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United States taxpayers have various international information return reporting requirements, including:
(1) foreign bank account reporting;
(2) foreign specified assets (IRS Form 8938);
(3) foreign corporations (IRS Form 5471); and
(4) foreign trusts, foreign trust beneficiaries, and large gifts received from foreign persons (IRS forms 3520 and 3520-A).
Now, the penalties for failing to comply with these stipulations can be, frankly, rather exorbitant. Yet, what’s truly astonishing is the widespread ignorance, even amongst seasoned practitioners, that the IRS actually extends certain programs to rectify such past oversights, serving as a more palatable alternative to simply submitting delinquent forms – a practice colloquially known as a “quiet disclosure”.
One such notable scheme is the “streamlined filing compliance procedures”. This particular avenue is exclusively available to individual taxpayers who can genuinely attest that their noncompliance was “non-willful”. Furthermore, the taxpayer must not be under criminal investigation or civil audit, and crucially, they must have failed to report gross income stemming from these noncompliant foreign assets. In our considerable experience, these streamlined procedures offer the most pragmatic resolution for taxpayers, effectively eliminating or substantially mitigating potential penalty exposures. It’s worth noting that the IRS, by and large, doesn’t often audit returns filed through these streamlined procedures, provided everything has been submitted correctly and all requirements are met. Should an audit nonetheless commence, the primary focus is typically on discerning the question of willfulness.
I’ve written about it extensively – https://htj.tax/?s=streamlined
There are, naturally, numerous scenarios where an individual taxpayer might possess noncompliant foreign financial assets without any resultant tax loss to the United States. For instance, one might incur a loss on a foreign investment, possess foreign tax credits that offset U.S. taxes, or simply be a signatory on multiple non-interest-bearing foreign bank accounts where the aggregate balance exceeds $10,000. Let’s consider a hypothetical: imagine the peak aggregate balance of such accounts over the past three years was, say, around $50,000. Under the streamlined procedures, an individual residing in the United States would face a maximum penalty of 5 percent of that highest aggregate value, equating to a mere $2,500. Conversely, if the individual is not residing in the United States, they would owe precisely nothing. Without these procedures, that same non-willful individual could be staring down the barrel of a $10,000 penalty per year, totaling a rather eye-watering $30,000, simply for having signature authority on non-interest-bearing foreign bank account.
Proposal Overview
From our vantage point, unintentional errors, misstatements, or omissions are, if not unavoidable, certainly present within any voluntary tax system.
This is particularly true in instances that unfortunately fall on the less straightforward side of tax policy’s simplification versus complexity conundrum. When taxpayers or their advisors identify noncompliance with these intricate issues, the path to resolution can become even more convoluted]. It truly is a policy decision for tax administrators as to how they bring noncompliant taxpayers back into the system. Striking the delicate balance between not encouraging noncompliance and simultaneously encouraging taxpayers to re-engage with the system and maintain future compliance is, without doubt, a difficult tightrope walk.
However, creating options so punitive that a taxpayer is effectively barred from returning to the system, even if they earnestly wish to, serves neither the government’s nor the taxpayers’ interests. Moreover, the IRS’s reduced enforcement capabilities, owing to a substantial cut in personnel, should further incentivise the agency to render voluntary disclosure programmes more accessible to taxpayers.
The Current Penalties Are Steep
In our experience, the typical U.S. taxpayer, along with tax practitioners who don’t specialise in international tax matters, are wholly oblivious to the U.S. reporting requirements pertaining to foreign financial assets and interests. They are equally unaware of the substantial penalties that can be imposed for failing to adhere to these reporting mandates. Conceptually, many of the taxpayers we assist are utterly bewildered as to how such steep penalties can be levied against what are, fundamentally, purely informational returns.
Moreover, the average individual U.S. taxpayer can find themselves subject to these U.S. reporting requirements by virtue of their immigration to the United States or simply through familial relationships abroad. To put it another way, these reporting requirements are not solely the concern of sophisticated U.S. taxpayers engaged in foreign investments for financial gain and strategic tax planning. Consequently, lower and middle-class taxpayers also face considerable penalty exposure and will typically incur significant legal and professional fees post-facto in defending against these penalties. Many of these individuals simply cannot afford either the penalties themselves or the legal and professional expenses required to challenge them.
Overview of Filing Compliance Procedures
The streamlined filing compliance procedures are, as previously mentioned, solely available to individual taxpayers who can genuinely attest to the “non-willful” nature of their noncompliance and who disclose any adverse facts as per FAQ #1. The taxpayer must not be under criminal investigation or civil audit, and must have failed to report gross income from the noncompliant foreign asset(s).
There are two distinct submission types within these streamlined procedures: one for taxpayers residing in the United States, and another for those residing outside the United States. If a taxpayer resides in the United States, they are obliged to pay a miscellaneous offshore penalty equivalent to 5 percent of the value of the unreported foreign assets. However, if the taxpayer resides outside the United States, they are not required to pay any penalty at all. All taxpayers, regardless of residence, are required to pay any previously unreported income tax due, plus interest, for the preceding three years.
In our experience, the IRS does not frequently audit returns filed through these streamlined procedures, assuming the submission is correctly prepared and all requirements are met. When the IRS does scrutinize a submission, it is typically with a view to determine willfulness. Recent statistics from the Office of Management and Budget indicate approximately 14 300, annual submissions under these streamlined procedures , a participation rate substantially higher than that of the voluntary disclosure program, which sees only around 222 annual submissions. A contributing factor to this robust participation in the streamlined procedures is likely their relatively taxpayer-friendly nature.
This program fosters goodwill with taxpayers by providing a degree of closure in what are often complex and, some might argue, inherently unfair circumstances. The program still successfully generates revenue for the IRS whilst simultaneously minimising the costs associated with discovering noncompliance through examinations. Practically speaking, future compliance would be a perfectly reasonable expectation once individuals have entered into the streamlined filing compliance procedures, precisely because the program affords taxpayers the invaluable opportunity to rectify past errors and glean lessons for future adherence. Therefore, the streamlined filing compliance procedures truly ought to be a permanent program offered by the IRS.
