IRS Provides Potential Amnesty for Certain US Taxpayers with Offshore Income and Assets

On June 18, 2014 the IRS in IR-2014-73 (http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures) modified its “Streamlined” program for certain US taxpayers who have failed to properly file tax returns or foreign bank account reports (FinCEN 114, formerly TD F 90-22.1) (FBARs), offering the closest thing to a total amnesty practitioners could have predicted. Those that qualify could find it very beneficial; most significantly the program permits the potential waiver of most or all penalties.

Ultimately the determination of whether it is available to those otherwise qualified is based on whether the IRS decides a taxpayer’s past non-compliance was wilful. Depending on how one guesses the Service will come out on that tells taxpayers what they should do; if they feel they can make a good case for non-wilfulness they should embark on this new program, but if not then they might consider either entering the Offshore Voluntary Disclosure Program (OVDP) program, opting out or doing a “quiet disclosure.”

BACKGROUND

For years the Service and Treasury have been on a highly publicised crusade to uncover assets of US taxpayers hidden outside the US, the income from which is not reported, and criminally prosecute those non-compliant taxpayers and those bankers and advisors who accompanied or led them down this path. In this context hidden assets include accounts not reported on FBARs, foreign information returns such as the Form 3520 and, in more recent years, the Form 8938.

Alongside this stick the Service has dangled a carrot of sorts since 2009. Those taxpayers who properly voluntarily offered themselves up could get a virtual “get-out-of-jail-free card,” shielding themselves from criminal prosecution. But, unlike the game Monopoly, freedom is not free; participation in the OVDP (earlier versions were called the OVDI) cost some taxpayers a major portion of those hidden assets through tax payments, special FBAR penalties (now 27.5 per cent or maybe 50 per cent of certain asset values) and the 20 per cent accuracy related penalty and interest. Such is the cost of the certainty of freedom. This is coupled with the FATCA enforcement efforts directed against the foreign banks that, in effect, deputised hundreds of foreign banks to enforce US tax laws and become informants.

As practitioners became more familiar with the intricacies and nuances of this program they and their clients have gotten comfortable with alternative strategies, including “quiet disclosures” and opt outs.

Quiet disclosures are an attempt to discretely file late returns and forms without exposure to the OVDP penalties or criminal prosecution. This might slip through the audit web or it might not; the Service has said publicly that they are on the lookout for this and recently got significant public relations mileage out of a case where they (and ultimately a jury) came down particularly hard on a taxpayer out of Florida.[1] Opting out is an alternative that might be considered by a taxpayer who believes he or she is not at risk of criminal sanctions and can withstand a full audit.

As it turned out, given the typical fact patterns and relatively low revenues of the opt out cases on the one hand and the increased need for personnel to run these lengthy exams on the other, the Service was committing a disproportionately large amount of resources and, with the exception of cases like Zwerner, not getting anything like the revenues they get from the quicker OVDP cases or the explosive press they get from the criminal prosecutions.

The Service has recognized that there are clearly those who fall within the technical definition of non-compliant taxpayers but who, for one reason or another, have found themselves in that position without a wilful intent to avoid compliance. Thus, in 2011 they began a “Streamlined” program to allow non-wilfully non-compliant non-resident US taxpayers to come clean with far less exposure than otherwise available. But, given limiting definitions, this class turned out to be so small as to provide no measurable relief to the Service, still overwhelmed by not only the large number of OVDP participants but the even more time consuming opt outs. Clearly a better crafted Streamlined program would absorb many of those otherwise opting out, freeing Service personnel to pursue bigger game. And that is what we got on June 18, 2014

THE 2014 STREAMLINED PROGRAM

Eligibility Criteria

If the OVDP is for willfully non-compliant individuals who now wish protection from criminal prosecution and opting out is for those who, notwithstanding their failure to file returns, are comfortable they are not exposed to criminal prosecution and are willing to roll the dice on a body cavity audit and the potential array of income tax non-compliance penalties to avoid the 27.5 per cent of asset value “miscellaneous penalty,” the Streamlined Program is for those who know and can certify, if necessary, non-wilfulness, have not committed tax fraud and otherwise meet the eligibility requirements.

(For a helpful guide through the eligibility requirements see the flow chart below, if you are having problems viewing the chart, please click here)

The Streamlined Program is actually two programs with a common starting point, the Streamlined Foreign Offshore Procedures for those US taxpayers[2][2] who are non-residents and fit into the program and the Streamlined Domestic Offshore Procedures for those residents who qualify. For non-residents this can mean no penalties whatsoever; for residents the penalty can be a fraction of that to which they might otherwise find themselves subject.

Whether resident or not, each have several eligibility criteria to meet but it all starts with one litmus test: was the non-compliance wilful? Lack of wilfulness, we are told in the IRS announcement, means negligence, inadvertence or mistake or a good faith misunderstanding of the law.[3] Recent cases have determined that reckless disregard and wilful blindness is each an indicator of wilfulness.[4] Where the line is drawn between wilful and non-wilful is not clear.

Perhaps a depositor with a bank identified as a criminal actor under FATCA might imply wilfulness, certainly where there is evidence in the account record for evasive actions like a promise not to tell the U.S. government about the account. Perhaps an inheritor of a foreign account or one named to a foreign bank account by a parent without his own knowledge will be deemed non-wilful. Perhaps one born in the US but resident in a foreign country for the bulk of her life might never even think she has a US filing obligation and might be deemed non-willful. Certainly greyer areas exist.

In order to invoke this criterion, the taxpayer must certify under penalties of perjury that “[m]y failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-wilful conduct.” (A draft of the requisite form for the non-resident is at http://www.irs.gov/pub/irs-utl/CertNonResidents.pdf; for the resident it is at http://www.irs.gov/pub/irs-utl/CertUSResidents.pdf.) Don’t be wrong about wilfulness or not only will the taxpayer be rejected from the program but OVDP with its criminal protections will no longer be available and there might possibly be an additional charge of perjury.

Other criteria include:

• getting in their door before the Service or Justice Department is knocking on (or in) yours; there cannot be an active civil audit of any issue, not just the offshore issues, and there cannot be an active criminal investigation. A pre-clearance letter is a necessary first step as anything sent to the government during an investigation would be an admission;

• not being in the OVDP; being in the OVDP or being in the Streamlined Program are mutually exclusive…forever. Enter the Streamlined Program and kiss the possibility of OVDP and its shield against criminal prosecution goodbye; enter the OVDP after June 30, 2014 and the Streamlined Program is not available. However those in the OVDP before July 1, 2014 and not yet having executed a closing agreement are in a small club, able to test the OVDP waters and then jump to the Streamlined program. What’s unclear is if there is or will be any time limit to this choice.

But…if one does qualify, the benefits can be huge. It is a virtual amnesty from most if not all penalties for past non-wilful indiscretions and apparently a cost the government is willing to bear in order to return non-filers back onto the grid where their compliance can be monitored going forward.

Benefits for Residents (the Streamlined Domestic Offshore Procedures)

In addition to the eligibility criteria, resident individuals (citizens or permanent residents) or estates otherwise meeting the criteria must have filed a Form 1040 or 1041, as the case may be, for each of the three prior years for which a filing deadline (as extended) has indelibly passed and file an amended Form1040/1041 for each of those years along with all international information returns (eg, Form 3520, Form 5471 and Form 8938) even if such form would otherwise be filed separate from the return. Any retirement income deferral elections can be made retroactively. Also any unfiled FBARs that have not been filed over the prior six years must be filed. Finally any unpaid tax going back three years, interest and a “miscellaneous” offshore penalty must be paid upon entrance into the program.

The calculation of the penalty is different than its cousins in the OVDP. Whereas in the other programs the penalty is based on the highest value and highest account balances of all assets to which the penalty applies over the entire review period (six years or eight depending on which program), the Streamlined Program for residents looks to the highest aggregate year-end balances and account values over the time period for each relevant foreign financial asset. What this seems to mean, but is far from clear, is that it is an asset by asset review. For instance, for each asset that was excluded from an FBAR one would take the highest year-end value of that particular asset over the prior six years and apply a five per cent penalty.[5] If an asset was erroneously excluded from a Form 8938 or the gross income from an asset was not reported (even if the asset had been disclosed), then take the highest year-end value of that particular asset over the prior three years and apply a five per cent penalty. Then aggregate all such five per cent penalties. Notably, the calculation base for this penalty is limited to the undeclared assets rather than all of one’s foreign financial assets (whether required to be declared or not) that may have been related to the unreported income or assets, as would occur under the OVDP. However you cut it, this will be well below the total of the 20 per cent accuracy related penalty plus the 27.5 per cent penalty otherwise payable within the OVDP; this may even be a better deal than opting out simply from the perspective of costs and fees to get through the audit.

Speaking of audit, participants in the Streamlined Program are told that they need not worry that participation will necessarily lead to an exam or other penalties. The only caveat is that the returns are subject to audit in the normal return pool as would any other return that is filed that year. That presupposes that entrance in the Program is not an indicator on the DIF score or otherwise a red flag. Also, if the initial return was filed fraudulently or there are independent items on the return that could generate a deficiency or a penalty then those taxes and penalties can be assessed.

Benefits for Non-Residents (the Streamlined Foreign Offshore Procedures)

If residents have it good, non-wilfully non-complaint non-residents must be dreaming. If one can pass through the non-residency hoop and has non-wilfully “failed to report the income from a foreign financial asset and pay tax as required by US law, and may have failed to file an FBAR . . . with respect to the foreign financial asset. . . ” (emphasis added) then they have no penalties—zip…zero…nada—of any kind for anything that appears on the return. They just need to (1) file any delinquent Form 1040/1041 from the prior three years with any delinquent international information return, (2) file any delinquent FBAR from the prior six years and (3) pay all outstanding taxes and interest for the prior three years…even if they have been failed to pay tax for many more years than three.

Interestingly, although these programs have always been about unpaid taxes in the end of the day, it has always been bootstrapped by the investigation of the failure to disclose foreign financial accounts on the FBAR. Yet these non-resident Streamlined cases might involve only Form 1040 non-filing and might not have even involved a failure to file the FBAR.

As with the Domestic program, audits are not automatic but can happen in the normal course of events and deficiencies and penalties can arise for issues developed by the audit other than from the non-filings covered by the program.

Determining Non-residency

Determination of non-residency should not be confused with the rules of section 911 (the foreign earned income exclusion) that are so familiar to expatriate U.S. taxpayers. A US taxpayer is not a resident of the US if (1) he or she is physically outside the US for 330 full days in any one or more of the most recent three years for which the US tax return due date (as extended) has passed and (2) in that time frame the taxpayer did not have a US abode. The IRS, in an FAQ issued in October, 2014 states that:

[t]he reference to IRC § 911 and its regulations is only to the parts of those authorities that define “abode,” which are found in IRC §911(d)(3) and Treas. Reg. §1.911-2(b).  Non-residency for purposes of the Streamlined Foreign Offshore Procedures is defined in those procedures, and not in IRC §911 and its regulations.[6]

Physically Outside the US

To be physically outside the US seems self-explanatory and likely poses no real issues except for those on the cusp of meeting or failing to meet this rule. One might be tempted to look for guidance to the regulations under section 911 notwithstanding the admonition in the recent FAQ, but that section refers to days “present in a foreign country or countries,” whereas the rules interpreting “days present in a foreign country” treat days on the ground different than days flying over a foreign country, for instance, which would not seem to matter to those concerned only with days outside the US.

Also, the 330 day rule of section 911, which does not apply to this program, refers to a rolling 365 day period, and is not slavishly tethered to the calendar year. Accordingly, it seems the only way to make the rule work for the Streamlined Program would be to interpret the 330 day rule as 330 days out of a calendar year, ignoring section 911.

No Abode in the US

The question of where and whether one has an abode is the only area of the program that looks for guidance to section 911. What appears simple is not always so. Clearly, one with an abode in the US is a resident. The Service directs us to Publication 54, a dog eared copy of which (or the digital equivalent) is in the possession of every US expat, for an explanation of the term abode in this context.[7]  

“Abode” has been variously defined as one's home, habitation, residence, domicile, or place of dwelling. It does not mean your principal place of business. “Abode” has a domestic rather than a vocational meaning and does not mean the same as “tax home.” The location of your abode often will depend on where you maintain your economic, family, and personal ties.[8]

The guidance goes further to clarify that section 911 and its regulations would allow that “neither temporary presence of the individual in the United States nor maintenance of a dwelling in the United States by an individual necessarily mean that the individual’s abode is in the United States.”

A note on return filing deadlines

Throughout this Program timeframes are defined in terms of the last day (as extended) for filing a return. For the Form 1040, that will be April 15 for some taxpayers and October 15 for others. Still others will have a June 15 testing date. For the FBAR, that will be June 30. Advisors need to be cognizant of these dates in relation to what they tie to. For instance, for 2013 a taxpayer outside the country qualified to file on June 16, 2014 who satisfies the non-residency rule for 2010 but not for 2011, 2012 and 2013 (remember, this need be met for only one of the three years) would want to keep the filing date for 2013 from passing as long as possible in order to file for the Foreign Offshore Program using the 2010 non-residency dates. Had June 16, 2014 come and gone for that taxpayer without extension he cannot enter the Foreign Offshore Program. A similar analysis might benefit a taxpayer in the Domestic Offshore Program depending on how his year-end account values look for the relevant years for purposes of determining the penalty; in some cases letting a year pass helps, in others it could be devastating.

For the right taxpayer the Service has exhibited unusual generosity by waiving most if not all penalties and limiting the liability for past taxes to three years. But a detailed analysis is required to be certain one is the right taxpayer as a mistake can be terribly costly.

[1] U.S. v. Carl Zwerner, Civ. No. 13-cv-22082 (S.D. Florida, May 28, 2014): jury verdict for 150% of account values (50% for each of 3 years).  The case settled after trial for a lesser figure.

[2] Even non-citizen aliens are included in this group if they have a U.S. tax obligation and fail the substantial presence test for one of the prior three years.

[3] See, e.g., Cheek v. U.S., 498 U.S. 192 (1991); Income Tax Reg. 301.6651-1(c).  

[4] U.S. v. Williams, 489 Fed.Appx. 655, 2012 WL 2948569 (C.A.4 (Va.)), 110 A.F.T.R.2d 2012-5298, 2012-2 USTC P 50,475 (4^th Cir. 2012); U.S. v. McBride, 908 F.Supp.2d 1186, 110 A.F.T.R.2d 2012-6600, 2012-2 USTC P 50,666 (D. Utah 2012)

[5] Although the penalty is based on year-end values, the FBAR and Form 8938 filing requirements are based on thresholds relative to highest values during each year. An analysis must first look to the entire year to determine if a filing is mandated and then, if so, the year-end value for the penalty calculation.

[6] http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures-for-U-S--Taxpayers-Residing-Outside-the-United-States-Frequently-Asked-Questions-and-Answers

[7] This author finds it galling that the Service continues to lazily refer taxpayers to publications and then take litigating positions that such reliance is improper…and the Tax Court buys it no less.  See, eg, Bobrow v. Commissioner, T.C.Memo 2014-21 (January 28, 2014).

[8] Pub. 54, page 12. The concept of abode (or in New York, “permanent place of abode”) often comes up in the context of state residency (e.g. those who prefer to be state tax-free in Florida rather than state taxed in New York). See Gaied v. New York State Tax Appeals Tribunal, 22 N.Y.3d 592, 6 N.E.3d 1113, 983 N.Y.S.2d 757, 2014 NY Slip Op 01101 (2/18/2014).

David S. Neufeld, J.D., LL.M., AEP, TEP
David S. Neufeld, J.D., LL.M. (Taxation), AEP, TEP, has practiced law for 30 years, advising individuals around the world on sophisticated wealth planning (encompassing income tax, estate tax, residency tax planning, asset protection, and the legal aspects of insurance and investment planning) and fiduciary due diligence.  He is internationally recognized for his work with “private placement life insurance” and captive insurance companies, as well as a pioneer in domestic and offshore limited liability company law, including as author of the Caribbean island of Nevis’ LLC ordinance and its captive insurance company amendments. David has been honored as the recipient of the New Jersey Bar Association “Advocacy Award,” is rated AV-Preeminent by Martindale-Hubble, its highest rating, is listed in New Jersey’s Top Rated Lawyers, and has been repeatedly named to the Super Lawyers list.  David is a member of the Society of Trust & Estates Professionals (STEP) among other organizations, has published scores of articles and has spoken around the world on the areas of his expertise, as well as having been featured in BusinessWeek, Medical Economics, The Wall Street Journal and CNBC, among others.