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Canadian Investments and U.S. Tax Compliance

Kunal Patel

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Canadian Investments and U.S. Tax Compliance

For Canadians foreign nationals residing in the U.S. and U.S. expatriates living in Canada, taxation of Canadian investments in the U.S. can be complicated. It can even be difficult to find a tax advisor who can properly report these investments. Failure to file one or more of these forms can lead to severe penalties. This article provides a summary of the more commonly found Canadian investments. Read more

Foreign Investment in Real Property Tax Act (FIRPTA)

Kunal Patel

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Foreign Investment in Real Property Tax Act (FIRPTA)

The Foreign Investment in Real Property Tax Act (FIRPTA) was enacted in 1980 in order to impose a tax withholding requirement on foreign persons disposing of U.S. real property interests (USRPI). If you are a foreign person with investments in U.S. real estate, or are purchasing real estate from a foreign seller, here are things you need to know about FIRPTA.

Why was FIRPTA Passed?

Unlike U.S. persons who are taxed on worldwide income, foreign persons are only subject to tax on income that is effectively connected (ECI) with U.S. trade or business. Foreigners are also taxed on certain fixed, determinable, annual, or periodical income known as FDAP.

When a foreign person disposes of U.S. real property, any resulting gain from the sale is considered effectively connected income and is taxable in the U.S. It would be difficult to enforce U.S. tax law against a foreign person that does not reside in the U.S. In order to ensure tax compliance, FIRPA was created to require a mandatory tax withholding for foreign persons that dispose of U.S. real property. This requirement is imposed on the U.S. buyer or purchaser in the transaction.

How are Taxes Withheld Under FIRPTA?

When a seller purchases U.S. real property from a foreign person, he is required to withhold 15% of the sales price. The 15% is an increase from 10% that went into effect on February 17, 2016. The withheld amount is then reported on form 8288-A and filed with the IRS.

Exceptions Under FIRPTA

There are several important exceptions that allow for reduced withholding or eliminate the withholding requirement altogether.

If the seller provides a FIRPTA affidavit that he is a U.S. person, then the withholding requirement will not apply. A U.S. person can be a U.S. Citizen, permanent resident, or a taxpayer that meets the substantial presence test.

If the buyer purchases the property as a personal residence and the value of the property does not exceed $300,000, then there will be no withholding requirement. Or if the same applies but the value of the property is between $300,000 and $1,000,000, then the withholding amount will be reduced to 10% of the sales price.

FIRPTA Certification

If none of the above exceptions apply, then the seller can seek to have the withholding reduced upon certification by the IRS that a reduced withholding amount applies. A seller can apply for the FIRPTA certification by filing out Form 8288-B, no later than the closing date of the sale.

Special Rule for Partnerships

For domestic partnerships owned by foreign partners, there is an increased withholding requirement when the partnership disposes of a U.S. real property interest. In such event, the partnership is required to withhold 35% of the gain realized and allocable to the foreign partners.

Additionally, withholding is required of a purchaser of a partnership interest where 50% or more of the partnership’s gross assets consist of U.S. real property interests and 90% or more of the value of the partnership’s gross assets consist of U.S. real property interests plus cash and cash equivalents.

FATCA India Compliance Update

Kunal Patel

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FATCA India Compliance Update

May 1, 2017 is the compliance deadline for all US persons with mutual funds, bank accounts, and insurance products in India to comply with FATCA by providing their financial institutions with their FATCA declaration form.

What is FATCA?

FATCA, short for Foreign Account Tax Compliance Act, enables an exchange of financial information between India and the United States. FATCA was enacted as part of an anti tax evasion regime to locate income and assets held by U.S. persons in overseas accounts.

India and the U.S. signed a Model 1 Intergovernmental Agreement (IGA) which provides for a reciprocal information exchange between the two countries. The IGA came into effect on August 31, 2015 and requires financial institutions to obtain a FATCA declaration form for all individual and entity accounts opened between July 1, 2014 through August 31, 2015.

What is FATCA Declaration Form?

If you have a financial account in India and the bank has reason to believe you are a U.S. person or have a U.S. nexus, the bank is required to send you a FATCA declaration form. The FATCA declaration form will ask you to provide information such as:

  • Names on the account
  • Passport number
  • Country of residence for tax purposes
  • U.S. Taxpayer Identification Number (Social Security Number or ITIN)
  • Current Address

What Happens if You do Not Comply?

If your accounts were opened between July 1, 2014 and August 31, 2015, and you fail to self-certify by May 1, 2017, your account will be blocked or frozen, meaning that no transactions will be allowed on those accounts. All accounts opened after August 31, 2015 were required to self-certify by filling out a FATCA declaration form before opening the account, so these accounts are not affected by the May 1 deadline.

What Happens to Information Provided on the FATCA Declaration Form?

India’s Central Board of Direct Taxes (CBDT) provides rules and procedures for the maintaining and reporting of information regarding non-resident Indian (NRI) accounts.

After the financial institutions have completed their due diligence in identifying account holders that fall within the FATCA self-certification requirement, the financial institutions will report all such accounts that have values exceeding $50,000. The following information will be provided regarding each responsive account:

  • Name and address
  • Taxpayer ID for country of residence
  • Date and place of birth
  • Account number
  • Account balance at the end of the year or before closure
  • Gross income (interest, dividend, capital gain) in custodial accounts
  • Gross interest from deposit accounts
  • Any payments made to non-participating financial institutions

The financial institution will report this information to CBDT, which will in turn provide the information to the U.S. taxing authority.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

FBAR Criminal Prosecution – Case Study

Kunal Patel

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FBAR Criminal Penalties – Case Study

Offshore tax evasion, specifically failure to file FBARs, can result in two types of civil penalties – willful failure and non-willful failure. Additionally failure to file FBARs can result in criminal prosecution.

A few weeks ago I wrote an article about an FBAR civil penalty case that involved civil penalties for a willful violation. Here is a offshore tax evasion case that involves criminal prosecution.

The full report from the Department of Justice can be found here.

Case Facts

Dan Farhad Kalili, together with his brother, David Ramin Kalili, and David Shahrokh Azarian, admitted that they willfully failed to file Reports of Foreign Bank and Financial Accounts (FBARs) with the Internal Revenue Service (IRS) regarding secret bank accounts in Switzerland and in Israel.

Dan and David Kalili opened and maintained several undeclared offshore bank accounts at Credit Suisse Group (Credit Suisse) in Switzerland. He also opened and maintained several undeclared offshore bank accounts at UBS AG (UBS) in Switzerland. Dan and David Kalili also maintained joint undeclared Swiss bank accounts at both UBS and Credit Suisse. Meanwhile, Azarian opened and maintained several of his own undeclared accounts at Credit Suisse in Switzerland, and at UBS in Switzerland.

Dan Kalili, with the assistance of Beda Singenberger (Singenberger), a Swiss citizen who owned and operated a financial advisory firm called Sinco Truehand AG, opened an undeclared account at UBS in the name of the Colsa Foundation, an entity established under the laws of Liechtenstein.

Each of the defendants took affirmative steps to prevent their assets in UBS and Credit Suisse from being discovered. Dan Kalili opened an undeclared account at Swiss Bank A in the name of the Colsa Foundation and transferred his assets from the UBS Colsa Foundation account to Swiss Bank A. Dan Kalili opened undeclared accounts at Israeli Bank A and at Bank Leumi, both in Israel. He closed the joint undeclared account at Credit Suisse he held with David Kalili, as well as his own undeclared account, and transferred the funds. Shortly before its closure, the undeclared joint account of Dan and David Kalili at Credit Suisse held approximately $2,561,508 in assets. As of December 2009, Dan Kalili’s undeclared account at Israeli Bank A held assets valued at approximately $1,569,973, and his undeclared account at Bank Leumi held assets valued at approximately $2,497,931.

Similarly, in August 2008, David Kalili opened an undeclared account at Israeli Bank A in Israel, into which he transferred funds from his UBS accounts. David Kalili’s undeclared account at Israeli Bank A held assets valued at approximately $1,369,489.

In August 2008, Azarian, also opened an undeclared account at Israeli Bank A in Israel, and in May 2009, he closed his undeclared account held at Credit Suisse and transferred the funds to Israeli Bank A. At the time of its closure, Azarian’s undeclared account at Credit Suisse held assets valued at approximately $1,903,214.

Charges

Each of the three individuals were charged with and pled to one count of failure to file FBARs (felony) under 31 U.S.C. §§ 5314 and 5322(a), 31 C.F.R. §§ 1010.350, 1010.306(c, d) and 1010.840(b)

The statutory maximum sentence for this violation is 5 years imprisonment; a 3-year period of supervised release; a fine of $250,000, or twice the gross gain or loss resulting from the offense, whichever is greater; and a mandatory special assessment of $100.

Elements of Criminal Prosecutions in Offshore Tax Evasion Cases

In order for the Government to pursue willful civil or criminal charges for failure to file FBARs, the willfulness standard under the Bank Secrecy Act requires the government to prove the defendant acted with knowledge that his conduct was unlawful. It requires a voluntary and intentional violation of a known legal duty. In reference to 31 U.S.C. § 5322(a), which makes the failure to file a felony, courts have defined willfulness as a “purpose to disobey the law”, a “voluntary, intentional, and bad purpose to disobey the law, and a “knowledge of the reporting requirement and a specific intent to commit the crime.”

Willfulness Factors in Offshore Tax Evasion Cases

Here are some of the facts I believe led to the charges in this case:

  • Accounts were located in known tax havens and at “bad banks” on the foreign financial institutions or facilitators list
  • Defendants took affirmative steps to prevent their assets in UBS and Credit Suisse from being discovered by opening accounts in the name of holding companies. Some accounts were unnamed, numbered accounts to minimize the number of documents associated with the defendants. Swiss accounts were closed and transferred to accounts at Israeli banks to avoid being discovered.
  • Defendants partially declared accounts on their tax returns, while selectively omitting others
  • One of the defendants acknowledged to IRS CI special agents that he was aware of the legal requirement to report his interests in foreign bank accounts and to file FBARs. The defendant also falsely stated to the special agents that he declared his accounts at UBS when in fact he did not.
  • The failure to file FBARs spanned well over a decade and the accounts held assets that reached into the millions

Outcome

In his role for offshore tax evasion, Dan Farhad Kalili, 55, was sentenced to serve 12 months and one day in prison; his brother, David Ramin Kalili, 52, was sentenced to serve eight months in prison; and his brother-in-law, David Shahrokh Azarian, 67,was sentenced to serve eight months in prison.

In addition to the term of prison imposed, Dan Kalili was ordered to serve one year of supervised release and to pay $337,443 in restitution. He also agreed to pay a civil penalty of $2,674,329. David Kalili was ordered to serve one year of supervised release and to pay $243,019 in restitution. He also agreed to pay a civil penalty of $1,325.121. Azarian was ordered to serve one year of supervised release and to pay $197,840 in restitution. He also agreed to pay a civil penalty of $951,607.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

5 Things You Should do if You have Unreported Foreign Income

Kunal Patel

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5 Things You Should do if You have Unreported Foreign Income

Learn about what to do if you have unreported foreign income and accounts. Non-Compliance with foreign asset reporting can lead to some hefty penalties such as:

  • Failure to file FBAR: $10,000 for eacah non-willful violation
  • Failure to willfully file FBAR: the greater of $100,000 or 50% of the account’s highest balance
  • Failure to file Form 8938: $10,000 for each violation; an additional $10,000 for each 30 days of non-compliance after receiving a notice from the IRS regarding your failure to report
  • Penalty of 40% of your underpayment of tax resulting from undisclosed foreign financial assets; if the underpayment of tax is due to fraud, then the penalty is 75% of the tax on the unreported income

If that looks scary, that’s exactly what the IRS intended! These penalties are high enough to convince those with unreported foreign income and accounts to voluntary report them. Perhaps you just recently found out about the foreign reporting requirements or maybe you’ve known for a while but put it off. What are the first things you should do to protect yourself if you have unreported foreign income?

  1. DETERMINE IF YOU HAVE UNREPORTED FOREIGN INCOME. If you have unreported foreign assets but no unreported foreign income, you can simply file your delinquent FBARs.
  2. TALK TO A QUALIFIED ATTORNEY. While most will not require attorney-client privilege, it’s a good idea to speak to an attorney rather than your CPA or accountant regarding any unreported overseas accounts or assets. Your communications with an attorney are attorney-client privileged. Your attorney cannot be forced to provide information that is covered under this privilege. Federal law does not recognize an accountant-client privilege. As such, your accountant could be forced to testify against you or provide incriminating evidence.
  3. FILE YOUR FBARs. After you’ve chosen your attorney, the first thing the attorney should do is immediately file the FBARs. The tax returns will likely take some time, depending on the complexity. However, FBARs can be filed immediately. This reduces your exposure to FBAR penalties. As a practical matter, the IRS does not assess penalties on late-filed FBARs, but it does on FBARs that are not filed at the time the IRS discovers the non-compliance.
  4. GATHER FOREIGN ACCOUNT STATEMENTS. You’ll likely need to gather account statements for several years. While you are choosing your attorney, you should get a head start by gathering financial account statements. You’ll need to get 6 years of statements for streamlined offshore compliance procedures and 8 years for OVDP cases. This is often the hardest part for clients.
  5. DON’T PANIC AND STOP RESEARCHING. Many clients have convinced themselves that they’ve committed a serious tax crime, which is almost never the case. The more you continue to read about FBAR violations, the more you will confuse and worry yourself. It’s a perplexing area of tax where there aren’t always clear-cut guidelines. It’s important to work with a tax attorney to help you get through the process.

What’s Reported on the FBAR?

Kunal Patel

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Foreign Bank and Account Reporting on the FBAR

If you are a US citizen or tax resident, you may have a foreign bank account reporting obligation. Form finCEN 114, Report of Foreign Bank and Financial Accounts (also commonly known as the Foreign Bank Account Report, or “FBAR”) is required to be filed annually by “each United States person having a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country.”

In order for an individual to have an FBAR filing requirement, he or she must meet all of the following.

Are they a United States Person?

A United States person is any person that is a United States citizen or tax resident, and includes, individuals, corporations, partnerships, trusts or estates, joint stock companies, associations, syndicates, joint ventures, other unincorporated organizations or groups, Indian Tribes, and all entities recognized as legal personalities (including single-member LLCs that are otherwise disregarded for tax purposes).

Is There a Financial Interest, Signature or Other Authority?

There are two requirements for an account to be considered a reportable account on the FBAR.

(1) There must be a financial interest, signature authority, or other authority over the financial account.

A U.S. person has a financial interest in each account for which such person is the owner of record or has legal title, whether the account is maintained for his own benefit or for the benefit of others including non-U.S. persons.  Sometimes an individual may not be the legal account holder but may have an indirect financial interest in the account. Example: Bob sends $25,000 to his brother John in Canada to open up an investment account and deposit the money for him. John opens the account in his name, but the money clearly belongs to Bob. Bob has an indirect financial interest in that account and must report it on the FBAR. Any income earned from that account must also be reported on Bob’s U.S. income tax return.

A common scenario we’ve come across is where an overseas parent opens an account in a foreign country and includes their U.S. resident son or daughter as a legal account holder. This is common practice in some Asian countries as a will substitute. Such countries might not have a reliable probate system and the only way to ensure a seamless transfer of inheritance upon death is to include the future beneficiary on the account. This creates an FBAR filing requirement for their U.S. resident son or daughter. However, any income from these accounts may not need to be reported on the child’s tax returns. Unlike for FBAR reporting, for tax purposes there is a distinction made between equitable and legal ownership.

A person is considered to have signature authority over an account if the person can control the disposition of assets in the account by direct communication with the institution with whom the account is maintained.

(2) The foreign account must be a bank, securities, or other financial account. Below is a table of the types of financial accounts that are required to be reported on the FBAR.

Financial (deposit and custodial) accounts held at foreign financial institutionsYes
Financial account held at a foreign branch of a U.S. financial institutionYes
Financial account held at a U.S. branch of a foreign financial institutionNo
Foreign financial account for which you have signature authorityYes, subject to exceptions
Foreign stock or securities held in a financial account at a foreign financial institutionThe account itself is subject to reporting, but the contents of the account do not have to be separately reported
Foreign stock or securities not held in a financial accountNo
Foreign partnership interestsNo
Indirect interests in foreign financial assets through an entityYes, if sufficient ownership or beneficial interest (i.e., a greater than 50 percent interest) in the entity. See instructions for further detail.
Foreign mutual fundsYes
Domestic mutual fund investing in foreign stocks and securitiesNo
Foreign accounts and foreign non-account investment assets held by foreign or domestic grantor trust for which you are the grantorYes, as to foreign accounts
Foreign-issued life insurance or annuity contract with a cash-valueYes
Foreign hedge funds and foreign private equity fundsNo
Foreign real estate held directlyNo
Foreign real estate held through a foreign entityNo
Foreign currency held directlyNo
Precious Metals held directlyNo
Personal property, held directly, such as art, antiques, jewelry, cars and other collectiblesNo
‘Social Security’- type program benefits provided by a foreign governmentNo

 

Are the Accounts Above the Threshold for Filing an FBAR?

If the aggregate value (total value) of all reportable accounts exceeds $10,000 at any point in the calendar year exceeds $10,000, all such accounts must be reported.

Example: Bob has 5 foreign bank accounts. The highest total value of all accounts was on July 1, 2016. On this date Bank A had $1,000, Bank B had $3,000, Bank C had $0, Bank D had $5,000, and Bank E had $2,000, resulting in a total value of $11,000. Therefore, Bob has an FBAR filing requirement with respect to all 5 of his foreign bank accounts.

What Types of Financial Accounts are Required to be Reported?

Any financial account maintained in a geographic location outside of the U.S. is covered by the FBAR. A financial account includes the following:

Bank Account—a savings deposit, demand deposit, checking, or any other account maintained with a person engaged in the business of banking;

Securities Account—any account maintained with a person engaged in the business of buying, selling, holding, or trading stock or other securities;

Life insurance – An insurance or annuity policy with a cash value;

Brokerage – An account with a person that acts as a broker or dealer for futures or options transactions in any commodity or is subject to the rules of a commodity exchange or association; or

Mutual Funds – An account with a mutual fund, or similar pooled fund, which issues shares available to the general public that have a regular net asset value determination and regular redemptions. This definition excludes other joint investment arrangements such as private equity funds and hedge funds that do not meet these criteria.

Bonds and Stocks – Bonds and stock certificates individually held by a taxpayer are not financial accounts and do not need to be reported on the FBAR.

Safe-deposit Boxes – Safe-deposit boxes are generally not within the scope of the FBAR reporting requirements.

Debit cards and Pre-paid cards  –  Such accounts may be considered financial accounts and may be reportable on the FBAR.

Cryptocurrency – Bitcoin is considered by the IRS to be a “capital asset” like gold or silver. It does not need to be reported if it is directly held, but if it’s held through a platform like Coinbase or Bitstamp, it may be subject to FBAR reporting if the currency is stored on a computer or server located outside the U.S.

OtherAny account with a person that is in the business of accepting deposits as a financial agency; “Capital assets” such as foreign real estate and precious metals like gold and silver are not reportable on the FBAR if they are directly held. If your gold is located in a safe deposit box at a bank, then it’s reportable on the FBAR. But if your gold is located in a private, non-bank storage, such as a vault, then it might not be reportable on the FBAR as long as you own specific pieces of precious metals that are uniquely identified as belonging to you (e.g., serial numbers).

What is the FBAR Filing Deadline?

The deadline used to be June 30, however, beginning with the 2016 FBARs, the due date has been rolled back to April 15 coincide with the tax return due date. Additionally, the deadline can now be extended. If you file an extension for your tax return, your FBAR deadline will be automatically extended to October 15.

Consequences of FBAR Non-Compliance

The U.S. has intergovernmental agreements (IGAs) with an ever growing number of foreign jurisdictions under the FATCA regime. IGAs require foreign taxing authorities to provide information about individuals that are believed to be U.S. persons and have financial accounts in their jurisdiction. Even in the absence of an IGA, foreign banks often voluntarily choose to report this information since banks that do not comply with FATCA forfeit their ability to do business with the U.S.

Foreign banks that are FATCA compliant will send a letter to any clients they believe have a U.S. nexus. Often known as a “FATCA letter”, this is the first step in the process of information sharing with the IRS. If the account holder chooses not to respond or the bank determines that the account holder is not compliant, this information will be eventually provided to the foreign taxing authority which will in turn be disclosed to the IRS. Once the IRS determines there has been an FBAR violation, the IRS examiner will issue either a FBAR warning letter (Letter 3800) or decide to assess a penalty. Read about how the IRS examines FBAR violations. Whether the IRS examiner will issue a warning letter or assess a penalty will depend on the facts. Here’s an example provided in the IRM: “An individual failed to report the existence of five small foreign accounts with a combined balance of $20,000 for all five accounts, but properly reported the income from each account and made no attempt to conceal the existence of the accounts. The examiner must consider all the facts and circumstances of this case to determine if a warning letter is appropriate in this case or if it would be appropriate to determine civil FBAR penalties.”

FBAR Penalty Structure

The IRS imposes various levels of FBAR civil penalties and rarely criminal penalties for failure to file an FBAR, depending on the severity of the non-compliance.

Negligence

Under 31 USC 5321(a)(6)(A), a negligence penalty up to $500 may be assessed against a business for any negligent violation of the BSA, including FBAR violations. The simple negligence penalty applies only to businesses, not individuals. If any trade or business engages in a pattern of negligent violations of any provision (including the FBAR requirements)] of the BSA, a civil penalty of not more than $50,000 may be imposed. This is in addition to the simple negligence $500 penalty. The examiner is given discretion to determine the penalty amount up to the $50,000 ceiling.

Nonwillful FBAR Violations

Under 31 USC 5321(a)(5)(B), a penalty, not to exceed $10,000 per violation, may be imposed on any person who violates or causes any violation of the FBAR filing and recordkeeping requirements. The penalty should not be imposed if the violation was due to reasonable cause, and the person files any delinquent FBARs and properly reports the previously unreported account.

Willful FBAR Violations

Under 31 USC 5321(a)(5)(C),  a penalty for a willful FBAR violation may be imposed on any person who willfully violates or causes any violation of the FBAR filing and recordkeeping requirements. The statutory ceiling is the greater of $100,000 or 50% of the balance in the account at the time of the violation. There may be both a reporting and a recordkeeping violation regarding each account. Examiners may recommend a penalty that is higher or lower than 50 percent of the highest aggregate account balance of all unreported foreign financial accounts based on the facts and circumstances. In no event will the total penalty amount exceed 100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.


Sources:

Internal Revenue Manual § 4.26.16

31 CFR 1010.350 Reports of Foreign Financial Accounts

31 USC 5321

Is a Quiet Disclosure Ever a Good Option?

Kunal Patel

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Is a Quiet Disclosure Ever a Good Option in Non-Willful Cases?

What is a Quiet Disclosure?

In a non-willful failure to file FBARs and report foreign income, a quiet disclosure can refer to either (a) becoming compliant with only the current year and not correcting prior years, or (b) filing amended returns and paying any related tax and interest for previously unreported offshore income or assets without otherwise notifying the IRS through the OVDP or streamlined program. Under the later, you are filing FBARs and amended returns for the tax periods for which the FBAR and tax return statutes remain open.

What are the Risks Associated with Quiet Disclosures?

First, your previously uncorrected tax returns and FBARs can remain open for a number of years, and sometimes indefinitely.

The statute of limitations is extended to six years after a taxpayer’s return is filed if the taxpayer omits $5,000 from gross income attributable to a specified foreign financial asset, without regard to the reporting threshold or any reporting exceptions.

If the taxpayer fails to file or properly report an asset on Form 8938, the statute of limitations for the taxable year is extended until the taxpayer provides the required information. If the failure is due to reasonable cause, the statute of limitations is extended only with regard to the item or items related to such failure and not the entire tax year.

Source: IRS Explanation of Section 6038D Temporary and Proposed Regulations (link)

If your facts lend themselves to a strong reasonable cause statement, then all returns with open statutes should be submitted with reasonable cause statements per the Delinquent International Information Return Submission Procedures. You are submitting a reasonable cause statement, as part of your amended tax return, under penalties of perjury. You do not want to present incorrect facts in such a statement.

Otherwise, where a taxpayer submits a quiet disclosure in a non-willful case, the taxpayer is taking a gamble that in the event the IRS audits the return the result of the audit will be more favorable than an automatic assessment of a 5% Title 26 misc. offshore penalty assessment under the streamlined domestic offshore procedures.  IRS examiner will consider the facts and circumstances of the particular case. Such factors will include the nature of the violation and the amounts involved.

What is the risk of non-willful penalties in an audit of a quiet disclosure? For non-willful FBAR penalties, that penalty could be $10,000 per year, per account. However, in most cases after 2015, IRS examiners are instructed to not assess non-willful penalties of more than $10,000 per year.

IRM 4.26.16.6.4.1 (11-06-2015)
Penalty for Nonwillful Violations – Calculation
  1. After May 12, 2015, in most cases, examiners will recommend one penalty per open year, regardless of the number of unreported foreign accounts. The penalty for each year is limited to $10,000. Examiners should still use the mitigation guidelines and their discretion in each case to determine whether a lesser penalty amount is appropriate.
  2. For multiple years with nonwillful violations, examiners may determine that asserting nonwillful penalties for each year is not warranted. In those cases, examiners, with the group manager’s approval after consultation with an Operating Division FBAR Coordinator, may assert a single penalty, not to exceed $10,000, for one year only.
  3. For other cases, the facts and circumstances (considering the conduct of the person required to file and the aggregate balance of the unreported foreign financial accounts) may indicate that asserting a separate nonwillful penalty for each unreported foreign financial account, and for each year, is warranted. In those cases, examiners, with the group manager’s approval after consultation with an Operating Division FBAR Coordinator, may assert a separate penalty for each account and for each year. The examiner’s workpapers must support such a penalty determination and document the group manager’s approval.
  4. In no event will the total amount of the penalties for nonwillful violations exceed 50 percent of the highest aggregate balance of all unreported foreign financial accounts for the years under examination.

Is a Quiet Disclosure an Option?

A qualified quiet disclosure involves a gamble – determining the risk of the IRS auditing the returns and determining the likelihood and amount of penalties being assessed. This risk of an audit for international non-compliance is unknown. We counsel taxpayers to either file under the streamlined procedures or draft a reasonable cause statement to file amended tax returns and FBARs. We have not come across any non-willful situations that fall outside these two methods of compliance.

Offshore Tax Compliance for Investments in India

Kunal Patel

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FATCA India Compliance for Investments in India

For US residents with investments in India, compliance with FATCA and the US tax code can be burdensome. Indian clients often receive incorrect information from friends, family, and sometimes even their tax advisors. Since we receive a large number of Indian clients, we’ve created a short guide that may assist such individuals in properly reporting their foreign income and assets.

Worldwide Tax Reporting Requirements for U.S. Persons

U.S. Persons

The U.S. is one of the few countries in the world that taxes its residents on worldwide income and requires reporting of foreign assets. Immigrants from countries such as India may not understand or even know about these reporting requirements. In fact, many clients have come to us after having assumed that all U.S. income is reported in India and all Indian income is reported in India. While this may seem intuitive, it is not correct and can lead to major tax penalties if the IRS catches on. We’ll go over some of the penalties associated with unreported foreign income and assets later.

There are three classes of persons that are considered U.S. tax persons and are required to report worldwide income and assets above certain thresholds.

  1. U.S. Citizens
  2. Green Card holders
  3. Anyone who is present in the U.S. for at least 183 days in a given 1 to 3 year period. Read more about the substantial presence test and how it is calculated.

FinCEN 114 “FBAR”

If you fall into one of the above classes and have foreign financial accounts such as bank accounts, mutual funds, life insurance, and pensions, and the maximum total balance of all these accounts exceeds $10,000, you must file FinCEN Form 114, also known as FBAR. Read more about FBARs.

Form 8938 “FATCA”

If you are a U.S. person and the value of your specified foreign financial assets exceed tthe following thresholds,  you must file a Form 8938 with your tax return. Read more about Form 8938.

  • Unmarried taxpayers living in the U.S. and married taxpayers filing separate returns living in the U.S. – $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
  • Married taxpayers filing a joint return and living in the U.S. – $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
  • Unmarried taxpayers living outside the U.S. –  $200,000 on the last day of the tax year or more than $300,000 at any time during the tax year.
  • Married taxpayers living outside the U.S. and married taxpayers filing separate returns living outside the U.S. – $400,000 on the last day of the tax year or more than $600,000 at any time during the tax year

Form 8621 “PFICs”

If you own Indian stocks or mutual funds, you may have to report these investments on Form 8621. There is a special tax for such investments that are considered Passive Foreign Investment Companies or “PFIC”. Read more about PFICs.

Types of Indian Investments and Potential Reporting Requirements

Fixed Deposit Accounts

This is probably the most common type of unreported income in our streamlined cases involving Indian nationals. Those owning “fixed deposit” or savings accounts in India usually have an NRE or NRO account which is available for non-residents of India. Fixed deposit accounts are similar to CDs in the US.

Myth: Because the account holder will not receive the interest income until maturity, it is not reported on the US tax return.

Fact: Any interest accrued in such accounts, even if they are not yet distributed, are taxed in the US.

Public Provident Funds (PPF) and Employee Provident Funds (EPF)

A public provident fund (PPF) is a long-term investment option that is backed by the Government of India.

Myth: Because these are long-term investments that cannot be withdrawn until maturity (15 years), the income is not taxable in the US. In addition because it exempt from tax under 80C of the Indian tax code, that it is not taxable under the Internal Revenue Code.

Fact: The US does not recognize PPFs as tax-free investments.

Those with investments in PPFs are required to report all interest, dividends, and capital gains, even if they are “reinvestments”. It is unclear whether the accrued interest should be reported as it accrues or when it matures. Either way, the method should be consistent.

An Employee Provident Fund (EPF) is similar to a PPF, but it’s more like a 401(k) or IRA in the US. An EPF is a fund to which both a salaried employee the and employer may contribute a portion (12%) of the salary as a tax-deferred investment (tax-deferred in India). Since there is a maturity period before which the money can be withdrawn, it’s unclear whether the accrued interest should be reported as it accrues or when it matures. Either way, the method should be consistent.

Myth: If the account holder does not withdraw any money from an EPF, it is not taxable in the US.

Fact: The only types of employee pensions that can grow tax-free are those that are recognized under Section 401(k) of the Internal Revenue Code. A foreign employer sponsored deferred compensation plan is usually “non-qualified” and falls under the provisions of IRC 402(b). Non highly-compensated employees will be taxed when the benefits are distributed, but highly-compensated employees will be taxed on the growth. Employer contributions are taxable when made.

Life Insurance

Term life insurance plans are not reported on the US tax return or the FBAR. However, if the plan has cash value, such as a Unit Linked Insurance Plan (ULIP), there may be taxable income.

Myth: Life insurance is not taxable until the policy has been surrendered.

Fact: A ULIP is an investment portfolio. Any interest, “bonuses,” or dividends, including reinvestments are taxable. Additionally, you may have a PFIC filing requirement since this is a securities-based investment and have control over the investment choices.

Mutual Funds

Any interest, dividends, or capital gains from foreign mutual funds are taxable in the US. Additionally, they are likely also to be subject to the PFIC rules.

Demat Accounts

A demat account (short for dematerialized account) are shares and securities held electronically. These are paper stocks that have been dematerialized into electronic form. Additionally, they may be subject to PFIC reporting requirements.

Myth: Demats are not “real stocks” and do not need to be reported on the FBAR.

Fact: A demat account is considered a financial account and must be reported on the FBAR.

Penalties for Failing to Report Foreign Income and/or Assets

Maximum Penalties

Penalties for failing to report foreign income or any one of the foreign information reporting forms such as FinCEN 114, Form 8938, Form 8621, Form 5471, or Form 3520 can be enormous.

FormMaximum Penalty AmountStatutory Authority
FinCEN 114 (FBAR)$10,000 penalty for each non-willful violation (each year).
The greater of $100,000 or 50 percent of the account’s highest balance for willful violations.
31 U.S.C. sec. 5321
Form 8938$10,000 penalty for each violation (per year).

The maximum additional penalty for a continuing failure to file Form 8938 is $50,000.
IRC 6038D(d)
Form 35205 percent of the amount of such foreign gift (or bequest) for each month for which the failure continues after the due date of the reporting U.S. person’s income tax return (not to exceed 25% of such amount in the aggregate.IRC 6677(a)

These are maximum penalties per occurrence (i.e. per year). However, there are mitigating factors that the IRS will consider when assessing penalties.

Tax Treaty Relief

The following are some of the rules modified by the U.S. – India DTAA:

  • Dividends paid by Indian companies to U.S. residents will be taxed in the U.S. (no relief here) However, there is a reduced tax rate on that income in India.
  • Interest paid to U.S. residents will be taxed in the U.S. (no relief here) However, there is a reduced tax rate on that income in India.
  • Social security benefits and other public pensions are non-taxable in the U.S.
  • Government pensions (i.e., for government employees) are non-taxable in the U.S.

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

Recent FBAR Civil Penalty Cases

Kunal Patel

0

FBAR Penalties

Those required to file an FBAR who fail to properly file a complete and correct FBAR may be subject to civil monetary penalties. For penalties that are assessed after August 1, 2016, whose associated violations occurred after November 2, 2015, the following chart highlights the inflation-adjusted civil and criminal penalties that may be asserted for not complying with the FBAR reporting and recordkeeping requirements.

ViolationCivil Penalties Criminal
Penalties
Comments
Negligent Violation Up to $1,078.N/A31 U.S.C. § 5321(a)(6)(A);
31 C.F.R. 103.57(h)
Does not apply to
individuals.
Non-Willful Violation Up to $12,459 for each
negligent violation.
N/A31 U.S.C. § 5321(a)(5)(B)
Pattern of Negligent
Activity
In addition to penalty
under § 5321(a)(6)(A)
with respect to any such
violation, not more than
$83,864.
N/A31 U.S.C. 5321(a)(6)(B)
Does not apply to
individuals.
Willful - Failure to File
FBAR or retain records of
account
Up to the greater of
$124,588, or 50 percent of
the amount in the
account at the time of the
violation.
Up to $250,000 or 5 years
or both
31 U.S.C. § 5321(a)(5)(C);
31 U.S.C. § 5322(a);
31 C.F.R. § 103.59(b) for
criminal.
The penalty applies to all
U.S. persons.
Willful - Failure to File
FBAR or retain records of
account while violating
certain other laws
Up to the greater of
$100,000, or 50 percent of
the amount in the
account at the time of the
violation.
Up to $500,000 or 10
years or both
31 U.S.C. § 5322(b);
31 C.F.R. § 103.59(c) for
criminal
The penalty applies to all
U.S. persons.
Knowingly and Willfully
Filing False FBAR
Up to the greater of
$100,000, or 50 percent of
the amount in the
account at the time of the
violation.
$10,000 or 5 years or both 18 U.S.C. § 1001;
31 C.F.R. § 103.59(d) for
criminal.
The penalty applies to all
U.S. persons.

Note: Civil and Criminal Penalties may be imposed together. 31 U.S.C. § 5321(d). It is possible to assert civil penalties for FBAR violations in amounts that exceed the balance in the foreign financial account.

Note regarding civil penalty assessment prior to August 1, 2016: For those violations occurring on or before November 2, 2015, the IRS may assess a civil penalty not to exceed $10,000 per violation for non-willful violations that are not due to reasonable cause. For willful violations, the penalty may be the greater of $100,000 or 50 percent of the balance in the account at the time of the violation, for each violation.

Source: IRS FBAR reference guide.

Civil FBAR Penalty Cases

An FBAR penalty under 5321(a)(5) requires not just a failure to timely file but also evidence of willfulness.

When willfulness is established, the failure to timely file an FBAR will result in a maximum penalty that is the greater of (1) $100,000 or (2) 50 percent of the maximum balance in the accounts at the time of the violation.

Here are cases where the Government has prosecuted individuals for 5321(a)(5) violations.

U.S. v. Pomerantz

In this filed complaint, the Government is seeking to collect civil FBAR penalties assessed under 31 U.S.C. § 5321(a)(5), also known as the FBAR penalty statute. As discussed in a previous topic, any assessment of civil or criminal penalties under 5321(a)(5) requires evidence of willfulness. Although this case is still in pending litigation, it serves as a good example of fact patterns that can lead to civil FBAR penalties.

Case Facts

  • Defendant Jeffrey Pomerantz (“Pomerantz”) is a U.S. citizen and had an FBAR filing requirement for calendar years 2007, 2008, and 2009
  • Pomerantz had two personal checking accounts at Canada Imperial Bank of Commerce (“CIBC”) which were opened prior to January 1, 2001
  • In 2003 Pomerantz formed a corporation in the Turks and Caicos Islands and retained full rights to act on behalf of the entity
  • The newly formed entity conducted no active business, but was rather a shell entity to hold and manage his personal investments
  • Also in 2003, he opened two portfolio accounts in Switzerland that were titled in his business’s name
  • In 2007 Pomerantz opened an account with the Royal Bank of Canada (“RBC”) also titled under his dba
  • In 2010 the IRS commenced an income tax examination of Mr. Pomerantz’ returns.
  • Prior to the examination, it appears that Pomerantz did not file FBARs for any prior years
  • In 2014 the Government assessed civil FBAR penalties against Pomerantz in the amount of $860,300 due to willful failure to file his 2007, 2008, and 2009 FBARs.

Willfulness Factors

These are some factors that likely caused the government to pursue civil FBAR penalties under 31 U.S.C. § 5321(a)(5):

  1. Creating separate business entities which had no other purpose than to hold and manage his investments
  2. Location of the accounts in jurisdictions that are known tax havens (Turks and Caicos Island, Switzerland)
  3. Opening the foreign accounts using a dba rather than under his own name

It should be noted that he likely did not file any of his FBARs from 2001 onwards, but civil penalties were only assessed for 2007-2009. Presumably he filed in 2010 after being selected for an income tax examination. There is a 6 year statute on an un-filed FBAR that begins to run from the due date of the FBAR. The Government did not assess the penalties until 2014, so there were only three years (2007-2009) for which the statute was still open and the FBAR was not timely filed.

U.S. v. Mani

Here is an FBAR penalty case that resulted in a plea agreement. Link to DOJ press release.

Facts

  • Defendant, March Edward Mani, is a 48 year old U.S. citizen and resident
  • Mani is a plastic surgeon working in Beverly Hills, CA
  • Dr. Mani began to travel to Dubai in 2011 to perform plastic surgery for a foreign medical center
  • Dr. Mani’s accountant, who was aware that he was earning foreign income, informed Dr. Mani in late 2011 that he would be required to report foreign bank accounts under his ownership to the IRS. Defendant reported his 2011 foreign earned income on his 2011 federal income tax return.
  • In 2012 defendant opened a foreign bank account at Mashreq Bank in Dubai, where he deposited income he earned from the Medical Center. By 2013 his account contained $402,000 USD.
  • Defendant then consulted with other accountants whether he had to report foreign earned income and his foreign bank accounts to the IRS. The other accountants confirmed to Defendant that he did indeed have a reporting requirement.
  • Defendant filed his 2012-2014 tax returns, significantly underreporting his foreign earned income from the medical center.
  • Defendant failed to file his FBARs.

Charges

Defendant was charged with a violation of Title 31, USC § 5314 and 5322, and 31 C.F.R. § 1010.350.

The statutory maximum sentence for the above violations is a: five years of imprisonment; a three year period of supervised release; a fine of $250,000 or twice the amount of gross gain or gross loss resulting from the offense, whichever is greater.

The plea agreement can be found here (courtesy of Jack Townsend’s Federal Tax Crimes blog)

Willfulness Factors

The willfulness factors here are easy to spot:

  • There was a significant amount of foreign income that was unreported
  • Defendant had knowledge of the FBAR filing requirements

What should non-compliant taxpayers do?

If taxpayers are non-compliant with the foreign asset and income reporting requirements, they should consider applying to one of IRS’ voluntary disclosure programs:

We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.

IRS to Audit Certain OVDP Cases

Kunal Patel

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IRS to Audit OVDP Opt Out Cases

What’s new for 2017 IRS OVDP?

Each year the IRS rolls out campaigns to identify the the top compliance issues for the year. For each of these campaigns, the IRS will deploy resources, training, and tools, metrics and feedback to enforce compliance in these areas. One of the selected campaigns for 2017 involves the IRS OVDP program.

IRS OVDP Audit Campaign

This campaign will be lead by IRS executive Pamela Drenthe, Director of the International Individual Compliance Practice Area.

Who does this OVDP audit campaign affect?

This campaign addresses applicants who applied for OVDP or requested pre-clearance but either were denied access or withdrew from the program voluntarily.

What will happen if I am in one of the above categories?

If you were rejected from the OVDP program or voluntarily withdrew from the program, the “IRS will address any continued noncompliance through a variety of treatment streams including examination.” (emphasis added)

What should I do if I am potentially affected by this campaign?

If you’re not in compliance, you should immediately hire a legal representative and try to resolve your non-compliance through one of the offshore programs currently available. If your OVDP application was rejected, you’ll need to determine why you received the rejection letter. Voluntary disclosure requires the applicant to truthfully, timely, and completely comply with all provisions of the voluntary disclosure practice. If your application or pre-clearance was rejected, it’s likely due to one of the following reasons:

The application or pre-clearance request was not complete: This is easier to cure. You and your legal representative should determine what information was missing and resubmit.

The application or pre-clearance request was not timely: A request is not timely if the IRS has a pending civil or criminal investigation against you, notified you that it intends to conduct a civil or criminal investigation, or has received information from a 3rd party informing the IRS of your non-compliance. If your application or pre-clearance request was denied for one of these reasons, you’re potentially in a very bad situation. Your legal representative needs to contact the IRS Criminal Investigation Department to determine exactly why the application was denied.

Takeaways

Here are the two key takeaways from this recent focus on rejected and withdrawn OVDP cases:

1. If you decide to apply for pre-clearance or full OVDP, don’t expect to be able to withdraw without potential complications. Withdrawing from the program clearly puts yourself “on the radar” for a potential examination.

2. If your pre-clearance or OVDP application is rejected, find out exactly why and if necessary have your legal representative begin engaging in discussion with the IRS. “Laying low’ and doing nothing is probably the worst thing you can do because the consequences of continued non-compliance will be severe.

The fear of rejection from the OVDP program or pre-clearance should not dissuade anyone from applying when their conduct shows obvious signs of willfulness. In many cases where OVDP applications have been rejected, the IRS has considered a failed entry into the OVDP program to be a mitigating factor in favoring a lesser fine and probation rather than incarceration.


Sources:

“Large Business and International Launches Compliance Campaigns.” Internal Revenue Service, 28-Feb-2017, https://www.irs.gov/businesses/large-business-and-international-launches-compliance-campaigns

United States v. Tenzer, 213 F.3d 34, 42-43 (2d Cir. 2000) (treating as mitigating a defendant’s failed attempt to enter an IRS voluntary disclosure program).

United States v. Zabczuk, 10-60112 (S.D. Fla.) (defendant’s OVDP was rejected and received three years’ probation despite the government’s request for an 18-month sentence).