Delinquent filing options for international tax reporting

A general rule of life is to plan ahead and be prepared. Try as we may, we all make mistakes and it can be hard (impossible) to prepare for everything. This concept is particularly true when it comes to taxes - as such mistakes are not so easily or cheaply forgiven.

This article is going to talk about what your options are when you fail to file one of the "international" forms as provided below.

• Form 5471 "Information Return of U.S. Persons With Respect to Certain Foreign Corporations"
• Form 8858 "Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)"
• Form 8865 "Return of U.S. Persons With Respect to Certain Foreign Partnerships"
• Form 8938 "Statement of Specified Foreign Financial Assets"
• Form 114 "Foreign Bank Account Report ("FBAR")"

(I intentionally left out the foreign trust and gift Forms 3520 and 3520A as they deserve their own independent attention…to be continued)

This article is not to determine whether you have one of these filing requirements but, rather, to look at your options for rectification when you fail to file a required form.

Why Missed Filings Lead to Major IRS Penalties

All of the relevant international forms above come with a minimum $10,000 penalty per year, per form where it is delinquent (i.e., not filed) or considered substantially incomplete. The penalty can get worse if there are criminal or fraudulent charges as well as some other nuances but the general rule for these forms is $10k.

What's worse (or equally bad at least) is that if a taxpayer fails to file one of these forms the IRS has no time limit to examine or assess tax on the return until the necessary information is provided. In tax terminology, this means that the IRS has no statute of limitations related to the return. So theoretically they could come back decades later and impose the said penalties.

Steps to Regain Compliance and Minimize Penalties

So what do we do with this problem. Of course there is always playing the "audit lottery" and just hoping you don’t get caught. This is a dangerous option and not what I would advise. The goal is to get you back into compliance so you can sleep at night and limit the imposition of penalties in the process.

The three options below are generally what I provide to clients in this situation.

1. Streamlined Filing Procedures

This is an IRS program opened in 2012 as part of an effort to encourage U.S. individual taxpayers with undisclosed foreign assets to come into compliance. Initially, these procedures were only available to non-residents. In 2014, the IRS significantly expanded the program to include both U.S. residents (Streamlined Domestic Offshore Procedures) and non-residents (Streamlined Foreign Offshore Procedures), and also made the eligibility criteria more accessible. "Non-residents" will typically include expats even if you are still a US citizen.

For both the domestic and foreign programs, it requires 6 years of FBARs and 3 years of the most recent delinquent tax returns. Taxpayers must complete and submit Form 14654 (for residents) or Form 14653 (for non-residents), certifying that their conduct was non-willful as part of the overall filing.

Importantly, it is only available to taxpayers who can certify that their failure to report foreign assets, income, or file necessary forms was due to non-willful conduct (i.e., it was an inadvertent mistake or due to lack of understanding). Additionally, you cannot have already been contacted by the IRS about the delinquent information returns.

One important difference between the foreign and domestic procedures is that for US residents, there is a 5% miscellaneous offshore penalty on the highest balance in the unreported foreign assets over the past six years. For expats and non-residents, there is no such penalty.

This is the most conservative option and usually my starting place assuming that you qualify.

2. Delinquent International Information Return Submission Procedures ("DIIRSP")

Your next option may be the DIIRSP. This is typically the option when you do not qualify for the Streamlined filings procedures for some reason or maybe you are a US resident and want to take your chances and avoid the 5% miscellaneous offshore penalty.

To file under this method, you would submit the original or amended tax returns with the required international forms for each open year. Additionally, you would include a statement with an explanation of why the delinquency was due to reasonable cause and not due to willful neglect.

Reg. Sec. 301.6651-1(c )(1) provides that a failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship.

The point with this one is that the case for reasonable cause can be higher bar to pass then the case for non-willfulness under the Streamlined approach.

Delinquent FBAR Filing Procedures

The FBAR is actually a form that is filed separately from your tax return. So it is possible that you only need to correct your FBAR and the overall tax return is fine. In that case, these procedures may be for you.

These procedures are intended for taxpayers who failed to file due to non-willful conduct, such as oversight or misunderstanding, and who had no intention of evading taxes or concealing income. The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.

To comply, taxpayers must file all delinquent FBARs electronically using the BSA E-Filing System. Although not mandatory, it is encouraged to include a statement with the FBAR submissions explaining the reason for the delinquency and certifying that the failure to file was non-willful. Submissions should be made as soon as the taxpayer realizes they have not filed.

Conclusion

If you come to find out that there are certain international filings that you missed, the point here is that there are options but you are better off not waiting around as it can hurt your argument for penalty relief. Deciding which option to take is a discussion you should have with a qualified accountant or attorney with experience in this area.