From every bad dream there is an awakening. Morning brings you back to sanguinity.For those with offshore activities who are out of compliance with U.S. tax law, however,  morning will not come unless and until they undertake some course of action to cure the malady. The Panama Papers scandal demonstrates that there is no secret that cannot be uncovered.  Someone always knows and someone is bound to be snooping and hacking these days.  So, using the ostrich defense of sticking your head in the sand and hoping the problem will disappear is increasingly dangerous.

What corrective action is required depends on what kind of non-compliance is presented. Non-compliance can involve:

• Failing to report income from offshore activities such as foreign bank account interest, foreign mutual fund profits or rentals from real estate located outside of the U.S.
• Failing to file various U.S. foreign reporting forms such as Form 5471, Form 3520 etc.
• Failing to file FBARs.
• A combination of all three of the above.

These failings must be legally characterized under various U.S. laws, regulations and case-law authority as criminal, civilly willful or non-willful, reckless, grossly negligent, negligent or due to reasonable cause (meaning not negligent).

Thus, the tax lawyer is the central figure in helping a taxpayer come into compliance. This blog post will discuss the alternatives for coming into compliance and tax lawyer’s role in OVDP and Streamlined Filings.

OVDP

To begin the climb out of non-compliance the taxpayer should retain an experienced tax attorney to address where his or her conduct falls on the above ladder of culpability. Those who’ve failed to report income most often will end up in the OVDP or use the Streamlined Filing Compliance Procedures.  The tax lawyers task it to:

•   Determine if the taxpayer should enter the Offshore Voluntary Disclosure Program.
  • An OVDP submission may be necessary if the taxpayer has exposure to criminal prosecution or to the civil fraud penalty, maximum FBAR civil penalty or large income tax in earlier years for which the statute of limitations on assessment has no expired.
  • An OVDP submission may be suggested for those who cannot subject themselves to even a remote risk of criminal conviction. For example, an attorney who would be disbarred, a visa or greed card holder who could be deported or older individuals for whom prison or a draconian fine would be devastating.
  • The attorney and not the CPA preparer should oversee the entire OVDP process. The attorney should carefully monitor and supervise the CPA’s work and review all positions taken in the tax returns and FBARs being submitted to the OVDP.   Returns submitted to the OVDP are part of a criminal process and therefore require the preparer and lawyer to undertake a due diligence process to verify information being reported in the tax return. This process is unlike that which applies to timely filed returns outside of the OVDP where the preparer can accept information provided by the client as long as it is reasonable on its face.

The Streamlined Filing Compliance Procedures may be more appropriate for many taxpayers, especially for expatriates living abroad.

If the taxpayer is not a tax criminal and does not fear the draconian consequences discussed above, the tax lawyer must determine eligibility for the Streamlined Process with the understanding that IRS has the final say on eligibility and there is no guarantee of its agreeing with our determination. If the taxpayer is determined to be a candidate for a streamlined filing, the lawyer further must:

• Draft the required non-willfulness statement required under the Streamlined Filing Compliance Procedures (Streamlined Process) of the Internal Revenue Service.
• Review the returns, related foreign forms and FBARs prepared by the return preparer to make sure nothing in the returns could be viewed as untruthful or as indicating a lack of candor, being misleading, or being inconsistent with the non-willful certification.

• Prepare or suggest exculpatory statements to be included in the return, where appropriate, for example, if estimates or assumptions are employed due to any necessary records required for U.S. tax reporting not being available.  This is not uncommon because non-U.S. banks do not have programmed the generation of U.S. tax information forms.
• Review the final streamlined package and submit to IRS with a cover letter.

The remainder of this blog post shall deal with the Streamlined Process. I have many other blog posts dealing with the OVDP. Search The Tax Wars Blog using key word “OVDP”

Streamlined Filing Compliance Procedures (Streamlined Process)

The Streamlined Process is a special program under which IRS provides a relatively simpler route by which many U.S. taxpayers cam potentially resolve past tax oversights and become compliant with U.S. tax reporting rules regarding income, foreign bank accounts or other required foreign reporting forms.

Streamlined eligibility

The program is aimed at taxpayers who are not tax criminals and who meet the following eligibility requirements.

• Meet a certain residency or non-residency tests.
• If residing outside of the U.S., Have filed returns or have unfiled returns for the past three years for which the due date has passed.
• If residing inside the U.S., have filed returns for the past three years for which the due date has passed.
• Have failed to report the income from a foreign financial account as required by U.S. tax law and / or failed to file correct FBARs.
• Certify that the failure to report all income, pay all tax and submit all required information returns was due to non-willful conduct. The courts and IRS have defined willfulness as “the intentional violation of a known legal duty.” That phrase is easier to recite than to clarify and IRS has been coy about how aggressively it will review taxpayer certifications of non-willfulness. The test turns on both factual analysis which IRS seems to want to apply a “gut-test” and legal conclusions from those facts. With regard to eligibility for the Streamlined Process, IRS has the final say. For a more comprehensive  discussion of willfulness read my blog post on www.the-tax-wars.net “Will-O-The Wisp Willfulness in the Streamlined Process “(9/1/14)).

The Streamlined Process benefits

• Allows one to come into compliance by filing only three years of returns and six years of FBARS instead of the eight years of returns required under the OVDP.
• Avoids the OVDP harsh penalty regime which, may be inappropriate for many who are not tax criminals or willful violators and in all fairness should not be subject to the maximum FBAR penalties for willful violations. Instead, the Streamlined Process allows those residing outside of the U.S. to come into compliance without paying any FBAR penalty on unreported foreign financial assets or accuracy related penalty (can be 20%) on any increased income tax liability (persons residing inside the U.S. must pay a 5% FBAR penalty).
• Removes the cloud of fear hanging over one’s head about discovery of the non-compliance and possible passport revocation or non-renewal.
• Brings the taxpayer into compliance without identifying him or her as a tax-violator and without disclosing to the public that he or she has entered the program.

Expatriates versus persons living in the U.S.

Expatriates may find it less difficult to qualify for the streamlined filing benefits because they are less likely to have learned of the U.S. filing and report obligations before FATCA kicked-in.  Now, they are learning of these obligations because their foreign banks, which are not foreign to them, are contacting them and requesting Forms W-9.  Persons living in the U.S. have a more arduous task in convincing IRS that their conduct was non-willful.  But, these are very fact-intensive determinations and no two cases I have seen are quite the same.  The person with a Masters in Taxation is obviously held to a higher standard of care and knowledge than a person with a high school diploma who works as a sales clerk.  What would a reasonable person with the same educational background and work experience be expected to have known about reporting offshore income or filing FBARS?   What distractions arising from work, health and family were going on in their lives during the reporting period?  Answering these questions goes a long way towards resolving whether the taxpayer’s conduct was willful or non-willful.

The waiting period

Unlike the OVDP, the streamlined filer will not initially know if IRS has accepted them into the Streamlined Process. While an IRS audit of streamlined filed returns will not be automatic, returns may be selected for audit under normal IRS audit guidelines and IRS may determine that conduct, in its eyes, was not non-willful. In that case, IRS could go back further than three years and could assert an FBAR penalty at the conclusion of the audit process. The IRS would have to act within the period allowed under law for making income tax assessments, normally three years unless large amounts of income (more than 25% of all income reported) are found to have not been reported in your returns. This limitations period on making assessments would start to run from the filing date of  returns. These limitations periods, however, do not apply to a year for which IRS successfully proves that fraud was committed in filing the return. The limitations period for IRS assessing the FBAR civil penalty is six years from the due date of the particular FBAR. For a fuller discussion of the impact of limitations periods, read my blog post on www.the-tax-wars.net “Statutes of Limitations and Streamlined Filings or File Forward Strategies” (8/10/15).

Paths into compliance outside of the Streamlined Process 

Those who can establish that they were not negligent may still be able to file amended returns outside of the streamlined procedures and pay no penalty: but, tax counsel must feel strongly that they meet the legal standard in having a reasonable cause for  not having timely filed or reported. These will usually involve exceptional factual situations where events beyond the taxpayer’s control prevented compliance.

Those who have reported all offshore income but have failed to file FBARs or other foreign reporting forms can follow either the delinquent FBAR procedure or the delinquent foreign reporting form procedures found on www.irs.gov.

A word about return preparers

There are many capable return preparers in the U.S. But, not all capable return preparers are familiar with the unique issues involved in making an OVDP submission or in filing returns under the Streamlined Filing Compliance Procedures. These are not ordinary return filings and the preparer should be familiar with the OVDP or streamlined process and understand the additional due diligence necessary in preparing returns for these programs. In addition, returns with offshore activities present complex tax issues that many return preparers do no regularly encounter in their tax practice. These can include such matters as Passive Foreign Investment Companies, Forms 5471 filings, Forms 3520, special nominee entity rules to name just a few. Thus, I will not accept an engagement unless the client also engages a return preparer who is experienced in these matters.

Conclusions

The most difficult aspect of offshore non-compliance cases is determining the surest course to a safe harbor that is reachable with the least burdensome cost. Taxpayers and lawyers need to be aware that as more time passes, non-willfulness becomes more difficult to establish.   The Department of Justice has stated it is becoming skeptical of non-willfulness claims and intends to compare streamlined certifications of non-willfulness with information it is receiving from other sources. In light of these remarks, taxpayers and lawyers need to take great care in preparing accurate, truthful and transparent streamlined affidavits. The affidavit should state both favorable and unfavorable facts. Caveat: if too unfavorable, statements may add up to admitting facts sufficient for an indictment. That is why streamlined filing should be overseen by an experienced tax attorney. There is a fine line between helping a client out of a jam and getting them into an even bigger jam. Do not harm is always my legal gyroscope.

What should be very clear and require no further elaboration? Taxpayers still out in the cold should act sooner than later to retain counsel and start the wheels in motion that will bring them into compliance. Waiting is a sure no win game at this juncture.

© 2016 by Robert S. Steinberg, Esquire
www.steinbergtaxlaw.com