- 1 Streamlined Domestic Offshore Procedures – Overview
- 2 Eligibility for the streamlined domestic offshore procedures
- 3 Disqualification from the streamlined domestic offshore procedures
- 4 Title 26 miscellaneous offshore penalty
- 5 General treatment under the streamlined procedures
- 6 What if I cannot get all my documents from overseas?
- 7 What happens if the IRS rejects your streamlined domestic offshore filing?
Streamlined Domestic Offshore Procedures – Overview
The IRS streamlined domestic offshore procedures (SDOP) are one of the two programs available in the streamlined filing compliance procedures. It is available to those who have unreported income from undisclosed foreign financial assets.
U.S. taxpayers eligible to use the domestic offshore procedures will need to:
- file amended returns, together with all required international information returns, for the past three years; and
- file delinquent or amended Report Of Foreign Bank & Financial Accounts (FBAR) (FinCEN Form 114) for the past six years.
Qualified filers must submit the above along with a signed certification statement attesting under penalties of perjury that the failures above resulted from non-willful conduct.
Eligibility for the streamlined domestic offshore procedures
Individuals, including estates of individual taxpayers, are eligible to use the Streamlined Filing program if:
• They are a U.S. Resident.
• They have previously filed a U.S. tax return (if required) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed.
• They have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR (FinCEN Form 114) and/or one or more international information returns with respect to the foreign financial asset.
• The failures above resulted from non-willful conduct.
The failure to report all income, pay all tax, and submit all required information returns, including FBARs, must be due to non-willful conduct.
Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.
A taxpayer who understands that there may be a filing requirement, but deliberately avoids learning about international information reporting requirements can be considered to have acted willfully. The law does not protect deliberate ignorance or conscious avoidance.
Eligible filers will be assessed a Title 26 miscellaneous offshore penalty equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.
Disqualification from the streamlined domestic offshore procedures
Even if a taxpayer meets the previously-discussed elegibility requirements, the taxpayer is disqualified if either of these situations apply.
- Previous examination. If the IRS has started a civil examination of taxpayer’s returns for any taxable year, regardless of whether it relates to undisclosed foreign financial assets, the taxpayer will not be eligible to use the streamlined procedures. Taxpayers under examination may consult with their agent. Similarly, a taxpayer under criminal investigation by IRS Criminal Investigation is also ineligible to use the streamlined procedures.
- Unfiled return. Taxpayer has not previously filed their U.S. tax returns. Only amended returns, and not original returns, may be submitted under the streamlined domestic offshore procedures.
Title 26 miscellaneous offshore penalty
In consideration of the IRS’ agreement not to assert other penalties with respect to a failure to report foreign financial assets or the failure to report income from foreign financial assets, the taxpayer is assessed a Title 26 miscellaneous offshore penalty.
The Title 26 miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.
The highest aggregate balance/value is determined by aggregating the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance/value from among those years.
Determine the penalty base
First it must be determined which assets are to be included in the penalty base. A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty if:
- In a given year in the covered FBAR period if the asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year.
- In a given year in the covered tax return period if the asset should have been, but was not, reported on a Form 8938 for that year.
- In a given year in the covered tax return period if the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.
For example, foreign financial assets may include:
- financial accounts held at foreign financial institutions;
- financial accounts held at a foreign branch of a U.S. financial institution;
- foreign stock or securities not held in a financial account;
- foreign mutual funds; and
- foreign hedge funds and foreign private equity funds.
Exception for Canadian registered registered retirement savings plan (RRSPs)
For those with RRSPs, their Canadian retirement plan will not be included in the 5-percent penalty base. Eligible individuals under under § 4.02 of Rev. Proc. 2014-55, are treated as having made the election under Article XVIII(7) of the U.S.–Canada income tax treaty to defer U.S. income tax on undistributed income earned by a Canadian retirement plan.
Financial interest: beneficial interest and legal interest
The FBAR requires the reporting of all foreign financial accounts that a taxpayer has financial interest in or signature authority over. Financial interest includes both beneficial and legal interest.
Form 8938 only requires the reporting of an account in which the taxpayer has beneficial interest.
The Title 26 misc. offshore penalty applies to all reportable but unreported foreign financial assets. The penalty is not intended to reach assets in which the taxpayer had no financial interest, such as an employer’s account over which the taxpayer had only signature authority, or portions of assets in which the taxpayer had no personal financial interest.
We often come across clients who have foreign financial accounts in which they have legal ownership but no beneficial interest. In many countries, it is common practice for elderly parents to include their adult children as joint legal owners on their financial accounts. This ensures that their estate seamlessly passes to their children. If the source of the funds is their parents’, and the children do not deposit or withdraw funds into the account, directly or indirectly, it can be argued that there is no beneficial interest in the account. Such assets must be included on the FBAR.
The United States legal system is based on common law which makes an important distinction between legal ownership and beneficial ownership. If there is no beneficial interest, the account would not need to be reported on Form 8938; and the interest income would not be reported on the tax return. Properly excluding accounts from the covered tax return penalty base for which a taxpayer has no beneficial interest could potentially save a substantial amount in misc. offshore penalties in some cases.
Co-owners are liable for the penalty only on their individual percentage of the highest aggregate balance in the account.
Are previously reported accounts included in the penalty base?
Covered 3 year tax return period: If the financial asset was reported on both the FBAR and Form 8938, and the income was included on the tax return, it would not be included in the penalty base. Amount entered on the 14654 would be zero.
Covered 6 year FBAR period: For the 3 FBAR periods that don’t overlap with the covered 3 year tax return periods, if the asset was reported on the FBAR, it would not be included in the penalty base. Amount entered on the 14654 would be zero.
Determine the penalty amount
Once the assets in the penalty base have been identified for each year, enter the value of the financial interest in each asset as of December 31 of the applicable year. Once the asset values have been entered on the form, add up the totals for each year and select the highest aggregate amount as the base for the 5-percent penalty.
General treatment under the streamlined procedures
Tax returns submitted under either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will be processed like any other return submitted to the IRS. Consequently, receipt of the returns will not be acknowledged by the IRS and the streamlined filing process will not culminate in the signing of a closing agreement with the IRS.
Returns submitted under the Streamlined Domestic Offshore Procedures will not be subject to IRS audit automatically, but they may be selected for audit under the existing audit selection processes applicable to any U. S. tax return and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors, and other sources.
Thus, returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate. Taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns was due to willful conduct and who therefore seek assurances that they will not be subject to criminal liability and/or substantial monetary penalties should consider participating in the Traditional Voluntary Disclosure Program.
After a taxpayer has completed the streamlined filing compliance procedures, he or she will be expected to comply with U.S. law for all future years and file returns according to regular filing procedures.
What if I cannot get all my documents from overseas?
One of the biggest hurdles that clients face is obtaining documents from their financial institutions. In our experience, after a dilligent effort, all clients have been able to obtain their records. Or in extenuating circumstances, clients have been able to reconstruct their records using available information.
Here’s the IRS’ response on this question:
What should I do if I am having difficulty obtaining my records from overseas?
If you are having difficulty obtaining records, carefully document your attempts. For phone conversations, note the date, time, and duration of the call; note the complete name of the employee of the foreign financial institution with whom you speak. For correspondence, make a photocopy of all correspondence to and from the foreign financial institution. We recommend using a delivery or postal service that provides delivery confirmation or a return receipt for all correspondence sent to foreign financial institutions. Our experience with offshore cases in recent years has shown that taxpayers are ultimately successful in retrieving copies of statements and other records from foreign financial institutions.
If you’re not able to get records, you’re probably not trying hard enough. We’ve had clients even resort to making a trip abroad to visit the financial institutions in person to obtain records.
What happens if the IRS rejects your streamlined domestic offshore filing?
It is very rare for a streamlined filing to be rejected. Although it has never happened to us, we have seen it happen. Some situations that can lead to a rejection are:
- Using the wrong form for the certification
- Incomplete or missing narrative
- IRS had previously audited the taxpayer
If the streamlined application is rejected, the taxpayer will not be able to apply to the traditional voluntary disclosure program. In some cases, the IRS will allow taxpayers to cure mistakes on the original streamlined filing. Ultimately, if the IRS rejects the non-willful certification, the taxpayer forfeits the protection of the streamlined program and their tax returns are open for assessment of tax and penalties.