IRS Offshore Penalties and How to Protect Your Foreign Money

IRS Offshore Penalties: List of International Reporting Fines

IRS Offshore Penalties

In recent years, the Internal Revenue Service has increased enforcement of international tax and reporting compliance. With the globalization of the US economy, more than ever, US Persons across the globe have assets, investments, accounts, and income outside of the United States. Unfortunately, the IRS tax rules involving foreign assets and income reporting are very complicated. The penalty structure for foreign asset reporting is different than it is for other non-international reporting penalties — because international fines do not follow the typical deficiency procedure process. Oftentimes, taxpayers are penalized before they ever can negotiate a resolution with an IRS agent. Rather, taxpayers are forced to try to negotiate the penalty after being assessed penalties (usually on a CP-15 Notice), which puts them in a much more difficult negotiating position. Let’s go through some of the more common tax penalties and reporting penalties.

US Income Tax and Reporting

As a preface to this article, it is important to understand that, unlike almost every other country in the world, the United States follows a worldwide income and reporting model. That means, that whether a person resides in the United States or outside of the United States if they are considered a US person for tax purposes — then they are taxed on their worldwide income. This typically involves three categories of individuals: US Citizens, Lawful Permanent Residents, and Foreign Nationals who meet the Substantial Presence Test. You may also see worldwide income and reporting identified online as ‘Citizenship-Based Taxation’ but please keep in mind that the term is a misnomer, because it is not limited to citizens.

Taxes

Let’s take a look at some of the more common tax penalties:

Underpayment

The penalties for taxes are generally the same whether it is international or domestic. In other words, if a person fails to report income, they could get hit with an accuracy-related penalty. If instead, a person knowingly fails to report income then it could fall into the ‘tax fraud’ category — and if they are criminal implications, it could possibly lead to tax evasion or criminal fraud.

Fraud and Evasion

As mentioned above, if the IRS believes that a Taxpayer acted fraudulently in failing to report their foreign income then they could become subject to more serious fraud penalties as well as a potential IRS Special Agent Investigation. Depending on the outcome of that investigation, it may lead to more criminal-related issues.

Passport Revocation

One very serious penalty that tends to impact international taxpayers is passport revocation for having seriously delinquent tax debt. If a US person has a passport and they have a seriously delinquent tax debt, then in conjunction with IRS rules, the IRS can work with USCIS to have a passport revoked or renewal denied. The IRS has been using this tactic much more frequently lately – and courts across the nation have affirmed the IRS’ power to revoke or deny passports.

Levy, Lien, or Seizure

Just because a taxpayer may have missed reporting foreign income does not mean the IRS is limited to trying to go overseas to collect taxes and penalties. Rather, the IRS can put a Levy, Lien, or even a Seizure of a US Person’s United States property and bank accounts. Technically, the IRS may be able to go overseas to try to enforce tax liabilities and penalties by way of various double tax treaties and FATCA Agreements between the United States and foreign countries — but it is usually easier for the Internal Revenue Service to instead issue a Notice of Federal Tax Lien or Levy against US properties or assets.

Writ Ne Exat

While the Internal Revenue Service has many different options available when it comes to seeking enforcement of unpaid tax and penalty liabilities, the Writ Ne Exeat Republica is one of the least common and most lethal — if for no other reason than its ability to stun and immobilize a taxpayer. Unlike an IRS Levy, Lien, or Seizure – which remain focused on the accounts and assets of the taxpayer – this particular type of writ focuses on the taxpayer himself. More specifically, it may prevent the taxpayer from leaving the jurisdiction until a tax liability has been resolved. Let’s take a walk through the basics of a Writ Ne Exeat Republica.

International Penalties

When it comes to international reporting penalties, there are many different violations that the IRS likes to go after for US taxpayers who did not properly report their foreign assets. Some of the more common types of foreign money include:

• • • foreign bank accounts

    • foreign investment accounts

    • foreign trusts

    • foreign corporations

    • foreign gifts

    • foreign pension plans, and

    • foreign life insurance policies

First, 26 USC 6501(c)(8) Danger

As a preface to international reporting penalties, it is important to know that the general rule is that the IRS has three years to go after a taxpayer to assess penalties for international information reporting forms like the ones identified below. But, pursuant to 26 USC 6501(c)(8), if the taxpayer does not file the form then the statute does not begin to run – which is similar in concept to when a US taxpayer does not file a tax return and the statue does not begin to run either.  The kicker with international reporting forms is that even if the tax return is filed timely — if the taxpayer does not file a timely and correct international reporting form — the statute remains open, as well as the case in the recent tax court case of Fairbank.

FBAR

Each year, taxpayers who have foreign bank and financial accounts are required to file an annual FBAR if they meet the threshold requirements for reporting. As a result of the new 2023 Supreme Court FBAR ruling the penalty structure for civil non-willful FBAR violations has changed. For non-willful FBAR violations, the IRS is limited to $10,000 per year (adjusts for inflation). Willful civil FBAR penalties are still a 50% penalty on the maximum unreported value for each account, for up to six years. And while rare, the IRS (in limited circumstances) can refer the matter for criminal investigation.

The following penalties are reproduced from the IRS, as follows:

Form 3520 Trust

• • • “Section 6677. A penalty applies if Form 3520 is not timely filed or if the information is incomplete or incorrect (see below for an exception if there is reasonable cause). Generally, the initial penalty is equal to the greater of $10,000 or the following (as applicable).

      • 35% of the gross value of any property transferred to a foreign trust for failure by a U.S. transferor to report the creation of or transfer to a foreign trust in Part I. -2- Instructions for Form 3520 (2022)

      • 35% of the gross value of the distributions received from a foreign trust for failure by a U.S. person to report receipt of the distribution in Part III.

      • 5% of the gross value of the portion of the foreign trust’s assets treated as owned by a U.S. person under the grantor trust rules (sections 671 through 679), if the foreign trust (a) fails to file a timely Form 3520-A and furnish the required annual statements to its U.S. owners and U.S. beneficiaries, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information.

      • If a foreign trust fails to file Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for the Form 3520-A, which is otherwise due by the 15th day of the 3rd month after the end of the trust’s tax year) in order to avoid being subject to the penalty for the foreign trust’s failure to timely file Form 3520-A.

      • For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for U.S. owners who are individuals), is considered to be timely filed. See section 6677(a) through (c) and the instructions for Part II of this form and Form 3520-A. Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. If the IRS can determine the gross reportable amount (defined later), then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross reportable amount. For more information, see section 6677.”

Form 3520- Gifts

• • • Section 6039F.

      • In the case of a failure to timely report foreign gifts described in section 6039F, the IRS may determine the income tax consequences of the receipt of such gift, and a penalty equal to 5% of the amount of such foreign gifts applies for each month for which the failure to report continues (not to exceed a total of 25%). No penalty will be imposed if the taxpayer can demonstrate that the failure to comply was due to reasonable cause and not willful neglect. See section 6039F for additional information.

Form 3520-A

• • • “The U.S. owner is subject to an initial penalty equal to the greater of $10,000 or 5% of the gross value (defined later) of the portion of the trust’s assets treated as owned by the U.S. person at the close of that tax year if the foreign trust (a) fails to file a timely Form 3520-A, or (b) does not furnish all of the information required by section 6048(b) or includes incorrect information. See section 6677(a) through (c). If a foreign trust fails to file a Form 3520-A, the U.S. owner must complete and attach a substitute Form 3520-A to the U.S. owner’s Form 3520 by the due date of the U.S. owner’s Form 3520 (and not the due date for Form 3520-A) in order to avoid being subject to a penalty for the foreign trust’s failure to file a Form 3520-A. For example, a substitute Form 3520-A that, to the best of the U.S. owner’s ability, is completed and attached to the U.S. owner’s Form 3520 by the due date for the Form 3520 (such as April 15 for the U.S. owners who are individuals) is considered timely filed.

    • Additional penalties will be imposed if the noncompliance continues for more than 90 days after the IRS mails a notice of failure to comply with the required reporting. If the IRS can determine the gross value (defined later) of the portion of the trust’s assets treated as owned by the U.S. person at the close of the tax year, then the penalties will be reduced as necessary to assure that the aggregate amount of such penalties does not exceed the gross value of the trust. For more information, see section 6677.

    • Criminal penalties may be imposed under sections 7203, 7206, and 7207 for failure to file on time and for filing a false or fraudulent return.”

Form 5471 Penalties

• • • “A $10,000 penalty is imposed for each annual accounting period of each foreign corporation for failure to furnish the information required by section 6038(a) within the time prescribed. If the information is not filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign corporation) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.

      • Any person who fails to file or report all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure to the U.S. person, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038(c) (2) for limits on the amount of this penalty. See Regulations sections 1.6038-1(j) and 1.6038-2(k)(3) for alleviation of this penalty in certain cases. Failure to file information required by section 6046 and the related regulations (Form 5471 and Schedule O).

      • Any person who fails to file or report all of the information requested by section 6046 is subject to a $10,000 penalty for each such failure for each reportable transaction. If the failure continues for more than 90 days after the date the IRS mails notice of the failure, an additional $10,000 penalty will apply for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000. See section 6679. Criminal penalties. Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file the information required by sections 6038 and 6046.”

Form 5472 Penalties

• • • A penalty of $25,000 will be assessed on any reporting corporation that fails to file Form 5472 when due and in the manner prescribed. The penalty also applies for failure to maintain records as required by Regulations section 1.6038A-3. 

      • Filing a substantially incomplete Form 5472 constitutes a failure to file Form 5472. Each member of a group of corporations filing a consolidated information return is a separate reporting corporation subject to a separate $25,000 penalty and each member is jointly and severally liable. If the failure continues for more than 90 days after notification by the IRS, an additional penalty of $25,000 will apply.

      • This penalty applies with respect to each related party for which a failure occurs for each 30-day period (or part of a 30-day period) during which the failure continues after the 90-day period ends. Criminal penalties under sections 7203, 7206, and 7207 may also apply for failure to submit information or for filing false or fraudulent information.

Form 8865

• • • “Failure to timely submit all information required of Category 1 and 2 filers.

      • A $10,000 penalty is imposed for each tax year of each foreign partnership for failure to furnish the required information within the time prescribed. If the information isn’t filed within 90 days after the IRS has mailed a notice of the failure to the U.S. person, an additional $10,000 penalty (per foreign partnership) is charged for each 30-day period, or fraction thereof, during which the failure continues after the 90-day period has expired. The additional penalty is limited to a maximum of $50,000 for each failure.

      • Any person who fails to furnish all of the information required within the time prescribed will be subject to a reduction of 10% of the foreign taxes available for credit under sections 901 and 960. If the failure continues 90 days or more after the date the IRS mails notice of the failure, an additional 5% reduction is made for each 3-month period, or fraction thereof, during which the failure continues after the 90-day period has expired. See section 6038 (and the underlying regulations) for the maximum reduction, the exception due to reasonable cause, and the limits on the amount of these penalties. • Criminal penalties under sections 7203, 7206, and 7207 may apply for failure to file or for filing false or fraudulent information.

      • Additionally, any person that files under the constructive owners exception may be subject to these penalties if all the requirements of the exception aren’t met. Any person required to file Form 8865 who doesn’t file under the multiple Category 1 filers exception may be subject to the above penalties if the other person doesn’t file a correctly completed form and schedules. See Exceptions to Filing, earlier.”

For 8938 Penalties

• • • You may be subject to penalties if you fail to timely file a correct Form 8938 or if you have an understatement of tax relating to an undisclosed specified foreign financial asset.

    • Failure-To-File Penalty: If you are required to file Form 8938 but do not file a complete and correct Form 8938 by the due date (including extensions), you may be subject to a penalty of $10,000.

    • Continuing Failure To File: If you do not file a correct and complete Form 8938 within 90 days after the IRS mails you a notice of the failure to file, you may be subject to an additional penalty of $10,000 for each 30-day period (or part of a period) during which you continue to fail to file Form 8938 after the 90-day period has expired. The maximum additional penalty for a continuing failure to file Form 8938 is $50,000.

Form 8621 Penalties

• • • Disclosure, Privacy Act, and Paperwork Reduction Act Notice. We ask for the information on this form to carry out the Internal Revenue laws of the United States. Sections 6001, 6011, 6012(a), and 6109, and their regulations, require you to provide this information.

    • We need this information to ensure that you are complying with the Internal Revenue laws and to allow us to figure and determine the right amount of tax. You must fill in all parts of the tax form that apply to you. If you do not file a return under circumstances requiring its filing, do not provide the information we ask for, or provide fraudulent information, you may be charged penalties and be subject to criminal prosecution.

Current Year vs Prior Year Non-Compliance

Once a taxpayer has missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.