Foreign Life Insurance Taxation
Life insurance can be good way to ensure that loved ones are taken care of in the event of an unfortunate situation. However, owning a foreign life insurance policy with cash value can prove to be more of a headache than it’s worth. We’ve come across such types of investments regularly in our offshore compliance cases; the reporting and tax obligations can be burdensome. Hopefully, this article will help foreign insurance policy owners understand their U.S. tax obligations.
Willfulness vs. Non-willfulness: Offshore Compliance Cases Involving Immigrants
Nearly on a daily basis I get a call or email from a potential client with this almost exact same scenario:
Client from Country A moves to the U.S. and leaves behind some accounts and assets in Country A. Client finds out about FBAR filing requirements and learns that foreign income must be reported on the U.S. return.
IRS Tax Amnesty & Voluntary Disclosure Practice
What do you do if you have committed a serious tax crime but the IRS has not yet discovered it? Tax amnesty has been a longstanding practice of the IRS Criminal Investigation division whereby taxpayers are allowed to make timely, accurate, and complete voluntary disclosures to avoid criminal prosecution.
Taxpayers are given tax amnesty for “coming clean” regarding their tax crimes. There are two such programs depending on whether the tax evasion involves domestic or foreign income:
- Domestic Voluntary Disclosure Program (not to be confused with streamlined domestic offshore procedures which is a completely unrelated program)
- Offshore Voluntary Disclosure Program (OVDP)
IRS Form 3520 – What are the Reporting Requirements and Tax Consequences of Receiving a Gift from a Foreign Person?
It is a common scenario where a U.S. person receives a gift from a parent or relative who lives abroad. Such transactions usually trigger a Form 3520 filing requirement. There are two steps to determining the tax and reporting consequences of such transactions.
IRS Form 8938 (FATCA) Filing Requirements
The “FATCA” (Foreign Account Tax Compliance Act) provisions require specified individuals to report ownership of specified foreign financial assets if the total value exceeds the applicable reporting threshold. The IRS created Form 8938, Statement of Specified Foreign Financial Assets, for this purpose. Form 8938 must be included with the individual’s tax return. Failure to include the Form 8938, if required, could lead to significant penalties. Note that the Form 8938 is also referred to as “FATCA” which can cause confusion since that term also refers to the regulations themselves. Read more
How the IRS Investigates FBAR Violations
In this article are the IRS’ internal procedures for investigations of FBAR violations. After the foreign bank reports the non-compliant taxpayer’s account information to the foreign taxing authority, the information is then provided to the IRS. For those countries without intergovernmental agreements (IGAs), the account holder’s information will be sent directly to the IRS. Or the IRS has discovered the non-compliance based on stated or implied sources of foreign income on filed tax returns or information forms. Regardless of how the IRS obtains the information, what follows next is an investigation by an IRS examiner of the potential FBAR violation(s). Read more
Foreign Bank Account Reporting under the Bank Secrecy Act (FBARs)
If you are a US citizen or tax resident, you may have a foreign bank account reporting obligation. There are individuals who don’t report their foreign financial accounts to evade taxes, but that is an exception and not the norm. For the vast majority of those who fail to report, the reason is that they were simply unaware of their reporting requirements. Read more
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
Reporting of Foreign Assets
The requirements for reporting foreign assets can catch many by surprise.
A common scenario – a US Citizen goes abroad to work. He opens a bank account in a foreign country and reports and pays taxes in the foreign country. Maybe he even marries and has children there. He incorporates his business abroad, becoming an officer of the corporation. His small business turns into a multi-million dollar enterprise. Uncle Sam soon becomes a distant relative that he thinks about in passing. If he’s lucky Uncle Sam may send him a letter informing him that he forgot to file his tax return. Or years may pass without being contacted.
Another scenario – a foreigner comes to the US on an immigrant visa. He leaves his bank account active in his foreign country to help pay for his parents’ expenses. His parents pass away and he sells his inherited property, resulting in an enormous windfall. He keeps the funds in his foreign account since he plans to retire there someday. He decides later that he wants to start a foreign partnership with his brother to invest his money in foreign real estate.
Both of these taxpayers may have forgotten that the US taxes its citizens and residents on worldwide income. Both taxpayers would have failed to not only report the foreign income, but also to disclose their foreign assets and interests. Expats who remain US citizens or permanent residents have an obligation to report all foreign income and specified foreign assets. And permanent residents and temporary visa holders who meet the substantial presence test also have the same foreign income and asset reporting requirements. The penalties for failing to do so can be severe.
Reporting Foreign Assets
Individuals with foreign assets or interests may have one or more of the following reporting requirements:
- FinCEN Form 114, also known as FBAR
- Foreign Bank and Financial Accounts Reporting (FBAR). All US persons (which include US Citizens and resident aliens) who have a financial interest or signatory authority over foreign accounts which have an aggregate value of more than $10,000 at any time during the calendar year must report all foreign bank and financial accounts with the Department of Treasury by June 30.
- Form 8938 (FATCA):
- US Citizens, resident aliens, and aliens who meet the substantial presence test must report specified foreign assets on Form 8938 with their Form 1040.
- There is a filing threshhold which varies from $50,000 to $600,000 depending on the filing status of the taxpayer and whether the taxpayer is living in the US or outside the US.
- Form 3520:
- If you are a US Person who receives foreign gifts of money or other property over $100,000 (or $15,601 if received from a foreign corporation or partnership) must report the gift on Form 3520.
- Form 5471 & 5472:
- If you are a US citizen or permanent resident living abroad or a citizen or resident living in the US, you must report your interest in any foreign corporations if you have a specified relationship with the corporation and own or have control over a specified percentage of the total value of the corporation.
- Form 926:
- U.S. persons, domestic corporations or domestic estates or trusts must file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, to report any exchanges or transfers of property (as described in section 6038B(a)(1)(A) of the Internal Revenue Code) to a foreign corporation.
- Form 8865:
- This form is filed with your US tax return if you own 10% or more of a foreign partnership or foreign flow through LLC. This form shows the income and expense statement of the foreign partnership and the yearly balance sheet. It also reports details of the partnership and your allocable share of the partnerships income. It is similar to Form 1065 which is filed for a US based partnership or LLC.
Penalties for Failing to Report Foreign Assets
The IRS is serious about cracking down on offshore and overseas tax evasion, and the penalties associated with failing to report foreign assets reflect that.
Here are the penalties for failure to report foreign assets:
- FinCEN 114 (FBAR):
- The IRS can impose a $10,000 penalty for each non-willful violation of the FBAR filing requirement.
- Where a person willfully fails to file an FBAR, the IRS may impose a penalty equal to the greater of $100,000 or 50 percent of the account’s highest balance.
- Form 8939:
- If you are required to file Form 8938 but do not file a complete and correct Form 8938 by the due date (including extensions), you may be subject to a penalty of $10,000. See Treas. Reg. 1.6038A-4(a)(1).
- If you do not file a correct and complete Form 8938 within 90 days after the IRS mails you a notice of the failure to file, you may be subject to an additional penalty of $10,000 for each 30-day period (or part of a period) during which you continue to fail to file Form 8938 after the 90-day period has expired. The maximum additional penalty for a continuing failure to file Form 8938 is $50,000. See Treas. Reg. 1.6038A-4(d)
- If you underpay your tax as a result of a transaction involving an undisclosed specified foreign financial asset, you may have to pay a penalty equal to 40 percent of that underpayment.
- If you underpay your tax due to fraud, you must pay a penalty of 75 percent of the underpayment due to fraud.
- In addition to the penalties already discussed, if you fail to file Form 8938, fail to report an asset, or have an underpayment of tax, you may be subject to criminal penalties.
- Form 3520:
- The penalty for failure to report a large gift (or bequest) from a foreign person on a timely, complete, and accurate Form 3520 is 5 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). IRM 188.8.131.52.4
- Form 5471 & 5472:
- The noncompliance penalty adjustment permits the Service, in its sole discretion, to deny deductions and adjust cost of goods sold with respect to the related party transaction(s) based upon information available to the Service. IRC 6038(d)(3).
- Form 926:
- Anyone who fails to any exchanges or transfers of specified foreign properties must pay a penalty equal to 10 percent of the fair market value of the property at the time of the exchange. IRC § 6038B
- Form 8865:
- The initial penalty is $10,000 per failure.
- If any failure continues more than 90 days after the day on which the notice of such failure was mailed to the taxpayer (90-day period), additional penalties of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the 90-day period will apply. The maximum continuation penalty is limited to $50,000 per failure.
- The maximum total penalty under IRC 6679 is $60,000 per failure (an initial penalty maximum of $10,000 plus the continuation penalty maximum of $50,000 per failure).
In addition to the above foreign asset reporting penalties, if a US citizen or permanent resident living abroad fails to file a US tax return, the various return penalties (failure to pay, failure to file, and interest) are applied in combination with the above penalties.
Quick Reference Guide to International Penalties
||Penalty Code Section
|U.S. person with interest in:
||Foreign Corporation (FC)
|Foreign Partnership (FP)
|Foreign Disregarded Entity
|Penalty reducing Foreign Tax Credit:
||Foreign Corporation (FC)
|Foreign Partnership (FP)
|FC or FP with Foreign Disregarded Entity
|25 percent foreign-owned U.S. corporations
|25 percent foreign-owned U.S. corporations that fail to: 1) authorize the reporting corporation to act as agent of a foreign related party, or 2) substantially comply with a summons for information
|Transferor of certain property to foreign persons:
||Form 8865 Schedule O
|Foreign corporations engaged in U.S. business
|Individuals receiving gifts from foreign persons exceeding $100,000 or $10,000 in the case of a gift from a foreign corporation or foreign partnership (adjusted annually for cost of living)
|Individuals that relinquish their U.S. citizenship or abandon their long-term resident status
|Foreign persons holding direct investments in U.S. real property interests
|U.S. person who creates a foreign trust, transfers property to a foreign trust or receives a distribution from a foreign trust
|U.S. Owner of a foreign trust
|Failure to file returns with respect to acquisitions of interests in:
||Form 5471 Schedule O
||Form 8865 Schedule P
|IC-DISC, or FSC failure to file returns or supply information:
|Allocation of Individual Income Tax to Guam or the CMNI
|Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession
|Taxpayer’s failure to file notice of foreign tax redetermination under IRC 905(c) or IRC 404A(g)(2)
||Form 1116 or Form 1118 (attached to Form 1040-X or Form 1120-X)
|Taxpayer’s failure to file notice of foreign deferred compensation plan under IRC 404A(g)(2)
|Taxpayer’s failure to disclose treaty-based return position
||Form 8833 or statement
|Failure to Provide Information Concerning Resident Status (Passports and Immigration)
|Taxpayer’s failure to furnish information with respect to specified foreign financial assets
Taxpayers face increasingly burdensome foreign asset reporting requirements, and the penalties seem to get steeper each year. If you’ve been behind on reporting your foreign assets, it can seem to be a daunting and scary endeavor to get yourself complaint. Perhaps equally difficult is finding a tax attorney who is experienced in and understands expat tax issues. Contact us today to see how we can help you become complaint with your foreign asset reporting requirements, even if it has been many years since you’ve filed a US tax return.
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?
- 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.
- 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.
- 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.
- 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.
- 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.