Offshore Tax Compliance — How Fast are you Speeding?
In my offshore tax compliance practice, I’ve talked to hundreds of individuals from around the world – from people who’ve unintentionally violated U.S. foreign financial and tax reporting laws to those who’ve knowingly or recklessly violated them.
Two questions are invariably asked – “what are my risks, and what penalties am I facing?”
The penalty question is easier to answer. There’s a laundry list of penalties applicable to the failure to report foreign accounts and/or foreign income. The maximum penalties authorized for such violations is clear.
The difficult question is that of ‘risk.’ It involves two components: 1.) “getting caught” and 2.) the application of penalties. I’ve found that many people have a difficult time understanding risk, and think of it in black and white instead of as a continuum. This is especially the case when clients don’t understand the law. The laws involving the reporting of foreign assets and income are complicated.
To help clients understand risk in the context of offshore account compliance, I often use speeding as an example. The faster you’re speeding, the greater your risk.
Willfulness, non-willfulness, and reasonable cause
Bob, the willful speeder
Bob lives life in the fast lane, literally. He often drives 25-30 miles over the speed limit. Chances are good that he will eventually get a speeding ticket. It’s certainly much higher than someone who goes 5 or 10 miles over the speed limit.
Officer Biff spots Bob barreling down the highway in his shiny new red sports car going 100 mph on a 60 mph speed limit. When he pulls Bob over, he discovers that Bob has a radar detector.
Bob tries to explain to the officer that he didn’t mean to go fast and that he didn’t know the speed limit. However, a reasonable person would know that going that fast would likely be unlawful. Officer Biff certainly doesn’t buy it and arrests him for reckless driving. Bob hires an attorney and they litigate the charges to no avail. The government argues that Bob knowingly sped based on his possession of a radar detector. In the alternative, he was acting recklessly or was willfully blind as to the speed limit. Bob’s license is suspended, receives a huge fine, and spends 30 days in jail.
Similarly, in the world of foreign accounts compliance, the chances of “being caught” depend much on the degree of non-compliance. The higher your undisclosed account balances and unreported foreign income, the higher the odds are of an FBAR audit or other type of audit. A FBAR audit can then result in the discovery of other violations, including unreported foreign income and other missing international information forms, such as Form 8938, 5471, etc. Each one of these violations carries separate penalties, the most significant of them being the willful failure to file an FBAR. A person can be considered willful when they’ve knowingly violated the law or acted recklessly or willfully blind.
Sarah, the non-willful speeder
If you’re like me, you’re sometimes distracted while driving. You look down at your speedometer to notice that you’ve exceeded the speed limit by 5 miles. Or maybe you thought the speed limit was 60, but it turns out it was actually 50 and you simply missed the sign. In either case, you did not speed knowingly; nor were you acting recklessly or willfully blind like Bob.
Sarah is cruising along the road at 45 mph, completely oblivious that the speed limit on the road dropped from 45 to 35. Officer Biff pulls her over. Sarah then remembers she forgot to renew her inspection last week which is now expired.
Things could go a number of ways. Officer Biff might not notice the expired inspection. Or he notices it but is having a pleasant day and Sarah is charming enough, so he writes her a warning for both violations. Or maybe Biff is a stickler for the law and writes her a ticket for both violations, and even one for veering slightly outside the lane.
Sarah is awarded two tickets from Officer Biff but doesn’t want to pay them, so she hires an attorney. Her attorney meets with the prosecutor. The prosecutor settles to let her off on the expired inspection ticket because she immediately corrected it, and reduces the speeding ticket since this was her first violation in 5 years. Or it could turn out that they can’t come to an acceptable agreement and decide to litigate.
Most people who’ve failed to report foreign financial assets are non-willful. Those that non-willfully fail to report foreign accounts or income from them and are caught will likely pay a penalty. Again, the risk of “getting caught” in the first place would seem to depend on the degree of the violation.
Just like in Sarah’s situation where penalties can vary based on the police officer, an FBAR or opt-out audit would be very much the same. IRS examiners are humans, and like all of us, they have different temperaments. Some might be sticklers and will look for every possible violation. Others might be more reasonable.
After penalties are assessed in examination, a taxpayer can protest the assessment with the IRS Office of Appeals. Typically, appeals officers are reasonable and trained to factor in the “hazards of litigation.” In the vast majority of cases, an acceptable settlement is made. Otherwise, it would be necessary to litigate it in either tax court or district court, depending on the type of penalty.
David, the reasonable cause speeder
David is driving with his son and notices that his son is having a severe allergic reaction. He locates the nearest hospital and hits the pedal. Before he can reach the hospital, Officer Biff stops him for speeding. After learning of David’s situation, the officer obviously does not write him a ticket. David had a very good reason for speeding.
Or it could be a very rare situation where one gets ticket for driving just a few miles over the speed limit. It’s technically breaking the law, but one would think an officer has more important priorities. Let’s say it does happen. David lives in Texas where the speed limit is 75. He’s driving to Louisiana for the first time where the speed limit is 70. He gets pulled over just as he passes through the state border for driving at 72 mph. Officer Biff doesn’t like out-of-staters and gives him a ticket, even if it’s just 2 miles over. Biff hires an attorney to dispute the ticket. Since David was barely over the speed limit and due to his other circumstances, the prosecutor decides to dismiss it.
A smaller number of people who’ve failed to report foreign financial assets will have reasonable cause for not filing.
FATCA, red light cameras, and speed traps
Till now, we’ve assumed the only way of identifying law-breakers was through officers patrolling the highway. More recent technological advancements allow authorities to identify traffic violations through automated enforcement such as red light cameras and speed traps.
The Foreign Account Tax Compliance Act (FATCA), is a U.S. federal law that requires foreign financial institutions to search their customer databases to identify individuals suspected of being U.S. persons. For those individuals, the foreign financial institution (FFI) is required to disclose the account holders’ names, identification numbers, addresses, and transactions to the U.S. Dept of Treasury.
FATCA is essentially a huge red light camera. A red light camera, however, only collects information about drivers who’ve ran the red light. Imagine if the cameras collected information about every vehicle that passed through and some license plate numbers are missing or blurry – it would be quite difficult to find the violators. This is exactly the enforcement problem with FATCA, which requires FFIs to report information about all U.S. persons with foreign financial accounts – possibly hundreds of millions of accounts. There’s too much information, and the IRS doesn’t seem to have figured out a good way to identify the non-compliant taxpayers.
So you’re non-compliant — now what?
For the past several years, the IRS has offered taxpayers an opportunity to voluntarily come forward in a number of ways, in most cases with payment of taxes and reduced penalties. It’s not exactly because the government is being nice. It’s a business decision. The IRS, like all government agencies, has limited resources. It cannot possibly go after all FBAR and other offshore non-compliance. But the government has the cards stacked up against such taxpayers because of the maximum potential penalties. They’ve bet correctly that people will voluntarily come forward, as hundreds of thousands of taxpayers already have.
It is important that taxpayers who are non-compliant come forward before the IRS eventually reaches out to them. Taxpayers can voluntarily disclose their foreign assets and report income through one of three ways:
- Traditional voluntary disclosure – for willful violations like Bob’s
- Streamlined filing compliance procedures (SDOP and SFOP) – for non-willful violations like Sarah’s
- Delinquent international information return submission procedures – for those with reasonable cause like David
We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.