The Internal Revenue Service announced major changes in its offshore voluntary compliance programs, providing new…
Streamlined Filing Compliance Procedure’s New Revisions to Streamlined Foreign Offshore Procedures (SFOP)
In the midst of tough tax season, many U.S taxpayers are unfortunately surprised to discover that they have a U.S. tax reporting obligation on financial accounts or assets held overseas. Once they discover their tax and reporting obligation, there are a number of programs through which they can become compliant. One option, if the taxpayers meet the requirements, is to file under the Streamlined Domestic Offshore Procedures (SDOP) or the Streamlined Foreign Offshore Procedures (SFOP). This article focuses on the SFOP.
The Internal Revenue Service (IRS) recently modified the non-willfulness certification form that individual taxpayers must submit to enroll in the streamlined filing compliance procedures (SFCP). SFCP is a program offered by the IRS to individuals who have not previously disclosed foreign assets to the U.S. government.
The IRS introduced SFCP in June 2014 as an alternative to its existing Offshore Voluntary Disclosure Program (OVDP), which was designed more for taxpayers with evidence of willful failure to disclose foreign assets. Specifically, SFCP is for taxpayers who non-willfully failed to disclose foreign assets. Under the SFCP, non-willful conduct is specifically defined as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law”.
The most important first step in analyzing whether a taxpayer is eligible to participate in the streamlined procedures is to ascertain whether the taxpayer’s compliance failure, including the failure to file an FBAR, was actually non-willful. The IRS has defined “nonwillful conduct” as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” For failure to file FBARs, the IRS must establish knowledge of the law and evaluating indicators of willfulness (Internal Revenue Manual (IRM) §4.26.7). Willfulness in criminal tax cases generally means a voluntary, intentional violation of a known legal duty (Cheek, 498 U.S. 192 (1991)). The taxpayer does not have to have an improper motive or a bad purpose. All that is required is that the taxpayer knew of the duty and intended to violate it (Pomponio, 429 U.S. 10 (1976)).
It is extremely important that a taxpayer’s eligibility is carefully analyzed because once the SFCP is elected and the taxpayer claims the violations were non-willful, the taxpayer will not be eligible for the OVDP any longer. There are possible risk factors that need to be considered and analyzed such as the evidence of willfulness including intent of laws, knowledge and violations. Although filing an SFCP does not automatically select the taxpayer for an IRS audit, the taxpayers is still subject to the possible normal audit selection. The taxpayer needs to be prepared to defend filing a SFCP and be able to demonstrate their non-willfulness.
The IRS has two separate tracks for taxpayers wishing to enter in the SFCP: one track for taxpayers who reside in the United States (hereinafter “Streamline Domestic Offshore Procedure (SDOP)”) and another track for taxpayers who reside outside the United States (hereinafter “Streamline Foreign Offshore Procedure (SFOP)”).
The eligibility requirements for the separate tracks have some notable variations. The threshold eligibility inquiry is the taxpayer’s residency. A taxpayer will be treated as not residing in the United States if, in any one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the taxpayer did not have a U.S. abode and the taxpayer was physically outside the United States for at least 330 full days.
If the taxpayer meets the non-residency test, then the taxpayer may enter the Streamline Foreign Offshore Procedure (SFOP), provided the taxpayer can certify that: (1) he or she failed to report income from a foreign financial asset and pay tax as required by U.S. law [and may have failed to file a report of foreign bank and financial accounts (FBAR)]; and (2) such failures resulted from non-willful conduct.
If a taxpayer can certify that he or she meets the eligibility requirements, then the taxpayer may make a voluntary disclosure as part of the SFCP program. The SFOP requires the taxpayer to submit, in addition to filing any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed: (1) delinquent or amended or new tax returns, together with all required information returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date has passed); (2) the full amount of the tax and interest due in connection with the delinquent or amended returns; and (3) a completed and signed Certification by U.S. Person Residing Outside of the U.S. (Form 14653). Taxpayers who enter the SFOP are NOT subject to any penalties (i.e., failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, FBAR penalties, or a Title 26 miscellaneous offshore penalty). There simply is no penalty, which is a great uncommon result for non-compliant taxpayers.
Taxpayers in the SFOP must submit Form 14653 (Certification by U.S. Person Residing Outside the United States for Streamlined Foreign Offshore Procedures). As part of such certification, the taxpayer must provide specific facts and reasons (generally on a signed attachment) why their conduct was non-willful.
In February 2016, the IRS revised Form 14653 and added a section to Form 14653 requesting detailed information regarding presence outside the U.S. during the streamlined procedures submission period. The IRS now requires that U.S. citizens or lawful permanent residents indicate whether they were physically outside the United States for each year in the covered three-year period. Also, for joint submissions, the IRS states that both spouses filing a joint certification must meet the non-residency requirement. If the number of days physically outside of the United States differs for each spouse, then each spouse needs to disclose that on the chart on the Form 14653 or in an attachment thereto.
Also in February 2016, the IRS revised Form 14653 to require more disclosure. Now the IRS also instructs the taxpayer to:
Include the whole story including favorable and unfavorable facts. Specific reasons, whether favorable or unfavorable to you, should include your personal background, financial background, and anything else you believe is relevant to your failure to report all income, pay all tax, and submit all required information returns, including FBARs. Additionally, explain the source of funds in all of your foreign financial accounts/assets. For example, explain whether you inherited the account/asset, whether you opened it while residing in a foreign country, or whether you had a business reason to open or use it. And explain your contact with the account/asset including withdrawals, deposits, and investment/management decisions. Provide a complete story about your foreign financial account/asset. If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice. (italics added)
This is the third revision to this form in the last 18 months. The revision indicates that the IRS is receiving many incomplete disclosures. In fact, our law firm has cleaned up many rejected incomplete or inadequate SFCP non-willful certifications. As a result of the revision, the IRS is requesting the “whole story” in exhaustive detail. The revision poses a very delicate balance for our advocacy for our clients: we need to share enough information in order to persuasively demonstrate non-willfulness, including unfavorable facts and circumstances, however excessive disclosure could lead to new questions and complications.
Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. While the streamlined program offers a welcome option for many taxpayers with undeclared accounts, other ways to address past noncompliance remain viable, including the OVDP program and Delinquent FBAR Submission Procedures and Delinquent International Information Return Submission Procedures. The analysis to enter the one program versus other alternative options is complex and requires full legal analysis by a competent experienced tax attorney.
Patel Law Offices has consulted with hundreds of clients regarding their offshore asset and income compliance issues. Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimize) foreign assets.