Time May Be Running Out to Come Clean with the IRS on Foreign Investment Reporting
There is increasing evidence to support the belief that foreign bank account and investment holders who have not reported information regarding these accounts to the Treasury Department may soon pay very dearly for their failure to comply with its rules.
In a number of previous articles, we have explained the many reporting requirements imposed upon U.S. citizens who own or control foreign assets. Links to some of those articles are provided at the end of this one. Several recent actions suggest that the government may soon dramatically increase its enforcement of one requirement in particular, and the price for noncompliance may be severe.
The purpose of this article is to provide some general background, share our arguments supporting our belief that things are about to change, and encourage those who remain out of compliance to act – quickly.
- Many foreign investment holdings must be reported to the Treasury Department on an annual basis.
- The government has very recently gathered information on foreign account holders directly from foreign financial institutions, and has diverted significant resources into its ability to match those records with taxpayers’ self-reported records.
- The penalties for not reporting required holdings can be substantial – both in terms of overall IRS collections and relative to the size of an individual’s unreported account.
- The IRS recently created additional reporting requirements; and an updated Form 1040, Schedule B forces many taxpayers to state (knowingly or unknowingly, but under penalties of perjury) whether or not they meet certain filing requirements.
- Some voluntary compliance programs currently exist, but could soon end.
The reporting requirement
Of the several that exist, the foreign reporting requirement that seems poised to materialize into a nightmare for some people is a longstanding one that calls for foreign bank account holders to do two things: (1) report the existence of certain foreign accounts on Form FinCEN 114, and (2) report the investment income on Form 1040, Schedule B. Generally, those who have foreign cash holdings that exceeded $10,000 at any time in the prior year must list the highest balance, bank name and address, and account number on Form FinCEN 114 (formerly TD F 90-22.1). No tax is due with this form, but it must be filed by June 30 to report the prior year’s activity (beginning in 2017, the filing is due in April). Any interest income is reported on the account owner’s Form 1040, along with any domestic interest income. Those who fail to file Form FinCEN 114 when required (or have failed to file in prior years) can face some of the harshest financial penalties the Treasury Department imposes. The penalties begin at $10,000, and can reach as high as the greater of $100,000 or 50% of the highest underreported account balance. Because this penalty can be imposed annually on the same account, the penalty can greatly exceed – by multiples – the balance of the account itself! Worse, criminal penalties, including imprisonment, can apply too.
Voluntary compliance programs
Multiple programs remain available that allow people to come into compliance with the rules and resolve prior deficiencies. These programs provide reduced or even eliminated penalties. In many cases, though, these programs leave the taxpayer at the mercy of the IRS’s discretion, and the outcome is not known when a taxpayer applies for leniency using these programs. More information on these programs may be found in the links provided at the end of this article.
Why increased enforcement seems imminent
The IRS has not pursued individuals in a wide scale manner, possibly leading to complacency and the quiet belief that “if I ignore this long enough, it might just go away.” A number of developments suggest that the IRS is poised to drop the hammer on scofflaws of these foreign bank reporting requirements.
- Increased compliance “opportunities” have been introduced in recent years.
- For many years prior to 2011, Form 1040 asked taxpayers on Schedule B whether any foreign holdings were owned, and in what country. Beginning in 2011, an additional question appeared, asking whether the taxpayer is required to file TD F 90-22.1 (now FinCEN 114). Taxpayers must answer “yes” or “no” to this question under penalties of perjury. The addition of this question, on a commonly used form, will make it much harder for taxpayers to assert that a missed filing was an oversight, rather than willful.
- Form 8938 was introduced in 2011, calling for several new categories of foreign holdings to be reported, including cash. Form 8938 therefore overlaps the requirements of Form FinCEN 114, creating yet another speedbump designed to get a taxpayer’s attention. It is to be attached if applicable to Form 1040 on an annual basis, and a new penalty ranging between $10,000 and $50,000 can be imposed for failures to file this form.
- The Treasury Department and IRS have gathered significant account holder information by focusing first on foreign banks.
- Under the 2010 Hiring Incentives to Restore Employment Act (“HIRE”) and 2014 Foreign Account Tax Compliance Act (“FATCA”), the U.S. imposed significant reporting and information-sharing burdens upon foreign banks, forcing them to provide considerable information regarding account holders to the U.S. government. Information related to thousands of account holders has been gathered – but very few of them have been pursued.
- In the past, taxpayers essentially have been on “the honor system,” as it would be nearly impossible for the IRS to find evidence of foreign holdings by scrutinizing a taxpayer’s return that omitted it. With the data provided by these foreign banks, the IRS can now come at this from an entirely different (and well-informed) angle. This capability simply did not exist until recently.
- The IRS has increased its automated matching capabilities, and can much more easily cross-reference account information provided by foreign banks with information self-reported (or expected to be self-reported) by taxpayers. In other words, it not only has the data, but it can now process it with electronic efficiency.
- The Financial Crimes Enforcement Network is a division of the Treasury Department. (Its name is referenced by the form “FinCEN” 114.) Its fiscal year 2017 budget report (dated February 9, 2016) describes substantially increased electronic capabilities under a new system, resulting in a recent jump in automated alerts.
- FinCEN 114 forms, beginning in 2015, now must be filed electronically with the network.
- One of the network’s goals is to share information with other divisions of government, including the IRS. It is only in the last few years and months that the network has been given significant account information provided by banks that it can now compare to data that is self-reported by individuals on Forms 8938 and FinCEN 114. The ability to quickly and effectively compare these records and begin acting upon the results seems to be nearly completely perfected.
- The Financial Crimes Enforcement Network is small, consisting of just a few hundred employees. When the results of their efforts are turned over to the enforcement division of the IRS, and its much greater resources are deployed, things may get very ugly, very fast for those who ignored these rules.
- Pursuing these crimes is very profitable for the government – but to date it has been underused.
- A detailed breakdown of taxes and penalties collected during IRS audits is not readily available, but we have every reason to believe that a huge “bang for the buck” exists in their pursuit of noncompliant account holders – perhaps more so than with other areas. According to a 2008 Senate report, the use of offshore accounts costs the Treasury $100 billion per year, so they have every motivation to pursue this with vigor.
- The IRS does not need the public’s endorsement, but it is not hard to imagine that it will have the nodding approval of many by pursuing what are perceived to be wealthy scofflaws who hid their wealth at the expense of other taxpayers. Many prosecutions for willful violations have been very punishing, but there are relatively few cases of inadvertent failures to file that have resulted in large penalties. However, if this restraint is lifted, the assessments of penalties, interest and tax could be enormous.
- The IRS is directly warning individuals of these requirements.
- In Internal Revenue Bulletin 2016-42, the IRS reiterated the requirement to report foreign bank and investment holdings. IRS Commissioner John Koskinen noted that “Taxpayers here and abroad need to take their offshore tax and filing obligations seriously,” and that “improving offshore compliance has been a top priority of the IRS for several years, and we are seeing very positive results.”
- The current amnesty programs are not expected to last forever. According to Bloomberg, Commissioner Koskinen indicated as much in a speech made in December 2015. In that same speech, Mr. Koskinen made an assertion about people’s intent, when he also noted that “(A)t some point, we will have assumed that people have had enough notice that they should have become voluntarily compliant… after some period of time and you’re not compliant — it will be assumed that logically you are purposely not compliant” (emphasis added).
All of these factors taken together suggest that increased compliance efforts will soon commence, and we believe that it is inevitable. It seems highly unlikely that this massive effort and capability will remain unused when it is widely believed that taxes and penalties have been significantly underpaid.
Individuals who have not properly reported foreign holdings and income on Forms FinCEN 114, 8938 and 1040, Schedule B should address this deficiency thoroughly and promptly. Baker Newman Noyes is uniquely qualified to help taxpayers understand and navigate these requirements, and become compliant with prior year oversights. Our International Tax Practice has assisted many taxpayers in meeting their foreign reporting requirements on a current and retroactive basis, and can help you weigh your options. Based on our experience, you will be much better off reaching out to the IRS before the IRS reaches out to you.
Links to more information
- Foreign Bank Account Reporting – General
- Failure to Report Foreign Account Holdings Results in $2.2 Million Penalty
- How to Come Clean on Delinquent Foreign Bank Account Filings – Comparison of Options
- Tax Impact of Foreign Vacation Homes – Dos and Don’ts
- IRS Streamlined Filing Compliance Procedures
- New Offshore Voluntary Disclosure Initiative
Stuart Lyons is a principal and international tax practice leader at Baker Newman Noyes. Stan Rose is a tax director and editor of the firm’s newsletter, the BNN Briefing. If you have any questions regarding foreign asset reporting requirements, please contact Stuart Lyons, Celine Couillaut, or Colleen Mathews at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.