We’ve seen many taxpayers under audit for foreign earned income exclusion (FEIE). It was identified as a compliance campaign by IRS LB&I last year (link).
It’s easy to see why the IRS would audit this issue. A qualifying individual may exclude up to $104,100 (for 2018) of foreign earned income from U.S. taxation. In a typical 3 year audit, an adjustment favorable to the IRS could lead to additional taxes (plus penalties and interest) on more than $300,000 of income.
Sometimes FEIE is claimed although along with foreign tax credits (although scaled down). Likely the taxpayers with the highest audit potential are those that rotated in foreign countries with no income tax since there would be no foreign tax credits to claim in lieu of the FEIE. Most notably are contractors working in Middle Eastern countries such as Saudi Arabia and UAE. Short-term rotators generally do not qualify for the FEIE – although a series of 1 year rotations may qualify (see Linde v. CIR, T.C. Memo 2017-180).
Earlier this year the IRS announced that it would be ending the offshore voluntary disclosure program on September 28, 2018. There are signs that the the program could be replaced by a new program. After the announcement, the IRS requested comments from the public for its federal register on the following topics pertaining to the OVDP (link):
- whether the collection of information is necessary for the proper performance of the functions of the agency, including whether the information shall have practical utility;
- the accuracy of the agency’s estimate of the burden of the collection of information;
- ways to enhance the quality, utility, and clarity of the information to be collected;
- ways to minimize the burden of the collection of information on respondents, including through the use of automated collection techniques or other forms of information technology; and
- estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.
The U.S. Supreme Court on Monday declined to review a Ninth Circuit decision imposing a $1.1 million FBAR penalty on a taxpayer. The Internal Revenue Service assessed the penalty after finding the taxpayer failed to report assets exceeding $1 million in a Swiss bank account.
The taxpayer argued the amount of the assessment violated the Eighth Amendment protection against excessive fines and said the IRS improperly obtained nontax information, such as the existence of the foreign account, through the Swiss-U.S. tax treaty.
Below are details from the appellate history in United States v. Bussell.
The IRS released their yearly Dirty Dozen tax scams for 2018. Offshore tax cheating remains on its list this year, despite the large number of taxpayers who have voluntarily come forward since the offshore voluntary disclosure program was implemented. Here’s are some figures from the IRS’ offshore compliance efforts:
- There have been more than 56,400 disclosures and the IRS has collected more than $11.1 billion from the Offshore Voluntary Disclosure Program (OVDP) since it opened in 2009.
- In addition, another 65,000 taxpayers have made use of separate streamlined procedures to correct prior non-willful omissions and meet their federal tax obligations.
- The IRS conducted thousands of offshore-related civil audits that resulted in the payment of tens of millions of dollars in unpaid taxes. The IRS has also pursued criminal charges leading to billions of dollars in criminal fines and restitutions.
Source: IR-2018-62, March 19, 2018.
The IRS announced recently that it is ending the OVDP program which has been in existence since 2009. Here are more details from the announcement.
WASHINGTON – The Internal Revenue Service today announced it will begin to ramp down the 2014 Offshore Voluntary Disclosure Program (OVDP) and close the program on Sept. 28, 2018. By alerting taxpayers now, the IRS intends that any U.S. taxpayers with undisclosed foreign financial assets have time to use the OVDP before the program closes.
“Taxpayers have had several years to come into compliance with U.S. tax laws under this program,” said Acting IRS Commissioner David Kautter. “All along, we have been clear that we would close the program at the appropriate time, and we have reached that point. Those who still wish to come forward have time to do so.”
IRC 6038 Penalties in Dewees v. United States
Dewees v. United States, 16-cv-01579 (D.C. 2017) is a difficult case. The IRS appears to have been unusually tough on this taxpayer.
Dewees is a U.S. citizen living in Canada, where he operates a consulting business. Because the business is incorporated abroad, Dewees was required to furnish certain annual information about the company to the IRS. Unfortunately for Dewees, he neglected to do so for over a decade.
U.S. citizens who hold controlling interests in foreign corporations must annually file IRS Form 5471, which discloses certain ownership and financial information about the corporation. In addition, U.S. citizens living abroad must disclose holdings in foreign bank accounts over certain thresholds by filing a Report of Foreign Bank and Financial Accounts (“FBAR”).
Form 8938 & Statute of Limitations
IRC § 6038D, enacted on Mar. 18, 2010, and effective for taxable years beginning after the date of enactment, imposes reporting requirements with respect to certain “specified foreign financial assets”. The requirements are satisfied by an accurately filed Form 8938.
Form 8938, Statement of Foreign Financial Assets, is required to be filed by specified individuals who are beneficial owners of specified foreign assets in excess of the filing threshold.
IRS statute of limitations are time periods established by law to review, analyze, and resolve taxpayer and/or IRS tax-related issues. The Internal Revenue Code requires the IRS to assess, refund, credit, and collect taxes within specified limits. Once the applicable statute of limitations has expired, the IRS cannot assess additional tax, allow a claim for refund, or take collections action.
The general statute of limitations on assessment of taxes on a tax return is three years under IRC § 6501(a). There are at least two exceptions unique to offshore compliance cases:
- IRC § 6501(e)(1)(A)(ii) Where income attributed to a specified foreign financial asset is omitted and in excess of $5,000, the statute may be extended to 6 years with respect to the omitted income from the specified asset.
- IRC§ 6501(c)(8)(A) Where Form 8938 or any other international information return is required to be filed with a tax return, the statute is extended for any tax imposed under Title 26 with respect to any tax return, event, or period to which such information relates for three years after the information is provided (e.g., filing an accurate and complete form). Read more
CFCs, Tax Deferral, and Subpart F Income
While a U.S. corporation is subject to tax on its earnings and then its shareholders on their dividends, the U.S. has no taxing jurisdiction on a foreign corporation that neither receives U.S.-source income nor has income effectively connected with the conduct of a U.S. trade or business. However, any dividends earned by U.S. shareholders from foreign corporations are taxable. Without anti-deferral rules in place, U.S. individuals could make investments through foreign entities and indefinitely defer taxation in the U.S. by not issuing dividends. In addition to PFIC rules, Subpart F provisions are powerful anti-deferral mechanisms to prevent this deferral of foreign earned income. Subpart F rules, discussed below, apply to CFCs.
Foreign Account Reporting and Exchanges of Information
A question those who are seriously non-compliant with reporting of foreign accounts and assets sometimes ask is, “how will the IRS discover my account?” Hopefully this article will shed some light.
Foreign Account Tax Compliance Act (FATCA)
Automatic exchanges of foreign account information with the IRS are received by foreign financial institutions (FFIs) pursuant to the Foreign Account Tax Compliance Act (FATCA) which was passed into law in March 2010. FATCA requires financial institutions (FIs) to report certain information about certain financial accounts held by United States taxpayers, or by foreign entities in which United States taxpayers hold a substantial ownership interest.
FIRPTA witholding rules may apply to a disposition of a U.S. real property interest by a foreign person. Such transactions are subject to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) income tax withholding. FIRPTA authorized the United States to tax foreign persons on dispositions of U.S. real property interests.
Here’s what buyer and sellers need to know in situations where the buyer might be considered a foreign person.