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Kevin Mullin: Ramifications of U.S. Crackdown on Foreign Tax Havens
By Kevin Mullin, JD, CPA, LLM (Tax)
Compelled by the current recession to raise revenues from all quarters and emboldened by reports of thousands of U.S. taxpayers with unreported foreign accounts, the current administration is moving to crack down on rogue U.S. taxpayers with investments stashed abroad.
While the UBS scandal has attracted the most publicity, leading to the discovery of thousands of unreported accounts held by Americans, Switzerland is not the only focus. The Internal Revenue Service recently announced the opening of its first criminal investigation office in Panama and the agency is targeting far-flung jurisdictions which permit bank-secrecy, as well as tax havens around the world.
This has a direct impact on the thousands of U.S. taxpayers investing in real estate outside of the U.S., who often use a foreign bank, financial account, corporation, partnership or trust to take title to the property. They provide a convenient cash management account from which to make such investments or meet expenses of ownership. But they don’t necessarily shield owners from IRS scrutiny, as the U.S. account-holders of UBS have found out.
Most U.S. taxpayers with international investments are likely aware that they are required to declare income earned from all sources located anywhere in the world, but many are not aware of the extensive reporting requirements on foreign accounts and investments, regardless of whether they generate any taxable income. Nor are many investors aware of the draconian penalties that attend their non-compliance.
Besides the obvious obligation to report income, there are extensive requirements for the owners (or constructive owners) of such accounts to report transfers and ownership of foreign corporations and trusts, as well as ownership or signature authority over foreign financial accounts.
While many of these reporting requirements have been on the books for years, the focus of the U.S. on enforcing them has been, until recently, pretty half-hearted. But now the IRS is pursuing this arena with vigor.
The administration’s efforts culminated earlier this year with amnesty program for U.S, taxpayers with unreported income from foreign accounts--an admission that providing amnesty might bring new sources of revenue, which would otherwise simply burrow deeper underground. The amnesty program allowed qualified U.S. taxpayers with unreported income from foreign accounts to generally be relieved of criminal sanctions, although they would still be subject to back taxes, interest and civil penalties.
The announcement of the amnesty program, which ended on Oct. 15, triggered an avalanche of disclosures that have overwhelmed IRS staff. In its wake, a plethora of proposed legislation has been introduced aimed squarely at bringing a spotlight to the offshore arena.
Hereafter, the gloves are off and U.S. taxpayers who are discovered to have unreported income from foreign accounts should not expect a conciliatory attitude on the part of the IRS. For those U.S. taxpayers with foreign-source income and financial accounts, the requirement for obtaining competent legal counsel and accounting advice could not be more critical to their overall tax compliance efforts.
The following is a summary of the reporting requirements and potential civil penalties that could apply to a taxpayer, depending on their particular facts and circumstances. Note that serious criminal penalties with financial, as well, as incarceration possibilities are also possible for willful infractions. And if the IRS discovers non-compliance prior to the taxpayer providing information on a voluntary basis, the opportunity of pleading ignorance or inadvertence will likely fall on deaf ears and the likelihood of a criminal investigation increases.
A short summary of some of the compliance requirements:
- A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). U.S. citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account. Non-willful violations are subject to a civil penalty of not more than $10,000 for each account and for each year that the account is unreported.
- A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a U.S. person, transfers of property from a U.S. person to a foreign trust and receipt of distributions from foreign trusts. This return also reports the receipt by U.S. persons of gifts from foreign entities. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
- A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by U.S. persons with various interests in and powers over those trusts under section 6048(b).The penalty for failing to file each one of these information returns or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the U.S. person.
- A penalty for failing to file Form 5471, Information Return of U.S. Person with Respect to Certain Foreign Corporations. Certain U.S. persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
- A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
- A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. U.S. persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and 10 percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Kevin Mullin is a tax attorney with more than 20 years experience in international tax and estate planning services. With offices in Denver, Co., and McLean, Va., he can be reached at www.intl-taxlaw.com.
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