Correcting United States Income Tax and Foreign Asset Reporting Problems. D. Sean McMahon, J.D., LL.M. McMahon & Associates, PC Boston, Massachusetts

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1 Correcting United States Income Tax and Foreign Asset Reporting Problems D. Sean McMahon, J.D., LL.M. McMahon & Associates, PC Boston, Massachusetts

2 D. Sean McMahon, J.D., LL.M. Former Senior Attorney with the United States Internal Revenue Service ( IRS ) Office of Chief Counsel Former Special Assistant United States Attorney In private practice since January, 2017

3 The Problem Many US taxpayers have not been fully compliant with their income tax and foreign asset reporting legal requirements IRS has long been aware of the underreporting of non-us income, but previously has been unable to detect non-compliant taxpayers The Foreign Account Tax Compliance Act ( FATCA ) will provide IRS with new information 3 January, 2017

4 The IRS s Solution The IRS Offshore Voluntary Disclosure Program ( OVDP ) OVDP began in 2009 Currently on the 3 rd Version of Regular OVDP Streamlined OVDP added in 2014 for Non-willful violations Delinquent International Information Return Submission Procedures if OVDP is not nevessary 4 January, 2017

5 Two Areas of IRS Filing Problems 1. Income Tax Reporting US taxpayers are taxed on worldwide income 2. Foreign Asset Reporting Separate annual obligation to report: Non-US financial accounts (FBAR form FinCEN Form 114) Non-US controlled business entities (Forms 5471 & 5472) Non-US trusts (Form 3520 & 3520A) Non-US Assets (FATCA Form 8938) 5 January, 2017

6 IRS Filing Problem #1: Income Tax Reporting US citizens are taxed on worldwide income Not just US-sourced income Double taxation offset by: Foreign Tax Credit Foreign Earned Income Exclusion Tax treaties 6 January, 2017

7 IRS Filing Problem #1: Income Tax Reporting Possible Penalties: Criminal charges for tax evasion and filing a false return Civil penalties range from 20% to 75% of tax due 7 January, 2017

8 IRS Filing Problem #2: Foreign Asset Reporting Foreign Bank Account Report ( FBAR ) FinCEN Form 114 U.S. persons who have an interest in or signature authority over non-us accounts must file a FinCEN Form 114, ( FBAR ) if the aggregate value of the accounts is over $10,000 U.S. dollars during the year A U.S. person is a U.S. Citizen or U.S. resident, which can include corporations, partnerships, trusts, etc. 8 January, 2017

9 IRS Filing Problem #2: Foreign Asset Reporting Non-FBAR Foreign Asset Filing Obligations: Filed with US Income tax return Form 5471: Non-US business entities owned by US taxpayers Form 5472: US business entities owned 25% by non-us persons Form 8938: New in 2011 repeats other forms Filed Separately from US Income Tax return Form 3520 & 3520A: foreign trusts and transfers to foreign trusts FBAR 9 January, 2017

10 Possible Penalties: Tax and Certain Non-US Assets Income tax: Criminal Charges for Intentional violation Civil penalties range from 20% to 75% of tax due Non-US Asset Reporting Obligations (other than FBAR) Criminal Charges for intentional violation Maximum penalty per violation usually $10, January, 2017

11 Possible Penalties: FBAR Criminal Charges for intentional violation Civil Penalties: Negligence: Cannot exceed $10,000 per violation Intentional: Higher of $100,000 or 50% of high balance of unreported account per violation 11 January, 2017

12 Solution: Offshore Voluntary Disclosure Program IRS has always had General Voluntary Disclosure Program Purpose is to encourage taxpayers to disclose compliance problems to IRS by promising not to pursue criminal charges and impose reduced penalties Specific Offshore Voluntary Disclosure Program began in 2009 in response to UBS case 12 October, 2016

13 History: Little Enforcement Before 2009 Banking Secrecy Act enacted 1970 (31 USC ; NOT under title 26) IRS granted enforcement authority in 2003 UBS case November, 2014

14 Beginning of the End: UBS case in 2008 UBS charged with criminal conspiracy to commit tax evasion Plea Agreement required information on 4,500 US account holders and $780M penalty First real opportunity to get foreign account information Additional DOJ Deferred Prosecution Agreements with most Swiss Banks (over 100) 14 November, 2014

15 UBS/Swiss Bank Success inspire FATCA in 2010 The Foreign Account and Tax Compliance Act ( FATCA ) Over 110 Counties have signed FATCA Requires foreign banks to report US account holders (over $50,000) 15 November, 2014

16 Current OVDP Options OVDP ( regular OVDP) Available to any taxpayer with unknown problem No criminal charges 8 years of income tax filings and 20% penalty on tax due & interest One-time 27.5% or 50% penalty on unreported assets Streamlined OVDP Separate Programs for US Residents and Non- US residents 3 years of income tax filings and 6 years of FBARs 5% (US-resident) or 0% (non-us resident) on unreported assets 16 October, 2016

17 Streamlined OVDP: Non-Willful Conduct Conduct that is due to negligence, inadvertence, or mistake, or conduct that is the result of a good faith misunderstanding of the requirements of the law 17 October, 2016

18 Streamlined OVDP Residency Distinction To qualify as a Non-US resident, taxpayers must have spent less than 35 days in the US during at least one of the last 3 years Non-US Resident Streamlined OVDP taxpayers can still participate if they have not filed required returns during the last 3 years US-Residents cannot participate in the Streamlined OVDP if they have not filed required returns in the last 3 years 18 October, 2016

19 Streamlined OVDP Acceptance: Then What? Streamlined submissions are subject to less scrutiny that regular OVDP IRS may open an audit within 3 years if it believes submission is false Regular OVDP is not available if IRS rejects Streamlined submission IRS will computer match streamlined submissions with information obtained through FATCA 19 October, 2016

20 Regular OVDP Available to any taxpayer if not under audit/investigation and IRS is unaware of problem 3 Step Process 8 Year Look back period for Income Tax and Foreign Asset Reporting Cost: Additional Tax plus OVDP Penalty OVDP Penalty is either 27.5% or 50% 20 November, 2014

21 Regular OVDP: Acceptance Entire OVDP Package Examined Closing Agreement (Form 906) signed by IRS and taxpayer Case cannot be reopened unless fraud in submission 21 November, 2014

22 Case Study #1 Past Tax Evasion Regular Program Client obtain funds for account as a result of tax evasion Evasion that lead to account balance occurred in year before look back period Balance of funds escaped taxation 22 November, 2014

23 Case Study #2 Transitional Streamline Rejected Client entered Regular OVDP before Streamlined OVDP announced Applied for Transitional treatment IRS rejected transitional streamlined treatment because taxpayer was deceased Could not provide affidavit from taxpayer proclaiming non-willfulness 23 November, 2014

24 Case Study #3 Accidental Americans Ongoing project with Kuwait Many clients recently learned they were American Many do not have social security numbers - Situation not uncommon Need social security number to begin OVDP 24 November, 2014

25 Case Study #4 The Future IRS seeking willful penalties for taxpayers not in OVDP IRS has begun examinations for taxpayers for whom they have received Swiss bank information Agents being trained for FBAR and Foreign Asset reporting problems No Change income tax exam client subject to additional 10 month FBAR exam 25 November, 2014

26 QUESTIONS 26 October, 2016