribution. The penalty for doing so is 35% of the gross reportable amount and an additional $10,000 for every 30-day period the taxpayer fails to comply after 90 days have passed since notification by the IRS of a failure to report.
A U.S. taxpayer with a foreign corporation must also file Form 5471. There are varying penalties for failing to file this form. Generally the penalty is $10,000 but additional penalties of $10,000 per month up to $50,000 can be imposed after notice is given by the IRS or the penalty waived altogether upon proof of reasonable cause.
Taxpayers are also required to report transactions between a 25% foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the U.S. and a related party. The penalty for failing to file this Form 5472 informational return is $10,000 with an additional $10,000 each month up to $50,000 starting 90 days after the taxpayer has received notice from the IRS of a delinquency.
A taxpayer must report transfers of property to foreign corporations with Form 926. The penalty for not doing so is ten percent of the value of the property transferred up to $100,000 per return and with no limit if the failure to report was intentional. For failing to report interests in foreign partnerships utilizing Form 8865, the penalty is $10,000 with an additional $10,000 each month up to $50,000 starting 90 days after the taxpayer has received notice from the IRS of a delinquency.
If a taxpayer has an accountant prepare amended returns that are false, misleading, or incomplete, those actions can result in a further criminal investigation completely separate from the underlying failure to file the proper returns or to report all of the taxpayer's income the first time around.
The statute of limitations on a tax deficiency and the substantial understatement penalty is three years to six years, depending upon whether or not there was more than a 25 percent omission of income. As stated herein, however, there is no civil statute of limitations for fraud, and the difference in the penalty percentages can result in a difference in the hundreds of thousands of dollars.
What many wealthy taxpayers fail to realize, is that time is not their friend. Every year they fail to report their ownership of a foreign bank account and any income from their account on their U.S. tax returns and who fail to file FBAR's for any year in which those financial accounts are in existence, are committing new crimes. While past years drop off with statutes of limitations on penalties, new years are added on at the front end of their crimes and until the taxpayer comes forward, they will never be out of peril from criminal prosecution and some of the most serious civil tax penalties.
There is absolutely no ceiling on the civil penalty for failing to file FBAR's. That penalty is the greater of $100,000 or 50% of the highest balance of the account. That penalty alone can not only wipe out a taxpayer's foreign financial account, it can also wipe out additional domestic assets of the taxpayer. The civil fraud penalty of 75% on the taxes a taxpayer has failed to pay is nothing to shrug off either.
In compliance with IRS requirements, we must advise you that any U.S. federal tax advice contained in this informational article is not intended to be used nor is it published in order for it to be used and you may not use it for the purpose of avoiding penalties or fines, such as the FBAR penalty under the Internal Revenue Code. It is not intended to be used nor is it being published in order to promote, market or recommend any specific transaction, tax-related matter or estate planning tax scheme to any party.