New Foreign Financial Asset Reporting Requirements
The IRS reopened the Offshore Voluntary Disclosure Program (OVDP) on January 9, 2012 following continued strong interest from taxpayers and tax practitioners after the closure of the 2011 and 2009 programs. The third offshore program will be open for an indefinite period until otherwise announced.
The program’s objective is to bring taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with United States tax laws by offering consistency and predictability to taxpayers in determining the amount of tax and penalties they face. Also when a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure program, the IRS will not recommend criminal prosecution to the Department of Justice.
Key Differences from the 2011 OVDP
Unlike last year, there is no set deadline for people to apply. However, the terms of the program could change at any time going forward. For example, the IRS may increase penalties in the program for all or some taxpayers or defined classes of taxpayers – or decide to end the program entirely at any point.
The overall penalty structure for the new 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. Some taxpayers will be eligible for 5 or 12.5 percent penalties; these remain the same in the new program as in 2011.
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.
Participants face a 27.5 percent penalty, but taxpayers in limited situations can qualify for a 5 percent penalty. Smaller offshore accounts will face a 12.5 percent penalty. People whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the new OVDP will qualify for this lower rate. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined.
More Foreign Financial Asset Compliance with the Passage of the FATCA
In addition to the efforts of IRS through the 2012 OVDI, congress is also trying to improve tax compliance involving foreign financial assets and offshore accounts by passing the Foreign Account Tax Compliance Act (FATCA).
Under FATCA, U.S. taxpayers with specified foreign financial assets that exceed certain thresholds must report those assets to the IRS. This reporting will be made on Form 8938, which individual taxpayers attach to their federal income tax return for tax years beginning after March 18, 2010.
In addition, FATCA will require foreign financial institutions to report directly to the IRS information about financial accounts held by U.S. taxpayers, or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest.
When to Use Form 8938
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 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.
Instructions for Form 8938 explain the thresholds for reporting, what constitutes a specified foreign financial asset, how to determine the total value of relevant assets, what assets are exempted, and what information must be provided.
Form 8938 is not required of individuals who do not have an income tax return filing requirement. The new Form 8938 filing requirement does not replace or otherwise affect a taxpayer’s obligation to file an FBAR (Report of Foreign Bank and Financial Accounts). Failing to file Form 8938 when required could result in a $10,000 penalty, with an additional penalty up to $50,000 for continued failure to file after IRS notification. A 40 percent penalty on any understatement of tax attributable to non-disclosed assets can also be imposed. Special statute of limitation rules apply to Form 8938, which are also explained in the instructions.