Foreign Nationals & Expats
Houston Tax Attorney
- 1 Streamlined Domestic Offshore Procedures
- 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 happens if the IRS rejects your streamlined domestic offshore filing?
Streamlined Domestic Offshore Procedures
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.
Previously, the procedures were only available to filers outside the United States. In 2014 the Streamlined Filing Compliance Procedures were expanded to provide a means for U.S. taxpayers living in the United States to correct tax non-compliance with respect to non-U.S. investments resulting from non-willful conduct.
U.S. taxpayers eligible to use the domestic offshore procedures will file amended returns, together with all required international information returns (Forms 3520, 3520-A, 5471, 5472, 8938, 926, or 8621), for the past three years and will 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 (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) 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
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.
In addition, individuals who have not previously filed their U.S. tax returns are disqualified from using the streamlined domestic offshore procedures. Such individuals should either consider the OVDP (if needed) or file their U.S. tax returns reporting their foreign assets and income through the normal tax return and FBAR filing 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 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.
A foreign financial asset is subject to the 5-percent miscellaneous offshore penalty 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.
A foreign financial asset is also subject to the 5-percent miscellaneous offshore penalty 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.
- 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.
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. For any year in which a foreign financial account was FBAR compliant and (for the most recent three years) in which a foreign financial asset was both Form 8938 and Form 1040 compliant, the amount entered on the form will be zero. 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.
Beneficial ownership required
The Title 26 misc. offshore penalty applies to all reportable but unreported foreign financial assets. However, the penalty is not intended to reach assets in which the taxpayer had no beneficial 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 (i.e., beneficial interest).
In our practice we often come across clients who have foreign financial accounts in which they have legal ownership but no financial 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 ownership over 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.
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 Offshore Voluntary Disclosure Program (OVDP).
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 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. In one interesting situation, a foreign “tax professional” submitted a letter as the certification rather than one of the certification forms that the IRS provides.
- Incomplete or missing narrative
If the streamlined application is rejected, the taxpayer will not be able to apply to the OVDP program. In come 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.
We assist taxpayers who have undisclosed foreign financial assets. Schedule an appointment to see how we can help.