Over the past decade, the U.S. government has become much more interested in the ownership of foreign financial accounts. Concerns about security and financial fraud have prompted additional scrutiny of these accounts as well as the individuals and institutions that hold them.
While this increased scrutiny understandably spiked after Sept. 11, 2001, the 2009 revelation that UBS, Credit Suisse and other institutions were actively counseling American citizens on how to send assets to Switzerland and avoid paying U.S. income taxes further spurred more aggressive government efforts to address the issue.
Subsequently, the IRS has intensified taxpayer reporting obligations for holders of foreign accounts, implementing new programs such as the Offshore Voluntary Disclosure Program to encourage reporting and disclosure (even retroactively), and has significantly stiffened the penalties associated with failing to comply with regulatory obligations.
Consequently, foreign account holders and their legal and accounting advisors would be wise to familiarize themselves with the contours of this new legal landscape, and should be both thoughtful and strategic with respect to compliance, reporting and remedying any violations of the relevant statutes.
The U.S. government requires its citizens to report all their international and offshore income even if reported elsewhere. Additionally, U.S. citizens that have a financial interest in or signature authority over foreign financial accounts must file a foreign bank account report (the FBAR, now FinCen Form 114) if the aggregate value of that individual’s foreign financial accounts exceeds $10,000 at any time during the calendar year.
To clarify, a foreign financial account is an account located outside the United States (regardless of whether the financial institution itself is a U.S.-based bank). By contrast, an account maintained with a branch of a foreign bank that is physically located in the U.S. is not considered to be a foreign financial account. The reporting applies not only to traditional bank accounts, but virtually any kind of financial account or interest, including items like securities and brokerage accounts, insurance policies, commodity futures or annuities.
In 2009, an Offshore Voluntary Disclosure Program was designed to achieve the stated IRS objectives of bringing “taxpayers with foreign accounts and entities into tax compliance and stop[ing] undisclosed and unreported accounts.”
In addition, because it was determined that Americans disregarded existing reporting obligations regarding overseas income and foreign financial accounts were frequently unreported or underreported, Congress enacted the Foreign Account Tax Compliance Act, or FATCA, in 2010 to promote compliance.
The premise of the OVDP in 2009 was simple: account holders who previously or currently neglected reporting requirements could come forward on a voluntary basis. If a participant filed the correct paperwork (most notably past tax returns and FBARs), they could pay a penalty of 20 percent of their account value, pay the back taxes they owe, and in return will not be prosecuted and they will not be subject to harsher penalties for willfully evading the reporting of income.
The 2009 program was an immediate success. A few months after the original OVDP deadline expired, the program was renewed in 2011, with the penalty component increased to 25 percent. In 2012, the IRS decided to make the OVDP open-ended, with a set penalty of 27.5 percent. The program was further amended in 2014, with modest regulatory revisions and a new streamlined program with lower penalties for non-willful conduct. As of January 2017, there were over 45,000 taxpayer disclosures and over $6.5 billion dollars of revenue collected.
The financial penalties for OVDP program participants are calculated as follows: a 20 percent accuracy penalty on the income taxes owed, plus a sum equal to 27.5 percent of the highest year’s aggregate value of foreign accounts and assets during the period covered by the voluntary disclosure in lieu of the higher FBAR penalty. There is also a list of approximately 150 foreign banks that have a one-time 50 percent penalty applied to their accountholders rather the 27.5 percent penalty.
The civil liabilities outside the Offshore Voluntary Disclosure Program are significantly more punitive, however. They potentially include the taxes owed and accuracy-related penalties, if applicable; the failure to file and failure to pay penalties (plus interest); and FBAR penalties for willful failure to file complete and correct FBARs, which is 50 percent of the aggregate account balance per year of violation.
Exceptions and Considerations
Outside of OVDP, there are several situations where additional considerations apply. For example, there are additional penalties for fraud, if the foreign account or asset is held through a foreign entity, or if the investment is a passive foreign investment company.
Perhaps the most important distinction outside of OVDP is willful versus non-willful violations. In the streamlined disclosure program, taxpayers must certify under penalty of perjury that failure to file FBARs was not “willful.” Lesser penalties may be assessed for “non-willful violations,” defined as conduct that is due to negligence, inadvertent errors or good-faith misunderstandings.
The distinction is an important one. For non-willful violations, the maximum penalty is $10,000 per year, and the IRS cannot assert the penalty if failure to pay is due to “reasonable cause.” For willful violations, however, the maximum penalty is $100,000 per year, or 50 percent of the balance of the account per year, whichever is greater. It doesn’t take a financial whiz to recognize that the penalties for getting caught are dramatically higher than for those who come forward of their own volition and elect to participate in the OVDP.
Additional Reporting Requirements
FATCA also instituted additional reporting requirements on IRS Form 8938. This form requires disclosure of other types of foreign assets such as stock certificates, partnership interests, foreign trusts and ownership of other foreign entities.
The benefits of participating in the OVDP are significant. In addition to lower (fixed) penalties, foreign account holders who fulfill their obligations have the closure and peace of mind that comes from knowing they will avoid further legal and financial ramifications, and receive a written closing agreement with the government confirming full disclosure and payment. For 45,000 taxpayers and counting, that is literally and figuratively a good deal.