One of the difficult aspects of U.S. tax law for foreign persons to understand is how they become accidental U.S. tax residents. Even those here without a Green Card on non-immigration visas, can be required in any given year to file a U.S. tax return on the regular Form 1040 (as opposed to Form 1040 NR) reporting and paying U.S. tax on worldwide income, not just U.S. source income; and, required to file information returns about non-U.S. based assets and income. It happens if they are present in the U.S. for too many days over a three-year look-back test period. Under what is called the substantial presence test a foreigner in any calendar year will be treated as a resident alien (i.e., U.S. tax resident) if:
- He or she is present in the U.S. for at least 31 days in that year; and,
- The sum of days present in the U.S. for that calendar year plus 1/3 of the number of days for the prior calendar year and 1/6 for the days in the year before that, exceed 183 days (IRC Sec. 7701(b) (3).
Many non-U.S. citizen-non-Green Card holders arrive in the U.S. every day on various non-immigration missions, including to visit relatives, vacation, conduct business, etc.
These foreign visitors almost always come from countries that tax only domestic-sourced income of its citizens, no less income of non-citizen visitors. By and large their countries of origin do not impose citizen tax filing obligations on foreign visitors regardless of the length of stay. Thus, foreign guests of the U.S. are often unaware of that consequence should they dally too long on U.S. soil.
It is bad enough that they then become obligated to file U.S. resident fax returns (Form 1040), that they may have already filed non-resident returns if they earned income here and now must amend those returns and file Form 1040 instead. That process may involve many tax years and cost a bundle. But, far more troublesome and downright scary is the specter of becoming responsible for filing the Bank Secrecy Act Form TD F 90-22.1 (FBAR) and IRS foreign related Forms like Form 8938 and Form 3520. For not timely filing these forms carries the risk of substantial and even draconian penalties that can exceed many times over the value of the foreign assets involved.
Most of these accidental residents are clearly not tax criminals, although they may owe tax in the U.S. on their amended returns. Absent the potential for calamitous civil penalties for failure to file the FBAR, these taxpayers would simply file the amended returns and request waiver of penalties for having reasonable cause (ignorance of the law) for not having filed timely FBARS and other IRS foreign related forms. But, IRS states in its published Frequently Asked Questions under the 2012 OVDP, that those having unreported foreign related income are expected to enter the OVDP and that the agency will be on the lookout for those seeking to bypass this process through quiet disclosures by simply filing amended returns. Of course, the accidental residents could enter the program and opt-out; but, this practice is most helpful to those fearing criminal prosecution but believing a penalty lower than the OVDP’s 27.5% FBAR penalty would be more appropriate. Most accidental residents who’d file late FBARS are not likely criminal targets. But, IRS has not clearly elucidated how its civil penalty mitigation guidelines and reasonable cause determinations will be administered. Thus, there is uncertainty about how severe will be the penalty regime outside of the OVDP. A small number of Opt-out cases have resulted in surprisingly low penalties; but, this anecdotal evidence is scant and unreliable.
IRS has announced relief from the hardship of going through the arduous OVDP process for some taxpayers including:
- U.S. citizens living abroad who are classified as “low-risk,” and have nominal U.S. tax liabilities.
- U.S. taxpayers who’ve not filed FBARS but who have reported all income and paid the tax on such income.
No such relief has been provided to accidental residents who become responsible for filing FBARS solely by virtue of the substantial presence test. Yet, these taxpayers should have a strong “reasonable cause,” argument because:
- Often the tax preparer, if a Form 1040 NR was filed, will not have inquired about how many days they’ve been present in the U.S. during the testing period.
- Often they are not aware of the FBAR filing requirement even if they are aware of the need to count days in the U.S.
- Often they will owe little tax in the U.S. due to Treaty benefits or foreign tax credits.
- Age, education, health, experience and other factors may suggest reasonable cause for not having filed timely.
For a complete discussion of IRS FBAR penalty procedures see IRM 4.26.16, Report of Foreign Bank and Financial Accounts at www.irs.gov/irm/part4/irm_04-026-016.html.
For IRS standards for relief from other international penalties see IRM 20.1.1, Penalty Handbook at http://www.irs.gov/irm/part20/irm_20-001-001r.html.
I some cases, however, the resident alien may not be completely accidental or may have acted to conceal his or her foreign activities from U.S. authorities.
In counseling accidental residents and other resident aliens, I will carefully consider all of the facts and circumstances before recommending how to proceed: whether to enter the OVDP, enter and opt-out or simply file amended returns and FBARS with the IRS, attaching a statement requesting waiver of FBAR penalties with reasons why the taxpayer believes there exists reasonable cause for late filing.
© 2013 by Robert S. Steinberg, Esquire
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