Is Unreported Foreign Income or Assets Criminal (Examples)

Preventing Criminal Tax Consequences of Foreign Accounts

Is Unreported Foreign Income or Assets Criminal?

International tax law can be difficult — especially when it involves international information reporting of foreign assets and the U.S. tax implications of disclosing foreign income. Due to the complexities of the IRS tax forms, it is not uncommon for U.S. Taxpayers to make mistakes when reporting foreign accounts, assets, investments, income, trusts, entities, etc.  Most of the time when a Taxpayer fails to properly report their foreign assets or income timely or accurately, it is merely a civil tax violation. As a result, the Taxpayer is in no jeopardy of losing their liberty or freedom. Instead, it is just a matter of dealing with the consequences of being out of compliance and the headache of getting into compliance while attempting to minimize and avoid civil fines and penalties. However, sometimes a Taxpayer may violate a criminal statute, which can result in criminal tax consequences. Unlike a civil violation, with a criminal tax violation a Taxpayer may be at risk for both monetary fines and penalties as well as incarceration. Unfortunately for Taxpayers, there is no shortage of fear-mongering attorneys on the World Wide Web making it seem like every filing mistake is a criminal violation in the making when it is simply not true. Let’s look at some common examples of situations that Taxpayers find themselves in and how to try to avoid it from becoming a criminal issue.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Unreported Foreign Income

The United States follows a worldwide income tax model. That means that when a Taxpayer individual is considered a U.S. person for tax purposes, they are required to report both their U.S. and foreign income on their U.S. tax returns. This is true, even if the Taxpayer lives and works overseas and even if the Taxpayer files all their foreign taxes. If a Taxpayer fails to report their foreign income on their U.S. tax return it is not necessarily a criminal situation, but it can morph into a criminal situation if the Taxpayer does not take the necessary precautions and resolve the issue.

• • • Example 1: Peter lives in the United States but earns passive income from his foreign investments. Only very recently for the first time did Peter learn that he should have been reporting this information on his U.S. tax return, so he immediately goes back and amends the returns using one of the IRS disclosure programs. This is not a criminal violation.

    • Example 2: Brenda lives outside of the United States in a high tax jurisdiction. She files her U.S. tax returns in the United States and her foreign tax returns overseas — and pays a significant amount of foreign taxes. Only recently did Brenda learn that she should have been reporting her foreign information on her U.S. tax return. Brenda submits to one of the offshore disclosure programs and gets herself into compliance by following IRS protocol. This is not a criminal violation.

    • Example 3: Scott lives in the United States and earns a significant amount of income from foreign sources in which the income is not taxed in those jurisdictions. Scott thought that since the income was not taxed overseas it was not taxed in the United States either. Recently Scott learned that he should have been including this income on his U.S. tax return, but Scott does not want to pay U.S. tax on the foreign income, so he does not resolve the prior year unreported income and knowingly continues to file U.S. returns without including his foreign income (or reporting his foreign accounts). This may become a criminal tax violation.

Unreported Foreign Accounts and Assets

Just as the United States requires U.S. persons to report their worldwide income — even if it was sourced from overseas and even if the Taxpayer resides outside of the United States — Taxpayers are also required to report their foreign accounts and assets to the U.S. government. The U.S. government has developed several different international information reporting forms that a Taxpayer may be required to file to disclose their offshore assets to the IRS — and they may have to file multiple IRS tax forms in the same year. 

• • • Example 1: Dennis previously lived outside the United States but relocated to the U.S. a few years ago. He has several foreign accounts outside of the United States but was never aware that he was supposed to report the accounts, and his CPA never told him. Once Dennis learns that he is out of compliance, he immediately submits to one of the offshore disclosure programs to get into compliance. This is not a criminal tax violation.

    • Example 2: David lives outside of the United States and has several foreign accounts and investment accounts, including rental income from a foreign rental property — since he was not aware of the U.S. reporting requirements, none of this information was included on his U.S. tax return. When David completed the KYC forms at his different foreign financial institutions to open his accounts, he did let them know he was a U.S. citizen. Also, David has a foreign rental property but because his foreign rental income nets a loss, he was unaware that it was required to be reported on his U.S. tax return. Recently, David learned that he should have been reporting this information and so he submitted to one of the disclosure programs. This is not a criminal tax violation.

    • Example 3: Nancy has a few foreign accounts overseas, but she did not report the accounts. Recently, Nancy learned that she should have been reporting the accounts and she only learned this after she had received a large foreign inheritance. Nancy recently learned that she was also required to file Form 3520 for the inheritance. Nancy decides to not include any of these forms on her current or future filings and does not go back to resolve the prior year non-compliance. Each year that Nancy completes 1040 Schedule B she puts ‘No’ for foreign accounts — although she knows she has foreign accounts, and she knows they are reportable. She also excludes the interest income from the foreign account that she knows is reportable for U.S. taxes because they are tax exempt outside of the U.S., and she does not want to pay U.S. tax on the income. This may become a criminal tax violation.

Tax Fraud and Tax Evasion

It is important to understand that simply because the Taxpayer fails to report some income from a foreign country does not automatically mean that the Taxpayer committed tax fraud or tax evasion. It is based on the overall facts and circumstances of the non-compliance that will determine whether the Taxpayer’s non-compliance reaches the level of criminal willfulness.

• • • Example 1: Adam works outside of the United States and earns $110,000 a year. Adam did not file tax returns for the past few years because he thought that since he was under the Foreign Earned Income Exclusion, he was not required to file a tax return. Recently, for the first time Adam learned that he should have been filing U.S. tax returns and he immediately goes back and fixes his prior returns. This is not a criminal tax violation.

    • Example 2: Dennis works outside of the United States in a country that does not tax personal income. Dennis earns $300,000 a year and he thought because he lived outside of the United States, he did not have to file U.S. taxes. Once Dennis learns that he is required to report his foreign income he continues to not report it because he thinks he will not get caught and he does not want to pay U.S. tax on income that is exempt overseas. This may become a criminal tax violation.

    • Example 3: Scott has his own small business in a foreign country. Scott’s foreign business begins to flourish and because he does not have any deductions/expenses, he intentionally created false deductions to artificially reduce his income because he thought since he was in a foreign country the IRS could not find him. Unfortunately, after having continually falsifying his deductions he gets audited by the IRS and based on the amount of unreported income and the fact that there was no basis for any of these deductions over several years, it may become a criminal tax violation.

The Tip of the Iceberg

The goal of this article is to help clarify some of the basics of international information reporting. Reporting foreign assets to the U.S. tax authorities can be very complicated, especially when it involves additional items such as foreign life insurance policies, foreign corporations, foreign partnerships, and transactions between U.S. persons and foreign companies. Taxpayers should try to stay in compliance if they are already in compliance or should consider getting into compliance if they have not properly filed the necessary reporting forms if for no other reason than the fact that the IRS has made offshore compliance a key enforcement priority and has been issuing fines and penalties for non-compliance. 

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer 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 who 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. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

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.