If you have undisclosed foreign financial accounts or unreported foreign income, you may face heavy penalties for failing to comply with the IRS’s reporting requirements. The IRS imposes significant penalties for failing to disclose foreign financial accounts, even if the failure was unintentional.
Fortunately, taxpayers who discover previously unreported foreign financial accounts have a few options for correcting their mistake. The appropriate solution depends on the value of the accounts, if the income from the accounts was reported, and whether the failure to file was willful.
U.S. citizens and resident aliens must report their worldwide income, including income earned through foreign accounts. In addition, US taxpayers must file a Foreign Bank Account Report (FBAR) if the combined value of all their foreign financial accounts exceeds $10,000 at any point during the year. Lastly, US taxpayers must file Form 8938 (FATCA) with their annual tax return if they reside in the US and are single and had foreign financial assets exceed $50,000 on the last day of the year or if their foreign financial assets exceed $75,000 at any point during the year. The filing threshold is higher for married taxpayers and for taxpayers that reside outside the US.
If the taxpayer did not report either the foreign financial accounts or the income associated with the foreign financial accounts, and the failure was non-willful, the taxpayer may be eligible for Streamlined Filing Compliance Procedures. The taxpayers would have to file amended tax returns for the most recent 3 years, file FBARs for the most recent six years, pay any additional income tax and interest, pay a 5% fine equal to the highest aggregate value of the accounts, and certify that the failure to file was non-willful. A taxpayer based outside the United States would follow the same procedures but would not have to pay the 5% penalty.
Here’s what would happen if the taxpayer discovered a previously unreported bank account with a balance of $250,000 and it was the taxpayer’s only foreign account. The taxpayer would enter either the Streamlined Domestic Offshore Procedures if the taxpayer resided in the US, or the Streamlined Foreign Offshore Procedures if the taxpayer resided outside the US. The taxpayer would first have to file amended tax returns for the prior 3 years and FBARs for the prior 6 years. The amended return would have to include form 8938 (FATCA) if the taxpayer was living in the United States or if the taxpayer was living abroad and filed as a single person or married filing separately. If the taxpayer filed Married Filling Jointly and lived abroad, they would not have to include form 8938, because the thresh hold for foreign accounts for people married filing jointly is $400,000 on the last day of the year and $600,000 at any point during the year.
The taxpayer would have to pay any income tax due from any unreported income as well as any interest on that tax. If the taxpayer was using the domestic procedures, he would have to pay a 5% penalty, for a total of $12,500. If the taxpayer was using the foreign procedures, he would not have to pay the 5% penalty.
If the newly discovered account was worth $20,000 and not $250,000, then the taxpayer would not have to file form 8938 with the amended returns because the minimum filing threshold is $50,000. However, the taxpayer would still have to amended tax returns for the prior 3 years and FBARs for the prior 6 years. The taxpayer would have to pay any income tax due from any unreported income as well as any interest on that tax. If the taxpayer was using the domestic procedures, he would have to pay a 5% penalty, for a total of $1,000. If the taxpayer was using the foreign procedures, he would not have to pay the 5% penalty.
If the newly discovered account was only $5,000, and that is the only foreign account, the taxpayer does not have a reporting obligation because FBARs only needed to be filed when the taxpayer has foreign financial accounts in the aggregate exceed $10,000. However, any income earned on the $5,000 account would still need to be reported.
These Streamlined Procedures are only available if the IRS has not contacted the taxpayer. If the IRS has contacted the taxpayer for a civil examination or criminal investigation the procedures are not available and the taxpayer would face severe fines and penalties. The inflation-adjusted penalty for a missed FBAR is $16,536 per FBAR report for a non-willful failure-to-file. For a willful failure-to-file the penalty is the greater of $165,353 or 50% of the account balance. For FATCA Form 8938, the penalty for a non-willful failure-to-file starts at $10,000. If the IRS notifies the taxpayer of the failure-to-file and form 8938 is not filed within 90 days, additional $10,000 penalties apply every 30 days, scaling up to a maximum of $60,000. For a willful failure-to-file, the penalty is the greater of $100,000 or 50% of the account value.
Given the complexities of surrounding foreign accounts, it is important to review your reporting obligations with a tax professional annually. At Safeguard Law, PLLC, our team of experienced tax attorneys specializes in helping our clients navigate issues such as this. Contact us today to schedule a consultation! Our main business line is (202) 505-1741.