Dealing with Non-Compliance - Options for US persons with Connections to Foreign Trusts

With the first FATCA reports now out of the way for financial institutions, we have highlighted the options available for US taxpayers who are not up to date with their US tax filing requirements, including those who may have missed certain information reporting requirements with respect to interest in non-US trusts.

In such cases the IRS recommends one of two routes for late filing – the Streamlined Filing Compliance Procedures or the Offshore Voluntary Disclosure Program (OVDP).

Choosing the most suitable option is very much dependant on the taxpayer’s facts and circumstances which needs to be fully reviewed in co-ordination with the trustees filing obligations.

The IRS states the following on their website:

Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. The IRS remains actively engaged in ferreting out the identities of those with undisclosed foreign accounts. Moreover, increasingly this information is available to the IRS under tax treaties, through submissions by whistle blowers, and will become more available under the Foreign Account Tax Compliance Act (FATCA) and Foreign Financial Asset Reporting.

Streamlined Filing Compliance Procedures

The most beneficial is the Streamlined Filing Compliance Procedure, effective 1 July 2014.

The streamlined procedures require a Certification that the failure to report income from foreign financial assets, pay all tax due and submit all required information returns in respect of those assets did not result from wilful conduct on the part of the taxpayer.

There are two separate programs for US taxpayers residing outside or within the United States.

1. Streamlined Foreign Offshore Procedures. Under This Procedure, Taxpayers Will Be Required To File:

A taxpayer who is eligible to use these Streamlined Foreign Offshore Procedures and who complies fully with the process will not be subject to any penalties associated with non-compliance.

In order to be eligible to file under this procedure, the following requirements need to be met:

2. Streamlined Domestic Offshore Procedures

Under this procedure taxpayers will also be required to file the tax returns and information reporting outlined above. However, only amended income tax returns can be filed.

A taxpayer who is eligible to use the Streamlined Foreign Domestic Procedures and who complies fully with the process will not be subject to the usual penalty regime, but will be subject to a miscellaneous offshore penalty. This is equal to 5% 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 period.

In order to be eligible to file under this procedure, the following requirements need to be met:

  1. The taxpayer must fail the following non-residency requirement discussed above.
  2. Taxpayers must have previously filed a US tax return for each of the most recent 3 years in question
  3. Taxpayers must have failed to report gross income from a foreign financial asset and pay tax as required by US law, and may have failed to file an FBAR and/or one or more internationa l information returns with respect to the foreign financial asset.

If the above requirements are not met then either the OVDP or a ‘Quiet’ disclosure route should be considered - see below.

Offshore Voluntary Disclosure Program (OVDP)

The 2014 OVDP is directed at those who wilfully failed to meet their US tax obligations or those with a higher risk of being charged with criminal conduct. This is the preferred IRSroute for all voluntary disclosures that do not meet the streamlined criteria.

This program has a fixed penalty structure which is substantial, but in general has a significant reduction in the level of penalties that would be applied in cases where a taxpayer wilfully failed to file tax returns or disclose sources of income. Taxpayers with accounts at named institutions are likely to have an increased penalty of 50%.

Under the OVDP both delinquent and amended tax returns, and all required information reporting, will be required to be furnished for the last eight years on non-compliance.

This process would require the engagement of a US lawyer to enter into the program. The advantage of this route is that taxpayers will have a clear indication of where they stand in terms of penalty exposure. Choosing to go down this route is very much dependant on the taxpayer’s facts and circumstances and needs to be fully reviewed. Where there is a valid reasonable cause basis for not filing the returns, this may not necessarily be the best option.

Information Only Reporting (other than for FBARs)

The IRS has also provided information regarding how to submit late information reports where neither the Streamlined nor the OVDP is required to file delinquent or amended returns.

This procedure requires each late report to be submitted in accordance with the normal instructions, attaching a statement explaining why you are requesting a waiver of penalties under the reasonable cause exception.

Quiet Disclosure

The IRS is aware that some taxpayers have attempted so-called ‘quiet’ disclosures by filing and paying any related tax and interest for previously unreported offshore income without otherwise notifying the IRS. There is far less scope for this approach now as the Streamlined Filing Compliance Procedures have been significantly expanded from their original scope.

A quiet disclosure involves submitting six years’ worth of US tax compliance, and providing a statement of reasonable cause to abate any penalties that the IRS may look to levy. Returns submitted as part of a quiet disclosure are not immune from audit and may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate. However, the option to enter the OVDP still remains open. Any decision made as to how to proceed must take into account the overall situation.

To discuss this article in more detail, please contact your usual Frank Hirth adviser or connect with us by emailTwitter or LinkedIn.

This article has been written for the general interest of our clients and contacts to stimulate further thought and enquiry. It does not contain answers to specific situations and it is therefore essential to treat it as a prompt to take specific advice on any real and particular issues. We believe that the facts as summarised in this article are correct as at the time of going to press in November 2015. If we discover that the article might be read in a way that conveys a misleading impression (whether by tone, content, error or omission) we will make the necessary changes and draw attention to what has been changed once we become aware of the need to do so. We will not be responsible for any action taken by a reader who relies on the article but does not seek further advice to answer any specific query.

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