Part I of this series focused on the unforeseen nightmare and problem of unfiled tax returns for undocumented immigrants. The consequences of “kicking the can down the road”, will have significant legal and financial consequences for the 12 million undocumented immigrants that have not filed tax returns at the federal and state level. It is my view that most of the undocumented immigrants face this problem. Immigration attorneys handling cancellation of removal (deportation) cases relate how clients have to compile ten or more years of tax returns as part of a case that is extremely difficult to win in immigration court. Even if you win the deportation case, the immigrant still owes the IRS a bunch of money.
As the promise of immigration reform looms on the horizon following the presidential election, the immigration consequences of unfiled tax returns becomes a significant issue as any immigration reform will certainly require full tax compliance. The financial consequences of unfiled tax returns at the federal and state level will carry the burden of significant civil penalties, and interest along with back taxes. The point rarely mentioned is that it is a crime at both the state and federal level not to file a tax return even though it is infrequently prosecuted.
Part II of the series focuses on the other legal and financial time bomb facing undocumented immigrants as well as permanent residents and naturalized citizens – the problem of foreign bank account reporting (FBAR) and foreign asset reporting (Form 8938). Since I lived in South Florida for a number of years, I like to use Miami as my bellwether for trends in the Hispanic community. The reality is that most Latins are still generally unware of this requirement. Certainly, undocumented immigrants are unaware of this requirement.
I recall asking a tax attorney friend and colleague in Miami who primarily represents international clients, what he thought the level of tax compliance was for FBAR reporting. His response suggested an abysmal level of compliance indicating that the U.S. national debt would be eliminated two times over if there was full compliance from all of the Latin Americans in Miami.
Like the requirement of filing tax returns, the compliance requirements of foreign accounts and assets are a very serious matter. The existence of FATCA and GATCA make it virtually impossible to hide assets offshore. Virtually every country including the tax havens, have entered into treaties with the United States to share financial and tax information. The recent disclosure of offshore accounts in Panama aka Panama Papers demonstrates that it is only a matter of time before a government or hackers will find you and disclose information in a matter that is not only embarrassing but carries legal and financial consequences.
Many tax attorneys have previously written about FBAR but mostly with respect to the traditional U.S. taxpayer with offshore accounts. The implication is that FBAR requirements have a much farther reach to classes of taxpayers that would not ordinarily get mentioned in a discussion on offshore bank accounts – undocumented immigrants, permanent residents and non-immigrant visa holders. This article is focused on the legal requirements for the disclosure of foreign accounts and assets as well who is subject to these reporting requirements. The articles also focuses on the legal and financial consequences of non-compliance with the requirements.
Foreign Bank Account Reporting (FBAR)
U.S. citizens, resident aliens and certain nonresident aliens are required to report worldwide income from all sources including foreign accounts and pay taxes on income from those accounts at their individual rates. An undocumented person will be considered a U.S. resident for tax purposes under the Substantial Presence Test if the immigrant was present in the United States in the calendar year for 183 days of more. This rule also applies to immigrants with a valid non-immigrant visa as well as permanent residents with a Green Card.
U.S taxpayers with foreign accounts whose aggregate value exceeds $10,000 at any time during the year must file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR) electronically through FINCEN’s BSA E-Filing System. The FBAR is not filed with a federal tax return and must be filed by June 30 each year. Foreign account owners have to report their accounts to the government, even if the accounts do not generate any taxable income.
The willful failure to file an FBAR may be punished under both civil and criminal law. FBAR has a two-part reporting process. First, the taxpayer indicates on Schedule B, Part III, of the individual tax return (Form 1040) the existence of a financial account in a foreign country. Form 1040 refers the taxpayer to Form 114, the FBAR, which is now filed electronically for each calendar year on or before June 30.
A taxpayer is deemed to have a financial interest in a foreign account if the taxpayer holds title directly or indirectly or owns more than fifty percent of an entity with a foreign account. The term “financial” means both monetary and non-monetary assets. The regulations specifically refer to banks, brokerage and investment accounts, life insurance and annuity contracts and mutual accounts. The term does not include real or personal property. The term “account” refers to a relationship with a financial institution and not assets held directly by the taxpayer.
The chart below outlines the applicable civil and criminal penalties for the failure to comply with FBAR.
|Violation||Civil Penalties||Criminal Penalties||Comments|
|Negligent Violation||Up to $500||Not Applicable||31 U.S.C. § 5321(a)(6)(A) 31 C.F.R. 103.57(h).|
|Non-Willful Violation||Up to $10,000 for each negligent violation||Not Applicable||31 U.S.C. § 5321(a)(5)(B)|
|Pattern of Negligent Activity||In addition to penalty under § 5321(a)(6)(A) with respect to any such violation, not more than $50,000||
31 U.S.C. 5321(a)(6)(B)
|Failure to file FBAR
Or retain records or account
|Up to the greater of $100,000, or 50 percent of the amount in the account at the time of the violation.||
Up to $250,000 or 5 years or both
31 U.S.C. § 5321(a)(5)(C) 31 U.S.C. § 5322(a) and 31 C.F.R. § 103.59(b) for criminal. The penalty applies to all U.S. persons.
|Willful – Failure to File FBAR or retain records of account while violating certain other laws||Up to the greater of $100,000, or 50 percent of the amount in the account at the time of the violation.||
Up to $500,000 or 10 years or both
31 U.S.C. § 5322(b) and 31 C.F.R. § 103.59(c) for criminal The penalty applies to all U.S. persons
|Knowingly and Willfully Filing False FBAR||Up to the greater of $100,000, or 50 percent of the amount in the account at the time of the violation.||
$10,000 or 5 years or both
|18 U.S.C. § 1001, 31 C.F.R. § 103.59(d) for criminal. The penalty applies to all U.S. persons|
Taxpayers who do not need to use either the Offshore Voluntary Disclosure Program (OVDP) or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report or pay additional tax, but have not filed a required FBAR and are not under civil or criminal examination by the IRS or have not already been contacted by the IRS about delinquent reports, need to file the delinquent FBARs with a statement explaining why the FBARs are filed late. The IRS will not impose a penalty for a failure to file the delinquent FBARs if the taxpayer properly reported the foreign accounts on the U.S. tax returns and paid all of the taxes associated with the foreign financial accounts reported on the delinquent FBARs.
FORM 8938 STATEMENT OF SPECIFIED FOREIGN FINANCIAL ASSETS
Form 8938 must be filed by taxpayers with specific types and amounts of foreign financial assets or foreign accounts. It is important for taxpayers to determine whether they are subject to this new requirement because the law imposes significant penalties for failing to comply. Form 8938 reporting is in addition to FBAR reporting. Penalties apply for failure to file accurately.
Form 8938 is required when the total value of specified foreign assets exceeds certain thresholds. For example, a married couple living in the U.S. and filing a joint tax return would not need to file Form 8938 unless their total specified foreign assets exceed $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year.
The thresholds for taxpayers who reside abroad are higher. For example in this case, a married couple residing abroad and filing a joint return would not file Form 8938 unless the value of specified foreign assets exceeds $400,000 on the last day of the tax year or more than $600,000 at any time during the year.
For the Form 8938, the penalty may be up to $10,000 for the failure to disclose and an additional $10,000 for each 30 days of non-filing after IRS notice of a failure to disclose, for a potential maximum penalty of $60,000; criminal penalties may also apply.
For the FBAR, the penalty may be up to $10,000, if the failure to file is non-willful; if willful, however, the penalty is up to the greater of $100,000 or 50 percent of account balances; criminal penalties may also apply.
Types of Foreign Assets Reportable on Form 8938
|Financial (deposit and Custodial) accounts held at foreign institution||Yes|
|Financial account held at foreign branch of U.S. financial institution||No|
|Financial account held at U.S. branch of foreign financial institution||No|
|Foreign financial account or asset over which taxpayer has signatory authority||Yes, if income required to be reported on income tax return|
|Foreign stock or securities held at foreign financial institution||Yes, the account but not the holdings of the account|
|Foreign stock or securities not held in a financial account||Yes|
|Foreign partnership interest||Yes|
|Indirect interests in foreign financial assets through an entity||No|
|Foreign Mutual Funds||Yes|
|Domestic Mutual Fund with foreign securities and stock||No|
|Foreign Life insurance and Annuity||Yes|
|Foreign hedge fund or private equity fund||Yes|
|Foreign grantor trust where taxpayer is grantor||Yes|
|Personal Property – Jewelry, Antiques, Collectibles||No|
|Foreign Real Estate – Direct Ownership||Yes|
|Foreign Real Estate held by foreign entity||Yes based on the value of the underlying real estate|
|Social Security Benefit from Foreign Government||No|
The penalties related for the failure to file Form 8938 include a new penalty of 40 percent of the amount of the underpayment of tax for the failure to report the income attributable to an undisclosed foreign financial asset. This penalty is in addition to still other penalties (underpayment penalties, accuracy-related penalties, etc.). In the absence of reasonable cause, if a specified individual fails to report a single asset, the statute remains open on the entire tax return even if the taxpayer files Form 8938. It remains open until three years after the Form 8938 is corrected to include the missing asset.
FOREIGN GIFTS ANNUAL RETURN TO REPORT TRANSACTIONS WITH FOREIGN TRUSTS AND RECEIPT OF CERTAIN FOREIGN GIFTS
Taxpayers also need to be concerned with the implication of gifts from family members overseas while they are in the United States. Taxpayers need to report gifts or bequests valued at more than $100,000 form a non-resident alien or foreign estate.
Taxpayers need to report gifts of more $13, 258 (adjusted annually for inflation) from foreign corporations or partnerships. The foreign gifts are reported on IRS Form 3520. The failure to file on time is subject to a penalty of five percent of the amount of the foreign gift for each month for which the failure to report continues (not to exceed a total of 25 percent).
Fixing the Problem of Undisclosed Foreign Accounts and Assets
The IRS is on its third version of the Offshore Voluntary Disclosure Initiative (OVDI). OVDI was initially introduced in 2009 and subsequently modified in 2011.On January 9, 2012 the Internal Revenue Service reopened the offshore voluntary disclosure program to help people hiding offshore accounts. The program is similar to the 2011 program in many ways, but with a few key differences. Unlike prior programs, there is no set deadline for people to apply.
The overall penalty structure for the 2012 ongoing program is the same for 2011, except for taxpayers in the highest penalty category. For the new program, the penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25 percent in the 2011 program. If the value of the undisclosed account(s) was less than $75,000 at all times during the tax years in question, the penalty is reduced to 12.5 percent. Moreover, in limited situations, a penalty of 5% may be imposed.
Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties. The submission should include the taxpayer’s completed and signed Offshore Voluntary Disclosure letter, Form 8938 and FinCen Form 114. The taxpayer should also send a check for the amount of tax, interest and penalties. In the event the taxpayer is unable to pay the full amount, the taxpayer should submit a proposed payment plan along with a completed Form 433-A which outlines the taxpayer’s income and personal financial statement.
The IRS also introduced a streamlined procedure for non-willful taxpayers. Under the scenario outlined in this article, immigrants who have satisfied the Substantial Presence Test (183 days or more) are subject to all of the foreign financial account and asset reporting requirements. In the event the taxpayer can establish non-willful conduct due to negligence, inadvertence, mistake or a good faith misunderstanding, the streamline procedure can be used. For eligible taxpayers, the miscellaneous penalty will only be equal to five percent of the foreign financial assets.
Under the streamlined procedure the taxpayer sends tax original and amended tax returns for the last three years and delinquent FBARs for the last six years. The full amount of the tax and interest should be filed. A taxpayer who is eligible to use these Streamlined Foreign Offshore Procedures and who complies with all of the instructions will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties.
Even if returns properly filed under these procedures are subsequently selected for audit under existing audit selection processes, the taxpayer will not be subject to failure-to-file and failure-to-pay penalties or accuracy-related penalties with respect to amounts reported on those returns, or to information return penalties or FBAR penalties, unless the examination results in a determination that the original tax non-compliance was fraudulent and/or that the FBAR violation was willful.
The requirement to report and disclose foreign accounts and assets is the proverbial dropping of the other shoe. Like unfiled tax returns, the failure to comply with the FBAR requirements is a crime of moral turpitude from an immigration standpoint which makes the immigrant inadmissible and possibly removable (deportable) for immigration purposes. Unlike other legal waivers in the immigration arena which generally involve a written request, the waiver for the failure to file tax returns and FBARs will require a commitment to “pay up” or at least a promise to pay. The penalties are onerous. Fortunately, non-willful non-compliance should not land the taxpayer in jail.
While the topic of unfiled tax returns has infrequently be discussed from either a tax or immigration standpoint has rarely been discussed, the financial and immigration implications of FBAR as far as I know have never the discussion. The FBAR has a low threshold for taxpayers in order to become applicable. The first step in moving forward is an acknowledgement of the problem followed by steps to determine its application to the taxpayer. My sense is that where it applies to undocumented immigrants, the streamlined process would be available for many immigrants – documented or undocumented.
Gerald Nowotny – Osborne & Osborne, PA
266 Lovely Street
Avon, CT 06001