Undisclosed Foreign Accounts Are in the IRS’s Cross Hairs – New Rules Target Foreign Assets
Since 2004, Treasury and the IRS have been vigorously attempting to identify undisclosed foreign bank accounts held by U.S. taxpayers. Changes to Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts and its reporting requirements eliminated most disclosure exceptions. Enhanced IRS monitoring and enforcement mean that neglecting to file this form can have serious consequences -- it can result in criminal prosecution, particularly when the income from foreign undisclosed accounts is not reported on a U.S. taxpayer’s tax returns. The U.S. government is also pressuring foreign banks and foreign governments to release the names of U.S. taxpayers with foreign accounts.
On January 9th the IRS announced a new voluntary disclosure program for persons that have not filed TD F 90-22.1 in prior years. It offers an option that may result in a recommendation by the IRS to the Department of Justice not to seek criminal prosecution. As a corollary, criminal prosecution may be recommended for affected individuals who do not come forward.
The government is attempting to attack undisclosed foreign assets from a number of ways. Foreign financial institution disclosure is now being looked to as a way of supplementing taxpayer disclosure.
New Foreign Asset Reporting Requirements
The U.S. Department of Treasury and the IRS have issued sweeping proposed regulations implementing information reporting and withholding tax provisions for foreign financial institutions (FFIs). Although the proposed regulations are targeted at FFIs, they drive home the need for individual taxpayers with foreign accounts to be vigilant about compliance with their own reporting obligations.
U.S. taxpayers need to realize that the U.S. government is serious about enforcing its fundamental concept of worldwide taxation. Since the early 1960s, laws have been targeting tax schemes and devices designed to shelter income offshore and avoid U.S. tax. Undisclosed foreign income by U.S. citizens, resident aliens and some nonresident aliens, and “innocent” spouses, who filed joint tax returns, is not a minor violation of the law. The U.S. government is now vigorously pursuing felony convictions for tax evasion and criminal conspiracy, as well as collecting unpaid taxes and imposing draconian penalties. It has also initiating criminal conspiracy indictments against several foreign financial institutions.
Late last year, the IRS released Form 8938 (Statement of Foreign Financial Assets) for individual U.S. taxpayers who report foreign financial assets for the 2011 tax year to report the ownership of specified foreign financial assets if the total value of those assets is more than the applicable reporting threshold. The filing requirement is part of the Foreign Asset Tax Compliance Act (FATCA), which was enacted in 2010. The law is intended to improve tax compliance by U.S. taxpayers who hold offshore financial accounts.
Foreign Financial Institution Reporting
FATCA also requires FFIs to report to the IRS certain information about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest. FFIs that fail to provide the required information face significant U.S. tax penalties. Although many FFIs vigorously oppose these rules and argue that they violate bank secrecy rules, the IRS is working with foreign governments and invoking treaty to pressure FFI’s direct compliance or indirect compliance through government channels.
For each account identified as being held by one or more U.S. persons or U.S.-owned foreign entities, an FFI generally must report the:
- Name, address and taxpayer identification number (TIN) of each account holder who’s a U.S. person (or, in the case of an account holder that is a U.S.-owned foreign entity, the name, address and TIN of each U.S. person who’s a substantial U.S. owner of the entity)
- Account number
- Account balance or value
- Gross receipts and gross withdrawals or payments from the account
The term “U.S. persons” includes citizens, residents and entities created or organized in the United States or under the laws of the United States, as well as estates formed under those laws. Foreign trusts are considered U.S. persons to the extent that the U.S. person or persons control “substantial decisions” of the trust.
Major provisions
The proposed regulations require an FFI to enter into an agreement with the IRS to:
- Identify U.S. accounts
- Report certain information to the IRS regarding U.S. accounts
- Verify its compliance with its obligations under the agreement
- Withhold a 30% tax on certain payments related to U.S. investments and made to FFIs and account holders who won’t provide the required information
The proposed regulations would also:
Reduce the administrative burden of identifying U.S. accounts. The regulations base the required degree of due diligence for an account on its value and risk profile. They also, in many cases, allow FFIs to rely on information the institutions already collect, such as that obtained during customer intake procedures to comply with their anti–money-laundering obligations.
Expand the categories of “deemed-compliant.” Certain categories of FFIs are deemed to comply with FATCA without entering into an agreement with the IRS. The expansion is intended to focus the application of FATCA’s requirements on financial institutions that provide services to the global investment community.
Phase in reporting and withholding obligations over an extended transition period, culminating in 2017. Under the proposed regulations, FFIs would have to report the identities, account balances and other information on U.S. accounts in 2014 and 2015 (for the 2013 and 2014 calendar years). Beginning in 2016 (for 2015), FFIs must also report income associated with U.S. accounts. By 2017 (for 2016), FFIs would have to supply full reports, including gross proceeds from broker transactions.
Cross-Border regulatory systems
One of the primary concerns expressed by FFIs before the release of the proposed regulations involved the role of local secrecy laws. Some FFIs worried that providing the information required by FATCA directly to the IRS would necessarily require violations of their local banking secrecy laws.
To prevent such issues, the Treasury Department and the IRS issued a joint statement with several other governments on the same day the proposed regulations were released. The statement — joined by the governments of France, Germany, Italy, Spain and the United Kingdom — outlines a cross-border regulatory system.
Under the system, FFIs will report the required information to their respective governments, which will then share the information with the IRS pursuant to existing bilateral income tax treaties. This framework will serve as a model for future agreements between the United States and other countries. That means more FFIs will be reporting information on U.S.-held accounts in the future.
Self-reporting by U.S. taxpayers
FATCA requires certain U.S. taxpayers holding foreign financial assets with an aggregate value that exceeds $50,000 to report certain information about those assets on Form 8938, along with their annual tax returns, beginning with the 2011 tax year. As FFIs increasingly report the information, the likelihood of being tripped up by neglecting to file Form 8938 will become greater, as will the likelihood of incurring a costly penalty.
Failure to report foreign financial assets on Form 8938 will result in a penalty of $10,000, with an additional penalty of up to $50,000 for continued failure to file after receiving IRS notification to file. A 40% penalty on any understatement of tax attributable to nondisclosed foreign financial assets can also be imposed.
Taxpayers are also required to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), with the IRS if:
- The taxpayer had a financial interest in or signature authority over at least one financial account located outside of the United States, and
- The aggregate value of all foreign financial accounts exceeded $10,000 at any time during the calendar year to be reported.
The FBAR must be received by the IRS on or before June 30 of the year following the calendar year being reported.
Are you in compliance?
If you hold offshore financial accounts, it’s increasingly critical that you properly report them to the IRS. The proposed FATCA regulations will bring an increased level of scrutiny of your foreign assets. To ensure you’re in compliance or if you have questions regarding FATCA regulations, please give us a call at 713.622.1120. MFR can work with you and/or your attorney to settle your exposure with the U.S. government.
by William Leary, Director
MFR, PC | 
