Taxpayers who participate in international transactions potentially subject themselves to a panoply of international information return filing obligations. Take this simple example. John, a U.S. citizen, establishes and funds a foreign grantor trust. After creating the trust, John also travels to the foreign jurisdiction and sets up a foreign bank account in the foreign trust’s name. John’s activities seemingly do not amount to much—that is, unless you look at his international information return filing obligations. Under this simple example, John’s foreign activities have likely caused four separate information return filing obligations, including Form 3520, 3520-A, Form 8938, and FBAR. Yes, that is four potentially applicable information returns and therefore four potentially applicable civil penalties that John may have to pay if each return is filed late. Worse yet, John’s reporting requirements probably carry forward into subsequent tax years, potentially exposing John to even more civil penalties if those information returns are not timely filed.
As the world has grown smaller, more taxpayers similar to John have found themselves subject to these international information return reporting rules. Currently, there are reporting rules for almost any international transaction, ranging from receipt of a foreign gift (Form 3520), ownership or control over foreign corporations and partnerships (Form 5471 and Form 8865), contributions to and distributions from a foreign trust (Form 3520), ownership or deemed ownership over a foreign trust under the grantor trust rules (Form 3520-A), and interests in financial assets and foreign accounts (Form 8938 and FBAR). There are more, but this should give you a good idea of the breadth of these information return reporting obligations.
Each reporting obligation carries with it late-filing penalties, most of which are significant. Fortunately, taxpayers are not without options if they miss an information return reporting deadline. To further compliance initiatives, the IRS offers numerous programs. Because these are varied and have different risks and benefits, the trick is determining which program or programs the taxpayer may qualify for and then determining which program makes the best sense in the light of the taxpayer’s objectives, goals, and risks.
Taxpayers who fail to timely file an information return due to non-willful conduct may take advantage of the IRS’ Streamlined Filing Compliance Procedures (SFCP). Generally, non-willful conduct means that the taxpayer missed the information return filing deadline because of an honest mistake, inadvertence, or simple negligence. A good example of non-willful conduct is when a taxpayer relies on a tax professional who, after being fully informed of the foreign activities by the taxpayer, improperly advises that there is no information return filing requirement. There are additional requirements under the SFCP, but eligible taxpayers under this program may avoid all international information return penalties in exchange for a more modest penalty based on the value of certain undisclosed foreign assets. And, in some instances, taxpayers may avoid penalties altogether, particularly if the taxpayer resided in a foreign country for significant amounts of time in a three-year lookback period.
If a taxpayer willfully failed to file an international information return or report and pay tax associated with a foreign asset, the taxpayer should avoid the SFCP. Rather, these taxpayers should generally try to take refuge to absolve their willful conduct through making a disclosure under the IRS’ Voluntary Disclosure Program (VDP). Under this program, a taxpayer submits the late information returns, any original or amended income tax returns, and pays the associated income tax and interest to the IRS. The taxpayer receives mitigation from criminal prosecution but, in exchange, must pay a 75% fraud penalty on the highest income tax liability year and, if the taxpayer failed to file FBARs, a penalty based on the balance of the undisclosed foreign accounts. The taxpayer must also provide additional information to the IRS, such as the name of any promoters or facilitators or other individuals who aided with the willful conduct.
In addition to the SFCP and the VDP, the IRS also offers the Delinquent International Information Return Submission (DIIRS) procedures and the Delinquent FBAR Submission procedures. Under the DIIRS procedures, the taxpayer files the international information returns late, usually with a reasonable cause statement. Because the IRS systemically assesses many international information return penalties under this program, taxpayers are generally left fighting the assessments later in the IRS Independent Office of Appeals.
The Delinquent FBAR Submission procedures only apply to late-filed FBARs. Under these procedures, the taxpayer submits the late FBARs to FinCEN with an explanation for their tardiness. If the taxpayer reported the foreign income associated with the undisclosed foreign accounts on a tax return and paid the tax associated with the foreign income, the IRS indicates that it will not seek FBAR penalties against the taxpayer under this program.
The above explanations of the varied IRS programs are only an overview. Each program has its own nuanced requirements and taxpayers are well advised to seek tax advice from a knowledgeable tax professional regarding the risks and benefits of the individualized programs. Taxpayers with unfiled international information returns should also bear in mind the timeliness requirement of each IRS program. Under the timeliness requirement, a submission is generally timely only if the taxpayer makes it prior to receiving notice of an IRS civil or criminal investigation. In other words, taxpayers already on the IRS’s radar are precluded from taking advantage of the benefits of the above programs and must therefore fight any IRS penalty determinations regarding late-filed information returns through normal administrative channels.