Taxpayers with interests in foreign financial assets, financial accounts, and/or foreign trusts may have certain tax reporting obligations with the IRS. For example, taxpayers with a financial interest in or signature authority over foreign financial accounts with an aggregate value of over $10,000 at any time during the calendar year must file a Report of Foreign Bank and Financial Account (“FBAR”). 31 U.S.C. § 5314. The IRS has the authority to impose serious penalties on taxpayers for failing to meet their international reporting obligations. The most common international reporting penalties are discussed below.
Taxpayers who have an aggregate value of over $10,000 in a foreign financial account at any time during the year must file an FBAR. See 31 U.S.C. § 5314. The IRS will impose civil penalties for failing to file an FBAR (and taxpayers also faceserious criminal fines in the context of willful violations). See 31 U.S.C. § 5321. Specifically, the IRS can impose a $10,000 penalty for each non-willful violation of § 5314 or, for willful violations, a penalty that is the greater of $100,000 or 50% of the balance in the account at the time of the violation. Furthermore, the FBAR penalty may apply to each violation. See 31 U.S.C. § 5321(b). In other words, the penalty can be imposed with respect to each unreported account for multiple years. Practitioners should take special note that this can result in seemingly harsh and inequitable penalties against taxpayers. For example, a jury held a taxpayer liable for a total of $2,241,809 in willful FBAR penalties over three years with respect to an offshore account that had a maximum balance of $1,691,054. See U.S. v. Carl Zwerner, Civil Docket Case #1:13-cv-22082-CMA (S.D. Fla. 2014). The government and the taxpayer then settled for around $1.4 million in penalties aloneafter the jury verdict. Thus, practitioners should ensure that taxpayers timely file FBARs. Taxpayers who have existing reporting violations may need to consult an attorney regarding disclosure programs offered by the IRS, such as the streamlined compliance procedure or voluntary disclosure program, to mitigate penalty exposure prior to discovery/assessment by the IRS.
The Internal Revenue Code also requires taxpayers with interests in specified foreign assets or accounts to file certain information returns. See e.g. 26 U.S.C. § 6038D. Among the most common information returns required are Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations; Form 8865, Information Return of U.S. Persons With Respect to Certain Foreign Partnerships; Form 8938, Statement of Specified Foreign Financial Assets; and Form 3520 and 3520-A, Information Return of U.S. Persons With Respect to Certain Foreign Trusts.
The IRS can impose a penalty for a failure to file a Form 5471/8865 that equals $10,000 for each annual accounting period of each foreign corporation/partnership. 26 U.S.C. § 6038(b)(1). Furthermore, the IRS can assess “continuation penalties,” which are additional penalties for the failure to provide the required information within 90 days of the notification by the IRS that such information is required. 26 U.S.C. § 6038(b)(2). Specifically, the IRS can assess a $10,000 penalty per month for each foreign corporation/partnership during which the failure continues after the 90-day period has expired, up to a maximum of $50,000 for each failure. Id. Additionally, the IRS can reduce foreign tax credits of a taxpayer for failing to file a Form 5471/8865 and/or assess another penalty (10% of the value for nonintentional violations and no limitation for intentional violations) for failure of U.S. persons to report transfers of property in excess of $100,000 to a foreign corporation/partnership. 26 U.S.C. § 6038(c); 26 U.S.C. § 6038B.
Similarly, taxpayers with specified foreign financial assets of more than $50,000 (single or married filing separate) or $100,000 (married and filing jointly) at the end of the year, or specified foreign financial assets that exceed $75,000 (single or married filing separate) or $150,000 (married filing jointly) at any time during the year must file a Form 8938. 26 U.S.C. § 6038D. A failure to file a Form 8938 carries the same $10,000 penalty and “continuation penalties” as a failure to file Form 5471/8865. See 26 U.S.C. § 6038D(d)(2). Furthermore, the IRS can assess a penalty equal to 40% of the underpayment (or 75% if underpayment due to fraud) as a result of an underpayment of tax in a transaction involving an undisclosed specified foreign financial asset. 26 U.S.C. § 6662(j)(3); 26 U.S.C. § 6663.
Taxpayers with an interest in certain foreign trusts or foreign gifts are required to report such interest/distributions on a Form 3520 or Form 3520-A. Failure to report transactions with a foreign trust may result in penalties equal to the greater of $10,000 or 35% of the gross reportable amount pursuant to 26 U.S.C. 6677. Similarly, continuation penalties may be assessed for failure to provide the required information after the 90-day period. 26 U.S.C. § 6677(a). A penalty of 5% per month, up to a max of 25% of the total amount, may also be assessed for failing to report a foreign gift. 26 U.S.C. § 6039F. Failure to report ownership interests in a foreign trust with a U.S. owner on a Form 3520-A can result in a penalty of $10,000 or 35% of the gross value of the trusts’ assets. 26 U.S.C. § 6048(b); 26 U.S.C. § 6677.
Practitioners should ensure that taxpayers are in compliance so as to avoid these steep penalties. But taxpayers may avoid these penalties by establishing a reasonable cause defense or making a disclosure under one of the IRS disclosure programs to limit penalty exposure prior to discovery/assessment.
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