For various reasons, many U.S. citizens residing overseas fail to file U.S. income tax returns. Commonly, the non-filing may be due to the mistaken belief that no U.S. tax return is required with respect to income earned overseas. However, in most cases, U.S. citizens — regardless of their domicile or the source (U.S. or foreign) of their income — are required to file income tax returns.
Regrettably, the failure to file a U.S. tax return for U.S. citizens residing overseas can have significant and often times severe U.S. tax consequences. As an initial matter, the IRS can assert tax, penalties, and interest against a taxpayer for any year or years in which a return has been filed—i.e., the statute of limitations remains open indefinitely until the return is, in fact, filed. As another matter, U.S. citizens residing overseas often engage in certain business activities or other conduct which requires separate information return reporting.
For example, assume a U.S. citizen conducted his or her business through a foreign corporation. Generally, the U.S. citizen would be required to file a Form 5471 for each year that he held an interest in the foreign corporation. A failure to file a Form 5471 can subject the U.S. citizen to penalties of $10,000 per year the form is not filed with the IRS. Assume also that the U.S. citizen held a foreign bank account in excess of $10,000 (a common scenario for those overseas). Generally, the U.S. citizen would have a separate reporting obligation – known as an FBAR – for each year he held the foreign account. In this instance, the IRS could assert that the U.S. citizen is liable for Title 31 penalties equal to the greater of $134,806 or 50% of the highest account balance for each year the FBAR was not timely filed.
Fortunately, the IRS has a program in place to assist U.S. citizens in getting back into compliance with their U.S. tax obligations. Moreover, this program permits the U.S. citizen to escape many of the penalties discussed above. The program is referred to as the Streamlined Foreign Offshore Procedures, and it is the subject of this Insight.
Streamlined Foreign Offshore Procedures
There are a litany of requirements to enter into the Streamlined Foreign Offshore Procedures. These include:
- The taxpayer must be an individual taxpayer, which can include an estate of an individual taxpayer.
- The taxpayer must certify that the failure to report all income, pay all tax and submit all required information returns (including, but not limited to, FBARs) was due to non-willful conduct.
- The IRS must not have initiated a civil examination (e., audit) of the taxpayer’s tax returns for any tax year, regardless of whether the examination relates to undisclosed foreign financial assets. Similarly, a taxpayer under criminal investigation by IRS-CI is also ineligible.
- The taxpayer must have a valid Taxpayer Identification Number (TIN). Generally, this is the taxpayer’s SSN.
- The taxpayer must meet the non-residency requirement.
Although all of these requirements are necessary to enter into the program, two of them are noteworthy: the non-willful requirement and the non-residency requirement.
To meet the non-willful requirement, the taxpayer must provide a narrative of relevant facts to the IRS, under penalties of perjury, explaining the taxpayer’s claim that the conduct was non-willful. For these purposes, non-willful generally means conduct that is negligent, inadvertent or by mistake and that is the result of a good faith misunderstanding of the requirements of the law. In the event the narrative fails to adequately support the non-willful claim, the IRS has the ability to challenge the claim and remove the taxpayer entirely from the program. Notably, in these instances, the IRS has been armed with a lot of useful information related to the unfiled returns simply through the submission itself.
For U.S. citizens to meet the non-residency requirement, the U.S. citizen must be able to show that in any one or more of the most recent three years for which a U.S. tax return due date has passed that the person did not have a U.S. abode and was physically outside the United States for at least 330 full days. Neither temporary presence in the United States nor maintenance of a dwelling in the United States will necessarily bar the taxpayer from meeting the non-residency requirement.
B. Filing under the Streamlined Foreign Offshore Procedures
If the U.S. citizen meets all of the requirements above, he or she must follow certain filing procedures to enter into the program. First, the U.S. citizen must file delinquent or amended tax returns, together with all necessary foreign information returns (e.g., Forms 5471, 8938, etc.), with respect to each of the most recent 3 years for which the U.S. tax return due date has passed. Second, for each of the most recent 6 years for which the FBAR due date has passed, the U.S. citizen must file delinquent FBARs (FinCEN Form 114, previously Form TD 90-22.1). Third, the U.S. citizen must generally remit the full amount of tax and interest due in connection with the tax return filings.
Complying with all of the eligibility and filing requirements brings with it some significant benefits. According to the IRS:
A taxpayer who is eligible to use these Streamlined Foreign Offshore Procedures and who complies with all of the instructions . . . will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties. Even if returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to failure-to-file and failure-to-pay penalties or accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original tax noncompliance was fraudulent and/or that the FBAR violation was willful.
For U.S. citizens who are not in compliance with past U.S. filing and reporting requirements, the Streamlined Foreign Offshore Procedure remains a good avenue to seek relief with the IRS. However, the issue of whether the conduct was willful or non-willful often takes center stage and requires careful consideration and analysis, particularly with respect to the non-willful narrative that must be submitted as part of the IRS submission. For U.S. citizens who do not qualify for streamlined relief due to willful conduct, they may nevertheless find some refuge in the IRS’ voluntary disclosure program, which has been discussed in a prior Insight and Firm podcast.
Freeman Law’s international and criminal tax attorneys have advised hundreds of taxpayers in streamlined filings and voluntary disclosures. Our team can help businesses and individuals manage critical tax risks and make sense of complex international tax compliance rules. Schedule a consultation or call (214) 984-3000 to discuss your streamlined filing or voluntary disclosure concerns or questions.