Source: https://www.thetaxadviser.com/issues/2016/apr/streamlined-filing-procedures-for-disclosing-foreign-assets-and-income.html
Timestamp: 2019-04-18 21:29:18+00:00

Document:
By Donald T. Williamson, J.D., LL.M., CPA, and Mark Schweighofer, Esq., LL.M.
Streamlined filing compliance procedures, introduced in 2012 for individuals residing outside the United States and in 2014 revised and expanded to also apply to taxpayers inside the United States, offer a potentially easier and less expensive alternative to the Offshore Voluntary Disclosure Program (OVDP) for qualifying taxpayers who wish to disclose unreported foreign assets and income and file related delinquent information returns.
The streamlined procedures are available only to taxpayers whose failure to report assets and income and file required information returns was due to nonwillful conduct. Under the procedures, taxpayers residing in the United States are subject to a 5% miscellaneous offshore penalty, and taxpayers residing outside the United States are not subject to the penalty.
Whether a taxpayer is considered a resident of the United States is determined under rules specific to the streamlined procedures. Some taxpayers that are residents for income tax purposes may be nonresidents for purposes of the streamlined procedures.
Despite the advantages of the streamlined procedures, some taxpayers may nonetheless want to proceed under the OVDP because the OVDP is not available if the IRS rejects a taxpayer's disclosure request under the streamlined procedures. In particular, taxpayers who may have difficulty proving that their conduct was nonwillful should consider using the OVDP.
In June 2014 the IRS announced revised "streamlined" procedures for individuals who unintentionally fail to report foreign-source income or foreign assets, generally, foreign bank accounts.1 In part, the revised procedures address concerns of taxpayers and their professional advisers that the traditional offshore voluntary disclosure programs (OVDPs) often resulted in unduly harsh penalties for inadvertent conduct.2 Under the revised procedures, in addition to avoiding criminal prosecution, qualifying taxpayers enjoy significantly reduced penalties, and in the case of certain nonresidents, penalties may be excused entirely.
Since 1970, individuals have been required to report their ownership of and/or signature authority over foreign financial accounts,5 but not until 1976 did the IRS ask individuals if they had such accounts. Specifically, Schedule B, Interest and Ordinary Dividends, line 7a, of the current Form 1040, U.S. Individual Income Tax Return, asks, "At any time during [the tax year] did you have a financial interest in or signature authority over a financial account (such as a bank account, securities account, or brokerage account) located in a foreign country?" If the answer is "yes," the form next asks, "[A]re you required to file FinCen Form 114, Report of Foreign Bank and Financial Accounts (FBAR), to report that financial interest or signature authority?"
The 2012 OVDP, like its predecessors, excuses taxpayers from criminal prosecution and fraud penalties but requires the assessment of substantial understatement penalties under Sec. 6662 as well as interest on any deficiency. Under each iteration of the OVDP, taxpayers were required to file amended returns for a period of six to eight years (depending on the program), file all delinquent FBARs, and submit any information returns or schedules required in connection with the taxpayer's overseas assets.
In lieu of all other penalties attributable to the undisclosed foreign accounts, assets, and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, participating taxpayers pay a "miscellaneous offshore penalty" calculated on the highest aggregate balance of the taxpayer's assets during any single year covered by the disclosure period. Regardless of the taxpayer's culpability, this penalty started at 20% under the 2009 OVDP and escalated to 27.5% under the 2012 OVDP, subject to certain rare exceptions.
In June 2014, the IRS made sweeping changes to its offshore initiative to allow most taxpayers who had not willfully failed to disclose foreign accounts and income to use the streamlined procedures and mitigate the penalties for making a disclosure. The Service jettisoned the streamlined procedures in the traditional OVDP, replacing them with a set of revised streamlined procedures, the Streamlined Domestic Offshore Procedures (domestic streamlined procedures) available to individuals living in the United States and Streamlined Foreign Offshore Procedures (foreign streamlined procedures) available to individuals living outside the country.18 In lieu of an analysis of whether the individual is a high or low compliance risk, the revised streamlined procedures call for the individual to declare under penalties of perjury that the failure to report income, pay tax, and submit all required information forms, including FBARs, was due to negligence or other mistake that arose from a good-faith misunderstanding of the law.19 Finally, to be eligible for the revised streamlined procedures, at the time of application, the individual must not be under IRS examination, without regard to whether the audit relates to undisclosed foreign assets or income.
Unlike under the OVDP, the IRS will neither acknowledge nor necessarily audit any tax returns filed under the revised streamlined procedures, so that the process will not culminate in the signing of a closing agreement. Of course, tax returns submitted may be audited to verify their accuracy and completeness, which may require the taxpayer to submit bank statements or other information from foreign financial institutions.
If an individual meets the above eligibility criteria, the streamlined foreign procedures permit individuals who qualify as nonresidents who have not reported the existence of and/or income from a foreign financial asset to avoid all penalties in connection with the failure. The rules that apply in determining if an individual is a nonresident eligible to use the foreign streamlined procedures depend on whether or not the individual is a U.S. citizen or lawful permanent resident.
U.S. citizens and lawful permanent residents: For purposes of the streamlined procedures, U.S. citizens and lawful permanent residents, i.e., green card holders, are nonresidents if, in one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, they (1) did not have an abode in the United States and (2) were physically outside the United States for at least 330 full days.
Some individuals who are resident for purposes of the income tax will be nonresidents under the foreign streamlined procedures.
Example 1: X was born in the United States but moved to a foreign country when he was 5 years old, has lived there ever since, and does not have a U.S. abode. Although X, being a U.S. citizen, remains a resident for income tax purposes, he is a nonresident for purposes of the revised streamlined procedures.
Example 2: Assume the same facts as Example 1, except that X returns to the United States and acquires a U.S. abode in the current year, after the due date for his U.S. tax return for the prior year, for which he did not file for an extension. Because X does not meet the substantial-presence test of Sec. 7701(b)(3) in one of the last three years for which his U.S. tax return due date (or properly applied for extended due date) has passed, he remains a nonresident for purposes of the streamlined procedures for the current year.
Example 3: Y is neither a U.S. citizen nor a green card holder but moves to the United States in the current year and was present in the United States for more than 183 days in the current year. While Y meets the substantial-presence test under Sec. 7701(b)(3) for the current year and is a resident for income tax purposes, she does not meet the substantial-presence test for at least one of the last three years for which the U.S. tax return due date (or properly applied for extended due date) has passed and is therefore a nonresident under the streamlined procedures for the current year.
Write in red at the top of the first page of each return, "Streamlined Foreign Offshore" to alert the IRS that the submission should be processed using the streamlined procedures.
Complete and sign IRS Form 14653, Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures, on which the taxpayer certifies that he or she is eligible for the streamlined procedures and has filed all required FBARs and that the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from nonwillful conduct. The individual must also provide on Form 14653 (or on a signed attachment) a detailed narrative statement describing the specific reasons for the taxpayer's failure to report all income, pay all tax, and submit all required information returns. In this statement, a taxpayer who relied on a professional adviser must give the adviser's name and contact information as well as a summary of the advice received.
Submit payment of all tax and interest due with each return, noting the taxpayer's identification number on the check.
If the individual is not eligible for a Social Security number and does not have an individual taxpayer identification number (ITIN), submit an application for an ITIN.
If the IRS finds that the taxpayer has met the above requirements, he or she will not be subject to penalties with respect to the returns and FBARs submitted. This waiver of all penalties applies even if the IRS subsequently selects the taxpayer's returns for examination, unless the audit results in a determination that the original noncompliance was fraudulent and/or that the FBAR violation was willful.
As previously mentioned, residents of the United States may be eligible to use the revised streamlined procedures. Individuals meeting the general eligibility criteria for the revised streamlined procedures (i.e., failures were nonwillful and the taxpayer is not under IRS examination) may use the domestic streamlined procedures if they have previously filed U.S. tax returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed (the covered return period). Residents who have failed to file returns in prior years cannot use the domestic streamlined procedure.
In this case, a U.S. resident may avoid criminal prosecution and all civil penalties other than a flat 5% penalty based on the highest year-end value of the financial assets the individual failed to report on Form 8938 for the covered return period or on an FBAR for each of the most recent six years for which the FBAR due date has passed (the covered FBAR period). Even if the taxpayer properly disclosed an asset, the 5% penalty still applies if the taxpayer failed to report the income from the asset. Thus, if an asset was omitted from Form 8938 or the taxpayer failed to report income from the asset (even if the asset was disclosed), the 5% penalty is applied to the asset's highest year-end value. However, unlike the OVDP, the penalty base for the streamlined procedures does not include assets that the taxpayer is not required to report on either Form 8938 or an FBAR. Thus, no penalty is imposed on unreported foreign real estate that is not held through an unreported foreign entity.
Example 4: A taxpayer has two unreported offshore accounts with the year-end balances shown in the exhibit below. Only account X earns interest. If the taxpayer discloses the accounts in year 7, FBARs are required for years 1-6 and amended tax returns for years 4-6. The 5% penalty is imposed on the highest aggregate year-end balance ($1,950,000) in year 6.
File amended tax returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed.
Include all required international information forms, even if those forms would not normally be filed with a Form 1040 if the individual were filing a complete and accurate original return.
Write in red at the top of the first page of each amended return, "Streamlined Domestic Offshore" to alert the IRS that the submission should be processed using the special procedures.
Complete and sign a Form 14654, Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures, on which the taxpayer certifies eligibility for the revised streamlined procedures, that all FBARs have been filed, that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, resulted from nonwillful conduct, and that the miscellaneous offshore penalty amount being submitted is accurate. The form requires reporting of the taxpayer's foreign financial assets, including account numbers, the date each account was established, and the year-end value of each account in the covered tax return period or the covered FBAR period. Like Form 14653, Form 14654 calls for a detailed narrative of the facts giving rise to the taxpayer's failure to report all foreign-source income, including the name and address of any professional adviser who assisted in the failure to file or report foreign assets and/or income, and a summary of the advice received.
Submit payment of all tax and interest due with the amended returns, along with the 5% penalty. The individual's Social Security number must be included on the payment check.
E-file delinquent FBARs for each of the most recent six years for which the FBAR due date has passed, using the BSA E-Filing System. On the cover page of the electronic form, the individual should select "other" as the reason for filing late and, in the explanation box that opens, enter "Streamlined Filing Compliance Procedures."
If desired and where permitted by treaty, request an extension of time to make an election to defer income from certain retirement or savings plans.
Where the taxpayer reported the income and paid the income tax on all foreign financial assets but failed to report foreign financial accounts on FBARs, the revised streamlined procedures permit filing delinquent FBARs without penalty if the IRS is not auditing the individual and the IRS has not contacted him or her about the missing FBARs. Because there is an absolute six-year statute of limitation for a failure to file an FBAR from the due date of the form,26 for 2015, delinquent FBARs are only required for 2009-2014.
Using the BSA E-Filing System, the taxpayer should select the FBAR submission option "other," which will open a window where the individual states that the criteria for penalty relief have been met, i.e., that all income and taxes related to the foreign account(s) have been reported and that the taxpayer has not been contacted by the IRS.
Where an individual has properly filed returns and paid income tax on all foreign assets, including filing all FBARs, but failed to file one or more required information forms, the taxpayer may request penalty abatement for failure to attach one or more of these forms to his or her return. The taxpayer must not have been contacted about the delinquent forms or otherwise be under IRS examination. A statement of the facts establishing reasonable cause for the failure and indicating that the taxpayer was not engaged in tax evasion must be attached to each information return being submitted. The delinquent information forms, except for Forms 3520 and 3520-A (which are filed separately according to the instructions for those forms), should be attached to an amended return filed in accordance with the amended return's instructions.
Finally, if the taxpayer chooses not to employ the streamlined procedures, he or she may still seek relief from criminal penalties and substantial civil penalties under the general provisions of the 2012 OVDP, as modified by the June 2014 notice.27 As noted, taxpayers electing the OVDP can avoid criminal and civil penalties for failing to report income from foreign assets or to disclose foreign assets on information returns or FBARs.28 The OVDP requires the taxpayer to file amended returns (or original returns if not previously filed), as well as any delinquent information returns or FBARs for eight years. In addition to requiring payment of all taxes, interest, and a Sec. 6662 accuracy penalty on unreported income, the OVDP imposes an additional penalty of 27.5% or, in certain circumstances, 50% on the highest aggregate balance of the taxpayer's offshore assets over the disclosure period.29 While the penalties of the 2012 OVDP are considerable, they are often substantially less than the criminal and civil penalties applicable outside the program.
The revised streamlined procedures are a welcome development for taxpayers who inadvertently failed to disclose offshore assets or report income from them. As noted, the penalties are substantially less than the statutory penalties or the higher penalty structure associated with the traditional OVDP, with some taxpayers avoiding penalties entirely. In addition, for taxpayers with small accounts and less complex filings, the revised streamlined procedures will result in significantly lower legal and accounting fees, due both to the reduced lookback period and the less formal procedures than under the traditional OVDP.
However, these revised procedures are not for everyone with unreported offshore accounts.30 The prospect of reduced penalties and professional costs must be balanced against the potential criminal exposure and larger civil penalties if the taxpayer's revised streamlined disclosure request is rejected. In this regard, although proving that the taxpayer did not willfully avoid reporting the assets and/or income is critical, it can be difficult, as the taxpayer often has only circumstantial evidence available.
Under the concept of "willful blindness" willfulness is attributed to a person who made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.
Example: Willful blindness may be present when a person admits knowledge of, and fails to answer questions concerning, his interest in or signature or other authority over financial accounts at foreign banks on Schedule B of his Federal income tax return. This section of the income tax return refers taxpayers to the instructions for Schedule B, which provides guidance on their responsibilities for reporting foreign bank accounts and discusses the duty to file the FBAR. These resources indicate that the person could have learned of the filing and recordkeeping requirements quite easily. It is reasonable to assume that a person who has foreign bank accounts should read the information specified by the government in tax forms. The failure to act on this information and learn of the further reporting requirement, as suggested on Schedule B, may provide evidence of willful blindness on the part of the person.
While taxpayers may look to case law as a guide for what constitutes willful behavior, the revised streamlined procedures remain an administrative program where, unlike judicial determinations, the burden of proof regarding the taxpayer's conduct falls on the taxpayer, not the government, as is the usual case in matters involving fraud. This is an important distinction because the taxpayer is left to demonstrate a lack of intent to avoid filing responsibilities, i.e., that the taxpayer was unaware of the obligation to file a return or report the offshore income or asset. Absent independent evidence, such as a statement from a tax professional advising that the filing or reporting was not required, the taxpayer is faced with a difficult threshold of proof.
Two cases that have addressed the burden-of-proof issue with respect to fraud for failure to file FBARs adopted a "preponderance of the evidence" standard for establishing whether the individual's failure to file an FBAR was willful, rejecting a higher standard such as "clear and convincing evidence."33 However, while the taxpayer's burden to show his or her failure to report the foreign accounts was not willful is generally less than that for most issues involving fraud, the questions on Schedule B regarding the taxpayer's responsibility to disclose those accounts still make meeting that standard a difficult, but not insurmountable, challenge.
Compounding this problem, the IRS refuses to provide specific guidance with respect to when a taxpayer's conduct will be found to be nonwillful for purposes of the streamlined procedures. On an American Bar Association webcast, John C. McDougal, a senior special trial attorney in the IRS Office of Chief Counsel, stated that there is "not going to be anything further on that," i.e., what constitutes nonwillful conduct under the streamlined procedures.34 McDougal stated that substantial case law illustrates willfulness, enabling taxpayers to determine if their conduct is not willful.
While the case law on willfulness with respect to fraud is considerable, as a practical matter, rebutting a claim by the IRS in court that a taxpayer's conduct was willful is much different from establishing to the satisfaction of the IRS under the revised streamlined procedures that the taxpayer acted nonwillfully. Therefore, taxpayers seeking relief under the revised streamlined procedures should expect substantial IRS scrutiny on the issue of willfulness and be prepared to address whether their tax return preparer inquired about their foreign financial assets, particularly if the foreign accounts or the income from them are sizable or the accounts are held in foreign entities owned by the taxpayer.
In addition, because there is no appeal right if the IRS rejects the taxpayer's streamlined submission, the taxpayer faces the prospect of a full examination after having voluntarily disclosed significant information, as well as the possible waiver of attorney-client privilege in connection with any advice given about the submission. Most significantly, if the IRS rejects a revised streamlined disclosure request, the taxpayer may not fall back on the traditional OVDP.35 Furthermore, the IRS refuses to entertain requests for preclearance of possible submissions or other placeholders in anticipation of making a streamlined request.36 In short, taxpayers and their advisers must carefully consider whether to employ the revised streamlined procedures.
With increased enforcement of reporting provisions governing the disclosure of foreign assets, taxpayers wishing to use the revised streamlined provisions should act promptly, as eligibility for penalty relief depends upon the taxpayer's taking corrective action before being contacted by the IRS. For qualifying taxpayers, the steps described in this article and the advantages the streamlined procedures offer over other alternatives to disclose foreign assets and income should help taxpayers achieve compliance while minimizing or avoiding penalties.
1IRS News Release IR-2014-73. See IRS webpage, "Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014," available at www.irs.gov.
2For articles addressing other options available to individuals who have failed to report income from foreign financial assets, see Ward, "2012 Offshore Voluntary Disclosure Program: Issues and Opportunities," 41 Tax Mgmt. Int'l. J. 548 (2012), and Ward, "Offshore Voluntary Disclosure Program Round Four: IRS Announces Further Changes to Encourage Broader Compliance," 43 Tax Mgmt. Int'l. J. 604 (2014).
3In addition to civil penalty relief, because almost all criminal tax statutes require "willfulness" by the taxpayer, qualifying under the streamlined procedures will effectively excuse the taxpayer from criminal prosecution.
4IRS webpage, "2012 Offshore Voluntary Disclosure Program," available at www.irs.gov.
5Financial Recordkeeping and Reporting of Currency and Foreign Transactions Act of 1970 (Bank Secrecy Act), P.L. 91-508, codified at 31 U.S.C. §1051 et seq.
631 U.S.C. §5314 and 31 C.F.R. §1010.306(c).
7Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, P.L. 114-41, §2006(b)(11). For previous reporting years, the due date was on or before June 30 of the following tax year.
10See Velarde, "FBAR Penalty Cap Reflects Sensitivity to U.S. Constitutional Concerns," 2015 WTD 105-4 (June 2, 2015), citing IRS Memorandum SBSE-04-0515-0025.
14Statement of IRS Commissioner John Koskinen, available at www.irs.gov.
15IRS News Release IR-2012-65 and IRS questionnaire and instructions.
19Specifically, IRS webpages (available at www.irs.gov and www.irs.gov) define nonwillful conduct as "due to negligence, inadvertence, or mistake or conduct that is the result of good faith misunderstanding of the requirements of the law."
20IRS webpage available at www.irs.gov, referring to IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad, page 12 (Dec. 14, 2014).
21Sec. 7701(b)(3)(A). The individual will meet the test for any calendar year if he or she is present in the United States for 183 days during that year.
22Under these standards, even though an individual and spouse might file a joint income tax return, one spouse might be resident and the other spouse nonresident under the foreign streamlined procedures.
23E.g., Form 8938, Statement of Specified Foreign Financial Assets; Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund; Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business; Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts; Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner (Under Section 6048(b)); Form 926, Filing Requirement for U.S. Transferors of Property to a Foreign Corporation; Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities; and Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
24File FBARs by registering and linking to the BSA E-Filing System page available at bsaefiling.fincen.treas.gov.
25Rev. Proc. 2014-55 allows U.S. citizens and residents who participate in certain Canadian retirement plans to elect under the U.S.—Canada income tax treaty to defer U.S. income tax on income accruing in their plans until a distribution is made. See Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, and Article XVIII(7) of the U.S.—Canada income tax treaty.
27IRS webpage, "Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014," available at www.irs.gov.
28E.g., Sec. 6038D (failure to file Form 8938); Sec. 6048 (failure to file Forms 3520 and 3520-A); Secs. 6035, 6038, and 6046 (failure to file Form 5471); Secs. 6038A and 6038C (failure to file Form 5472); Sec. 6038B (failure to file Form 926); and Secs. 6038, 6038B, and 6046A (failure to file Form 8865).
29The 50% penalty is imposed if the government has taken public enforcement action against the financial institution holding the account(s).
30For a discussion of when taxpayers might "roll the dice" and make a "quiet" disclosure by simply filing amended returns over the period for which the statute of limitation is open, see Greaves and Wu, "Quietly Finding a Home in the Voluntary Disclosure World," 148 Tax Notes 207 (July 13, 2015).
31IRM §4.26.16.6.5.1(1) (Nov. 6, 2015).
32IRM §4.26.16.6.5.1(5) (Nov. 6, 2015).
33Williams, 489 Fed. Appx. 655 (4th Cir. 2012); McBride, No. 2:09-cv-378DN (D. Utah 11/8/12).
34Bennett, "No Willful Conduct Definition for Streamlined Offshore Disclosure Program, Official Says," BloombergBNA Daily Tax Report, G-11 (Feb. 25, 2015).
35IRS webpage, "Streamlined Filing Compliance Procedures," available at www.irs.gov.
36Velarde, "Official Highlights Problem Trends in Streamlined Submissions," 2015 TNT 123-7 (June 26, 2015).
37Colton, 306 F.2d 633 (2d Cir. 1962), cert. denied, 371 U.S. 951 (1963) (workpapers prepared in connection with filing amended returns are not privileged, even though the accountant was employed by the taxpayer's attorney to prepare amended returns); Abrahams, 905 F.2d 1276 (9th Cir. 1990) (communications made solely for tax return preparation are not privileged, while communications concerning legal advice about what to report on the return may be privileged).
38Kovel, 296 F.2d 918 (2d Cir. 1961).
39For an exhaustive discussion of the attorney-client privilege in the context of communications involving accountants, see Saltzman, IRS Practice and Procedure ¶13.11 (Warren, Gorham & Lamont 2002).
Donald Williamson is a professor of taxation, the Howard S. Dvorkin Faculty Fellow, and executive director of the Kogod Tax Center at the Kogod School of Business at American University in Washington. Mark Schweighofer is a principal in the Tax Practice Group with Stein Sperling Bennett DeJong & Driscoll PC in Rockville, Md. To comment on this article, contact thetaxadviser@aicpa.org.

References: §1051
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