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Method to Cure Delinquent or Incomplete Foreign Information Returns Without Penalties
Last year, the IRS announced its third offshore voluntary disclosure initiative. Like the earlier initiatives, the 2012 OVDP is designed to encourage taxpayers with unreported offshore accounts and assets to voluntarily disclose them to the IRS.
The 2012 OVDP is available to individuals and entities, including corporations, partnerships and trusts. Unlike the previous initiatives, this one does not contain a specific termination date. As was the case with the earlier initiatives, the 2012 OVDP was accompanied by a comprehensive set of Frequently Ask Questions (FAQs). Two of those FAQs—FAQ 17 and 18—are the primary focus of this article. These two FAQs present a significant opportunity for taxpayers who properly reported all their taxable income to obtain automatic penalty relief for failure to file certain international-related information returns.
FAQ Nos. 17 and 18 address a number of significant reporting penalties related to undisclosed offshore financial accounts and undisclosed foreign assets. In general, the civil penalty for each non-willful failure to report a foreign financial account on Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, (the “FBAR”) can range up to $10,000 and the penalty for a willful failure is the greater of $100,000 or 50 percent of the account balance. The various international-related information reporting rpenalties are also severe and may apply even if there is no income tax liability attributable to the foreign entity. For example:
• The penalty for failure to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation, is equal to 10 percent of the fair market value of the transferred property (generally limited to $100,000).
• The penalty for failure to file Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, is equal to 35 percent of the gross reportable transaction amount.
• The penalty for failure to file Form 5471, 8865, or 8858 (information returns of U.S. persons with respect to foreign corporations, partnerships, and disregarded entities) is $10,000 plus a possible reduction of any applicable foreign tax credits.
FAQ No. 17—FBAR Filing Failures Related to Foreign Financial Accounts
FAQ No. 17 establishes an automatic waiver of the reporting penalties for failure to file the FBAR, when the taxpayer has properly reported—and paid tax on—all taxable income, but only recently learned that it was subject to the FBAR reporting requirement. However, unlike the 2011OVDI, FAQ No. 17 of the 2012 OVDP explicitly excludes taxpayers who have been previously contacted by the IRS regarding an income tax examination or a request for delinquent returns. FAQ No. 17 provides:
[Q:] I have properly reported all my taxable income but I only recently learned that I should have been filing FBARs in prior years to report my personal foreign bank account or to report the fact that I have signature authority over bank accounts owned by my employer. May I come forward under this new program to correct this?
[A:] The purpose for the voluntary disclosure practice is to provide a way for taxpayers who did not report taxable income in the past to come forward voluntarily and resolve their tax matters. Thus, if you reported, and paid tax on, all taxable income but did not file FBARs, do not use the voluntary disclosure process.
For taxpayers who reported, and paid tax on, all their income for prior years but did not file FBARs, you should file the delinquent FBAR reports according to the instructions (send to Department of Treasury, Post Office Box 32621, Detroit, MI 48232-0621) and attach a statement explaining why the reports are filed late. TheIRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.
The FAQ makes clear that a taxpayer qualifying for penalty relief under its terms should not file under the 2012 OVDP but instead should file any delinquent FBARs in the normal manner.
The FBAR filing instructions provide that delinquent reports should be filed with the IRS Detroit processing center along with an explanation of why the report is late and a specific reference to FAQ No. 17. The explanation can be provided in an attached statement, “Request for Penalty Relief under FAQ #17,” which, in addition to specifically referencing the penalty waiver language in FAQ No. 17, provides facts to show that the reporting failure was not willful and that all income has been reported and taxes paid. Taxpayers should use the current version of the FBAR (TD F 90-22.1 (Jan. 2012)) for anyperiod covered by their submission.
FAQ No. 18 establishes an automatic waiver of penalties for failure to file certain international-related information returns when the taxpayer has properly reported all taxable income and paid the applicable tax, but only recently learned that it was subject to the reporting requirements. However, similar to the relief provided for delinquent FBAR filers, FAQ No. 18 explicitly excludes taxpayers who have been previously contacted by the IRS regarding an income tax examination or a request for delinquent returns. FAQ No. 18 provides:
[Q:] Question 17 states that a taxpayer who only failed to file an FBAR should not use this process [the 2012 OVDP]. What about a taxpayer who only has delinquent Form 5471s or Form 3520s but no tax due? Does that taxpayer fall outside this voluntary disclosure process?
[A:] A taxpayer who has failed to file tax information returns, such as Form 5471 for controlled foreign corporations (CFCs) or Form 3520 for foreign trusts but who has reported, and paid tax on, all their taxable income with respect to all transactions related to the CFC or foreign trust, should file delinquent information returns with the appropriate service center according to the instructions for the form and attach a statement explaining why the information returns are filed late. (The Form 5471 should be submitted with an amended return showing no change to income or tax liability.) The IRS will not impose a penalty for the failure to file the delinquent Forms 5471 and 3520 if there are no underreported tax liabilities and you have not previously been contacted regarding an income tax examination or a request for delinquent returns.
The penalty relief provided is not limited to the two information returns cited in FAQ No. 18. It applies to all the following international-related information returns:
• Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation
• Form 3520, Annual Return to Report Transactions with Foreign Trusts & Receipt of Foreign Gifts
• Form 3520-A, Annual Information Return of Foreign Trust With a U.S. Owner
• Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations
• Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business
• Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities
• Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships
• Form 8938, Statement of Specified Foreign Financial Assets
In summary, these two FAQs present an excellent opportunity for taxpayers who properly reported all their taxable income to obtain automatic penalty relief for failure to file certain international-related information returns.