I. OVERVIEW: RIGHT TO HOLD FUNDS

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1 1 I. OVERVIEW: RIGHT TO HOLD FUNDS U.S. taxpayers can hold offshore accounts for a number of non tax reasons, including access to funds while living or working overseas, asset protection, investment portfolio diversification, enhanced investment opportunities, and to facilitate international business transactions. Page 1

2 2 I. OVERVIEW: REPORTING REQUIREMENTS U.S. taxpayers must report whether they have offshore accounts on Schedule B of the Form 1040 they are to pay taxes on income from the offshore accounts at their individual tax rates. Page 2

3 3 I. OVERVIEW: REPORTING REQUIREMENTS Some taxpayers with large offshore account balances are also required to report additional account information, such as the name and location of their bank, by filing a form TD F , Report of Foreign Bank and Financial Accounts (FBAR). Page 3

4 4 I. OVERVIEW: OBLIGATION TO FILE FBAR Page 4 Under the Bank Secrecy Act (BSA), a U.S. person with a financial interest in, or signature or other authority over a bank, securities, or other financial account in a foreign country, is required to report their interest to the IRS annually. A U.S. person must report the maximum account value of each foreign financial account on the FBAR in each year the aggregate amount in such accounts exceeds $10,000 at any point during the year.

5 5 I. OVERVIEW: TAX LOSS TO GOVERNMENT Page 5 U.S. financial institutions are required to provide information returns that report income earned by account holders to the IRS. IRS uses the information to check whether taxpayers are reporting investment earnings and other income correctly. There is no reporting regime for foreign financial institutions. Thus, the IRS believes that this lack of information has limited its ability to ensure taxpayers were reporting offshore income accurately.

6 6 I. OVERVIEW: TAX LOSS TO GOVERNMENT Former Internal Revenue Service (IRS) Commissioner Charles O. Rossotti said in 2002 at a congressional hearing that he believed offshore noncompliance to be several tens of billions of dollars. Page 6

7 7 I. OVERVIEW: OFFSHORE INFORMATION REPORTING Page 7

8 8 I. OVERVIEW: FOREIGN ACCOUNT TAX COMPLIANCE ACT Foreign Account Tax Compliance Act (FATCA), beginning in 2015, requires U.S. Financial institutions to withhold a portion of certain payments made to foreign financial institutions that have not entered into a specific agreement with IRS to report information on their U.S. clients. Page 8

9 9 I. OVERVIEW OFFSHORE VOLUNTARY COMPLIANCE INITIATIVE Almost All 2009 OVDP Participants Received the Maximum Offshore Penalty, Almost Half Had Accounts in Switzerland, and About Half of the Revenue Collected Came from A Small Percentage of High Penalty Cases. Page 9

10 10 I. OVERVIEW: OVDI DATA MINING IRS Generally Has Used 2009 OVDP Data Strategically, But Has Not Used the Data to Identify Additional Opportunities to Educate Taxpayers on Offshore Filing Requirements. Page 10

11 11 II. OFFSHORE PROGRAMS DATA MINING In an effort to learn the identities of some of the taxpayers suspected of noncompliance; the government employed the use of John Doe summonses. Page 11

12 12 II. OVDI PENALTY STRUCTURE Page 12 In lieu of other penalties that could apply to undisclosed foreign assets, including the FBAR penalties, the IRS imposes an Offshore Penalty equal to 27.5% (or in limited cases 12.5% or 5%) of the highest aggregate balance in foreign assets during any year in the period covered by the voluntary disclosure.

13 13 II. OVDI PENALTY STRUCTURE Page 13 The Offshore Penalty is based on all of the taxpayer s foreign assets that are related in any way to tax noncompliance. For this purpose, tax non compliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.

14 14 II. OVDI PENALTY QUIET FILING An alternative to participation in OVDP would be to quietly file FBARs and amended tax returns in the hope that they are processed without scrutiny. This would avoid the additional time and cost associated with the extensive OVDP document requirements. Page 14

15 15 II OVDP PENALTY SOMETIMES QUIET FILING The quiet filing strategy involves submitting FBARs and tax returns for years that are still open under the applicable statute of limitations. Generally, this means filing FBARs and amended tax returns for the prior six (6) years. Page 15

16 16 II. OFFSHORE PROGRAMS THEY LL FIND YOU. Taxpayers who do not participate in an OVDI program and are otherwise known to the IRS run the risk of being audited outside of an offshore program. Page 16

17 17 II. OFFSHORE PROGRAMS THEY LL FIND YOU. Since 2009, IRS and the Department of Justice (DOJ) have publicized more than 40 prosecutions of UBS clients and UBS bankers. Page 17

18 18 II. OFFSHORE PROGRAMS Since 2003, IRS has carried out four offshore voluntary disclosure programs, collectively referred to as offshore programs. As of December 2012, these offshore programs have resulted in more than 39,000 disclosures and over $5.5 billion in revenues. Page 18

19 19 II. OFFSHORE PROGRAMS A Quiet disclosure is to file amended tax returns and FBARs that report offshore income from prior years. Page 19

20 20 II. OFFSHORE PROGRAMS Another technique is for taxpayers to declare existing offshore accounts for the first time with their current year s tax return moving forward only. Page 20

21 21 II. OFFSHORE PROGRAMS DATA MINING IRS May Not Be Identifying a Large Number of Quiet Disclosures or Other Attempts to Circumvent Some of the Taxes, Interest and Penalties that would be Otherwise Owed by Not Participating in an Offshore Program Page 21

22 22 II. OFFSHORE PROGRAMS DATA MINING IRS may also use information gathered through prior offshore programs to identify other banks or countries where U.S. taxpayers may be hiding offshore income Page 22

23 23 III. APPLICATION TO OVDI Provided that they meet certain criteria, taxpayers are accepted into one of IRS s offshore programs by responding to IRS questions about the nature of their offshore noncompliance in an application letter and filing amended or late tax returns and FBARs. Page 23

24 24 III. APPLICATION TO OVDI Investigators from IRS s Criminal Investigation division generally review applications to verify that taxpayers are not sources, and that the taxpayer has made a complete and truthful disclosure. Page 24

25 25 III. OVDP APPLICATION IRS Criminal Investigation will review the Disclosure Letter and then likely provide preliminary acceptance to make a full voluntary disclosure. Thereafter, you have 90 days to submit the full OVDP package. The full OVDP package disclosure will require the following items: A. Copies of previously filed original federal income tax returns for tax years covered by the voluntary disclosure; Page 25 B. Complete and accurate amended federal income tax returns for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account;

26 26 III. OVDP APPLICATION C. Complete and accurate original or amended FBARs for tax years covered by the voluntary disclosure; D. Cooperation in the voluntary disclosure process, including providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing Title 26 liabilities and FBAR penalties. Page 26

27 27 III. OVDP APPLICATION E. Payment of 20% accuracy related penalties under IRC Section 6662(a) on the full amount of offshore related underpayments of tax for all years; F. Payment of failure to file penalties under IRC Section 6651(a)(1), if applicable; G. Payment of failure to pay penalties under IRC Section 6651(a)(2), if applicable Page 27

28 28 III. OVDP APPLICATION H. Payment of a miscellaneous Offshore Penalty equal to 5%, 12,.5% or27.5% depending upon the tax payer s qualifications this figure is calculated on the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during that period covered by the voluntary disclosure.; I. Full payment of any tax liabilities for years included in the offshore disclosure period and all tax, interest, accuracy related penalties for underpayments related to offshore accounts and entities, and, if applicable, the failure to file and failure to pay penalties with the required submissions or make good faith arrangements with the IRS to pay in full, the tax, interest, and these penalties; Page 28

29 29 III. OVDP APPLICATION J. Execution of a Closing Agreement on Final Determination Covering Specific Matters, Form 906; and K. Agreement to cooperate with IRS offshore enforcement efforts by providing information about offshore financial institutions, offshore service providers, and other facilitators, if requested. Page 29

30 30 III. OVDI APPLICATION The letter from CI will provide instructions to submit the full voluntary disclosure package of information to the Austin Campus: Page 30 Internal Revenue Service 3651 S. I H 35 Stop 4301 AUSC Austin, TX ATTN: 2011 Offshore Voluntary Disclosure Initiative.

31 31 III. OVDI APPLICATION Page 31 The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: A. 1040s or 1040x for all tax years covered by the voluntary disclosure. They are to be accompanied by all applicable schedules detailing the amount and type of previously unreported income from the account or entity (e.g. Schedule B for interest and dividends, Schedule D for capital gains and losses, Schedule E for income from partnerships, S corporations, estates or trusts).

32 32 III. OVDI APPLICATION The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: B. Completed Foreign Account or Asset Statement for each previously undisclosed foreign account or asset during the voluntary disclosure period; C. For those applicants disclosing offshore financial accounts with an aggregate highest account balance in any year of $1 million or more, a completed Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer had undisclosed accounts or transactions during the voluntary disclosure period. Page 32

33 33 III. OVDI APPLICATION The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: D. Properly completed and signed Taxpayer Account Summary with Penalty Calculation; E. A check payable to the Dept of Treasury in the total amount of tax, interest, accuracy related penalty, and the failure to file and failure to pay penalties, for the voluntary disclosure period. If you can t pay the total amount of tax, interest and penalties as described above, submit your proposed payment arrangement and a completed Collection Information Statement. Page 33

34 34 III. OVDI APPLICATION The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: F. For those applicants disclosing offshore financial accounts with an aggregate highest account balance in any year of $500,000 or more, copies of offshore financial account statements reflecting all account activity for each of the tax years covered by your voluntary disclosure. Page 34

35 35 III. OVDI APPLICATION The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: G. For those applicants disclosing offshore financial accounts with an aggregate highest account balance of less than $500,000, copies of offshore financial account statements reflecting all account activity for each of the tax years covered by your voluntary disclosure must be readily available upon request Page 35

36 36 III. OVDI APPLICATION The package sent to the 2012 Offshore Voluntary Disclosure Initiative must include: H. Properly completed and signed agreements to extend the period of time to assess tax and to assess FBAR penalties. Page 36

37 37 IV: OVDI - PENALTIES Page 37 Form TD F United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year.

38 38 IV. OVDI - PENALTIES Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 % of the total balance of the foreign account per violation. See 31 U.S.C. 5321(a)(5). Non willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation. Page 38

39 39 IV. OVDI - PENALTIES A penalty for failing to file Form 3520; Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC This return also reports the receipt of gifts from foreign entities under IRC 6039F. Page 39

40 40 IV. OVDI PENALTIES A penalty for failing to file Form Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35% percent of the gross reportable amount, except for returns reporting gifts, where the penalty is 5% percent of the gift per month, up to a maximum penalty of 25 % of the gift. Page 40

41 41 IV. OVDI PENALTIES Page 41 The Form 3520 reports various transactions involving foreign trusts, including creation of a foreign trust by a U.S. person, transfers of property from a U.S. person to a foreign trust and receipt of distributions from foreign trusts under Code Sec This return also reports the receipt of gifts that, in the aggregate, exceed $10,000 from foreign entities under Code Sec. 6039F.

42 42 IV. OVDI - PENALTIES You are required to file Form 3520 in any of the following circumstances: you are the responsible party for reporting a reportable event that occurred during the current tax year, or you held an outstanding obligation of a related foreign trust (or a person related to the trust) that you treated as a qualified obligation during the current tax year; You are a U.S. person who, during the current tax year, is treated as the owner of any part of the assets of a foreign trust under the grantor trust rules. Page 42

43 43 IV. OVDI PENALTIES You are required to file Form 3520 in any of the following circumstances: You are a U.S. person who received (directly or indirectly) a distribution from a foreign trust during the current tax year or a related foreign trust held an outstanding obligation issued by you (or a person related to you) that you treated as a qualified obligation during the current tax year. You are a U.S. person who, during the current tax year, received either 1. more than $100,000 from a nonresident alien individual or a foreign estate (including foreign persons related to that nonresident alien individual or foreign estate) that you treated as gifts or bequests; or 2. more than $13,561 (adjusted each year) from foreign partnerships (including foreign persons related to such foreign corporations or foreign partnerships) that you treated as gifts. Page 43

44 44 IV. OVDI PENALTIES A continuation penalty of $10,000 will be added for each 30 day period, or fraction thereof, that such failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. Page 44

45 45 IV. OVDI PENALTIES Page 45 The total penalty cannot exceed the amount of money transferred. The penalties will not apply if the failure to file is due to reasonable cause and not willful neglect. The fact that a foreign country would impose penalties for disclosing the required information, or reluctance of a foreign fiduciary to provide such information, does not constitute reasonable cause.

46 46 IV. OVDI - PENALTIES Page 46 Failure to file a complete and accurate Form 3520 will extend the period of limitations on assessment and collection of any tax imposed with respect to any event or period to which the Form 3520 applies to 3 years after the date on which the required information is reported.

47 47 IV. OVDI PENALTIES Page 47 Deficiency procedures do not apply to the initial monetary penalties assessed for failure to timely file a complete and accurate Form However, when the required information under Code Sec is not provided, the IRS is authorized to treat any distribution from a foreign trust to a U.S. beneficiary as an accumulation distribution includible in gross income of the distributee. Moreover, when information required by Code Sec. 6039F is not provided to the IRS, it can determine the tax consequences of a gift. These determinations and related adjustments to tax are subject to deficiency procedures.

48 48 IV. OVDI PENALTIES A penalty for failing to file Form 3520 A,The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 5% percent of the gross value of trust assets determined to be owned by the United States person. Page 48

49 49 IV. OVDI PENALTIES Any U.S. Person with ownership interests in a foreign trust is responsible for ensuring that the trustee files a Form 3520 A for each tax year of the trust, setting forth a full and complete accounting of all trust activities and operations, Code Sec 6048(b)(1)(A), and issues income information to each U.S. grantor and trust beneficiary who directly or indirectly receives a trust distribution for that year. The Form 3520 A is due on the 15 th day of the third month after the end of the trust s tax year and is filed with the IRS. Page 49

50 50 IV. OVDI PENALTIES No penalties shall be imposed if the failure to file is due to reasonable cause and not willful neglect. The fact that a foreign country would impose penalties for disclosing the required information, or reluctance of a foreign fiduciary to provide such information, does not constitute reasonable cause. Page 50

51 51 IV. OVDI PENALTIES Willful failure to file a required Form 3520 A constitutes a criminal offense under Code Sec Filing a false or fraudulent Form 3520 A calls within the scope of Code Secs and Page 51

52 52 IV. OVDI PENALTIES The Form 5471 must be filed by U.S. persons that have a certain level of control (i.e. officers, directors or shareholders) of certain foreign corporations to report information required by Code Secs. 6035, 6038 and This information includes foreign corporation entity data, stock ownership data, financial statements and intercompany transactions with related persons. The taxpayer must report the information required by Code Secs and 6046, and must compute income from controlled foreign corporations under Code Secs The Form 5471 must be filed with a taxpayer s income tax return. Page 52

53 53 IV. OVDI POTENTIAL PENALTIES A penalty for failing to file Form Per Return is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return. Page 53

54 54 IV. OVDI PENALTIES Persons subject to the Form 5471 reporting requirements fall within five filing categories. Penalties imposed for failure to file complete and accurate Forms 5471 are outlined in Code Sec (filing category 2 and 3) and Code Sec (filing category 4). Page 54

55 55 IV. OVDI PENALTIES Any person who fails to report information required by Code Sec on a Form 5471 (filing category 2 and 3) is subject to a $10,000 penalty per reportable transaction. Failing to report information required by Code Sec. 6038(a) (filing category 4 and 5), results in a similar penalty of $10,000 for each Form 5471 that is filed after the due date of the income tax return (including extensions) or that does not include the complete and accurate information described in Code Sec. 6038(a). Page 55

56 56 IV. OVDI PENALTIES Page 56 If the required information is not provided within 90 days of a notice from the IRS of such failure (a notice letter ), an additional penalty of $10,000 will be imposed for each 30 day period, or fraction thereof, during which the failure continues up to a maximum of $50,000 per return (the continuation penalty ).

57 57 IV. OVDI PENALTIES U.S. persons failing to file a required Form 5471 will be subject to a 10 percent reduction of the foreign tax credit available under Code Secs. 901,902 and 960. Page 57

58 58 IV. OVDI PENALTIES Failure to file a complete and accurate Form 5471 will extend the period of limitations on assessment and collection of any tax imposed with respect to any event or period to which the Form 5471 applies to three years after the date on which the required information is reported. Page 58

59 59 IV. OVDI PENALTIES Penalties for failure to timely file a complete and accurate Form 5471 may be avoided or abated for reasonable cause. The requirements for establishing reasonable cause are set forth in Reg. Section (k)(3)(ii). Page 59

60 60 IV. OVDI POTENTIAL PENALTIES Form 5472: Information Return of a 25% Foreign Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency. Sec: IRC SS 6038A & 6038C. Page 60

61 61 IV. OVDI PENALTIES Willful failure to file a required Form 5472 constitutes a criminal offense under Code Sec Page 61

62 62 IV. POTENTIAL PENALTIES Form 926: Return by a U.S. Transferor of Property to a Foreign Corporation. The penalty for failing to file for each one of these information returns is 10 % of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional. Page 62

63 63 IV. POTENTIAL PENALTIES Form 926: A penalty for failing to file Form 926. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC 6038B. Page 63

64 64 IV. POTENTIAL PENALTIES The information is reported on a Form 926 and filed with the taxpayer s income tax return for the tax year that includes the date of the transfer. There are certain exceptions to these filing requirements, as well as additional rules that must be considered for transfers by U.S. partnerships, transfers by a husband and wife, and transfers of cash to a foreign corporation. Page 64

65 65 IV. POTENTIAL PENALTIES The period of limitations to assess tax due on the transfer is extended to three years after the required information under Code Sec. 6038B is provided. The penalty will not apply if the failure to file is due to reasonable cause. Page 65

66 66 IV. POTENTIAL PENALTIES Form 8865: Return of U.S. Persons With Respect to Certain Foreign Partnerships. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and 10 percent of the value of any transferred property that is not reported, subject to a $100,000 limit. Page 66

67 67 IV. POTENTIAL PENALTIES Form 8865: A penalty for failing to file Form United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC 6038, 6038B, and 6046A. Page 67

68 68 IV. OVDI - PENALTIES Form 8865 must be attached to the related income tax return (or partnership or exempt organization return) or, if no income tax return is required, filed by the date and to the same place you would have filed that return. Page 68

69 69 IV. OVDI - PENALTIES Page 69 Penalties depend on the filing category. Category 1 and 2 filers who fail to timely submit all information required by Form 8865 face penalties of $10,000 for each year of each foreign partnership. An additional $10,000 penalty is imposed for 30 day period, or fraction thereof, that such the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to $50,000 per return. Those persons failing to submit the required information will also face a reduction in their foreign tax credits under Code Secs. 901, 902 and 960. Code Sec. 6038( C ). Willful violations can also result in criminal penalties under Code Secs. 7203, 7206 and 7207.

70 70 IV. OVDI - PENALTIES Page 70 Category 3 filers that fail to report a contribution to a foreign partnership that is required to be reported under Code Sec. 6038B can be assessed a penalty equal to 10 percent of the fair market value of the property at the time of the contribution, not to exceed $100,000 unless the failure is due to intentional disregard. In addition, the transferor must recognize gain on the contribution as it the contributed property had been sold for its fair market value at the time of the contribution.

71 71 IV. OVDI PENALTIES Page 71 Category 4 filers who fail to properly report all the information requested by Code Sec. 6046A are subject to a $10,000 penalty. A continuation $10,000 penalty is imposed for 30 day period, or fraction thereof, that such the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to $50,000 per return. Those persons failing to submit the required information will also face a reduction in their foreign tax credits under Code Secs. 901, 902 and 960. As is the case with other penalties imposed under Code Sec. 6677, deficiency procedures to not apply.

72 72 IV. OVDI - PENALTIES Failure to file a complete and accurate Form 8865 will extend the period of limitations on assessment and collection of any tax imposed with respect to any event or period to which the Firm 8865 applies to 3 years after the date on which the require information is reported. Page 72

73 73 IV. POTENTIAL PENALTIES Page 73 Civil fraud penalties imposed under IRC 6651 (f) or Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 % of the unpaid tax.

74 74 IV. POTENTIAL PENALTIES Page 74 A penalty for failing to file a tax return imposed under IRC 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 %of the balance due, plus an additional 5 % for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 %.

75 75 IV. POTENTIAL PENALTIES Page 75 A penalty for failing to pay the amount of tax shown on the return under IRC 6651 (a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of.5 % of the amount of tax shown on the return, plus an additional.5 % for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 %.

76 76 IV. POTENTIAL PENALTIES An accuracy related penalty on underpayments imposed under IRC Depending upon which component of the accuracy related penalty is applicable, a taxpayer may be liable for a 20 % or 40 % penalty. Page 76

77 77 IV. POTENTIAL PENALTIES Page 77 If a revenue agent conducting a Title 26 audit seeks information regarding potential FBAR violations, the agent must obtain a relevant statute memorandum (Form 13535) (RSM) signed by a Territory Manager before the information from the tax examination can be obtained and used in the FBAR investigation.

78 78 IV. POTENTIAL PENALTIES To establish a willful violation for purposes of the civil FBAR penalty under 31 USC 5321 or to sustain the heavy burden of proof to obtain a criminal conviction under 31 USC Section 5322, the government must establish a voluntary intentional violation of a known legal duty. The government must prove that the taxpayer was aware of the requirement to file the FBAR and intentionally failed to do so (or filed a false FBAR). Short of a concession or a confession, the government will rely on circumstantial evidence and infer willfulness based on a course of conduct. Page 78

79 79 IV. POTENTIAL PENALTIES -FBAR A failure to file an FBAR may subject one to civil and/or criminal penalties. A. The civil penalty for willfully failing to file can be up to the greater of $100,000 or 50% of the total balance of the foreign account at the time of the violation. B. Non willful violations are subject to a penalty of up to $10,000 per violation. C. A penalty does not apply if a violation is due to reasonable cause. Page 79

80 80 IV. FBAR - POTENTIAL PENALTIES FBAR penalties are determined per account. For Individuals who own multiple foreign accounts and do not file an FBAR could be subject to an FBAR penalty for each account. Fortunately, multiple penalties per FBAR are considered only in the most egregious cases. Page 80 Remember, the statute of limitations for FBAR civil penalties is six (6) years from the due date of the FBAR, which is June 30 th of the year following the calendar year being reported. Therefore, no such penalty can be imposed for years prior to 2006.

81 81 IV. POTENTIAL PENALTIES -FBAR Page 81 Criminal Penalties. A willful failure to file the FBAR can result in criminal sanctions, including imprisonment. Both civil and criminal penalties may be imposed together, with criminal sanctions potentially including: A. A willful failure to file FBAR or retain records while violating certain other laws penalty of up to $500,000 and/or 10 years imprisonment; B. A penalty for knowingly and willfully filing a false FBAR of up t0 $10,000 and/or 5 years imprisonment.

82 82 IV. POTENTIAL PENALTIES -FBAR In determining whether a taxpayer s offshore account violations were committed willfully, the IRS takes the view that an omission to check yes on Schedule B may provide some evidence of willful blindness on the part of the taxpayer. The IRS defines willful blindness as a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements and could seek to impose the willful FBAR penalty under these circumstances. Page 82

83 83 IV. POTENTIAL PENALTIES -FBAR Page 83 The Taxpayer is required to submit tax returns for the past three (3) years along w/forms: TD F , Reports of Foreign Bank and Financial Accounts ( FBARs ), for the past six (6) years. All of this is to be accompanied by any payment of tax and related interest due.

84 84 IV. POTENTIAL PENALTIES The IRS has 6 years after the transaction with respect to which the penalty is assessed to assess a civil penalty related to an FBAR violation. [ 31 USC Section 5321 (b) (1). ] While the civil statutes on assessment and collection of the FBAR penalty can be waived, a waiver of limitations for purposes of a Title 26 audit will not extend the limitations with respect to the FBAR penalties. The IRS has 2 years from the later of the date of assessment or the date any judgment becomes final in a criminal action involving the same transaction that resulted in the penalty, to sue to recover the civil penalty. Page 84

85 85 IV FBAR PENALTIES The first step is to determine if an FBAR should have been filed, whether it was in fact filed, and what records have been retained. Page 85

86 86 IV COMPLIANCE RISK DETERMINATION Page 86 The Taxpayer is required to submit tax returns for the past three (3) years along w/forms: TD F , Reports of Foreign Bank and Financial Accounts ( FBARs ), for the past six (6) years. All of this is to be accompanied by any payment of tax and related interest due.

87 87 IV COMPLIANCE RISK DETERMINATION Page 87 These new compliance procedures ( Streamlined Procedure ) are aimed at U.S. taxpayers residing overseas and who have neither filed U.S. tax information or returns. To qualify, you must not: a. currently reside in the U.S.; b. have resided outside of the U.S. Since Jan 1, 2009; c. and have not filed any U.S. tax returns during that period.

88 88 IV COMPLIANCE RISK DETERMINATION To further qualify, if you represent the low compliance risk, the IRS sets out to examine: A refund on one of the tax returns; Material economic activity in the U.S.; Failure to declare all income in country of residence; Taxpayer is under audit or investigation by the IRS; FBAR penalties were previously assessed against the taxpayer or taxpayer previously received FBAR warning letter; Page 88

89 89 IV COMPLIANCE RISK DETERMINATION In representing the low compliance risk, the IRS examines: Financial interest or authority over accounts located outside of country of residence; Financial interest in an entity located outside of country of residence; U.S. Source Income; Page 89 Indications of sophisticated tax planning or avoidance; or Less than $1,500 in tax is shown as due.

90 90 IV COMPLIANCE RISK DETERMINATION Should a Taxpayer s submission represent a higher compliance risk, then the application will be subject to a more comprehensive review. This includes potentially a full examination which could expand beyond the three (3) years initially submitted in the returns. Page 90

91 91 IV SL CONUNDRUM On one hand, they say that only individuals who have not filed U.S. returns since 2009 are eligible to participate in the program. Hence, those with amended returns will be treated as having high compliance risk and subject to examination. Page 91

92 92 IV STREAMLINED PROCEDURE Appears to be aimed at resolving certain issues related to foreign retirement plans; Specifically Canadian Registered Retirement Savings Plans. Page 92

93 93 IV STREAMLINED PROCEDURE Under Streamlined Procedure, there is no protection from criminal prosecution. In such cases, OVDP may be a better alternative. Applicants are barred from making a later OVDP application. Page 93

94 94 V. F OREIGN INCOME The worldwide income of U.S. citizens and resident aliens is generally subject to taxation by the United States. Essentially, U.S. taxpayers who fails to report foreign income could be subject to a failure to pay taxes penalty equal to 0.5% of the tax per month the tax is outstanding, up to 25%. In addition, an accuracy related penalty equal to 20% of the underpayment of tax could apply if underpayment of tax is attributable to negligence or a substantial understatement of tax. Page 94

95 95 V. OVDI STATUTE OF LIMITATIONS IRC 6501 (e)(1 )(A)(i) allows assessment within 6 years after the later of the due date or date filed if the taxpayer omits from gross income an amount properly includible therein and such amount is in excess of 25% of the amount of gross income stated in the return. IRC 6501 (e)(1 )(A)(ii) allows assessment within 6 years after the later of the due date or date filed if the taxpayer omits from gross income an amount properly includible therein and such amount exceeds $5,000 and is attributable to one or more foreign financial assets described in IRC This exception was added to the law in 2010 and applies to (1) returns filed after March 18, 2010, and (2) returns filed on or before March 18, 2010, if the statute of limitations has not otherwise expired as of March 18,2010. Page 95

96 96 V. OVDI STATUTE OF LIMITATIONS Page 96 IRC 6501 (c)(4) allows the period for assessment to be extended for any period of time agreed upon in writing by the taxpayer and the IRS (e.g., by submitting Form 872). The statute of limitations for assessment of the FBAR penalty is 6 years from the due date of the FBAR (Form TD F ). The FBAR due date is June 30 of the year following the reporting year. For example, the statute of limitations for a 2004 FBAR will expire June 30, The FBAR statute continues to run whether or not the FBAR was filed. The FBAR statute may be extended by consent.

97 97 V. OVDI STATUTE OF LIMITATIONS IRC 6501 (c)(1) and (c)(2) allow assessment at any time if a tax return is false or fraudulent or there is a willful attempt to evade tax. IRC 6501 (c)(8) allows an assessment within 3 years after the date certain offshore information returns are filed, including Forms 3520, 3520 A, 5471, and Page 97

98 98 VI. OVDI FOREIGN TAX CREDIT COMPLIANCE Should a taxpayer receives foreign sourced qualified dividends and/or capital gains (including long term capital gains, unrecaptured section 1250 gain, and/or section 1231 gains) that are taxed in the U.S. at a reduced tax rate, the taxpayer must adjust the foreign source income that is reported on Form 1116, line 1a. Otherwise, the allowable foreign tax credit may be significantly overstated which can trigger a substantial underpayment penalty. Page 98

99 99 VI. OVDI FOREIGN TAX CREDIT COMPLIANCE Page 99 Charitable contributions are not apportioned against foreign source income. The amount of foreign tax that qualifies is not necessarily the amount of tax withheld by the foreign country. If you are entitled to a reduced rate of foreign tax based on an income tax treaty between the U.S. and a foreign country, only that reduced tax qualifies for the credit. If a foreign tax redetermination occurs, a redetermination of your US tax liability is required in most situations. You must file a Form 1040X or Form 1120X. Failure to notify the IRS of a foreign tax redetermination can result in a failure to notify penalty.

100 100 VI. FATCA FORM 8938 Page 100 Starting with 2011 for individual taxpayers, there will be an additional annual reporting requirement under IRC Section 6038D (contained in Title 26 of the U.S. Code) for specified foreign financial assets on Form This new reporting requirement is the result of the Foreign Account Tax Compliance Act (FATCA).

101 101 VI. FATCA OFFSHORE REPORTING Page 101 Other portions of FATCA will require foreign financial institutions to report directly to the IRS certain information about financial accounts held by U.S. taxpayers or held by foreign entities in which U.S. taxpayers hold a substantial ownership interest.

102 102 VI. FATCA Page 102 The IRS has aggressively pursued the disclosure of U.S. taxpayers with foreign accounts. To assist in their activities, they have introduced the Foreign Account Tax Compliance Act ( FATCA ). This law requires foreign financial institutions to report U.S. owned accounts to the IRS or potentially face a 30% withholding tax. Many foreign financial institutions holding money of U.S. persons closed the account to avoid the FATCA obligations.

103 103 VII. OVDI STATUTE OF LIMITATIONS ( SOL ) Page 103 There are a number of exceptions to the general 3 year statute of limitations under IRC 6501 (a). Depending on a taxpayer's particular facts and circumstances, one or more of these exceptions may apply: 1. IRC 6501 (c)(1) and (c)(2) allow assessment at any time if a tax return is false or fraudulent or there is a willful attempt to evade tax. 2. IRC 6501 (c)(8) allows an assessment within 3 years after the date certain offshore information returns are filed, including Forms 3520, 3520 A, 5471, and 5472.

104 104 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC Page 104 Passive income includes dividends, interest, gains from the disposition of stocks and securities, and gains from commodities trading. A foreign company is considered a Passive Foreign Investment Company PFIC is at least 75% of its gross income is passive income and/or if at least 50% of its assets produce passive income.

105 105 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC Because most of the income of a mutual fund consists of items that can be defined as passive income, nearly all overseas mutual funds are PFICs. A foreign mutual fund might escape classification as a PFIC if a majority of its holdings consists large shares of other corporations whose income would be classified as active and not passive income. Page 105

106 106 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC To avoid certain excise taxes, U.C. based mutual funds generally distribute earnings and capital gains to their shareholders. These amounts are then reported annually to the IRS on a Form 1099 Page 106

107 107 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC Prior to the passage of the PFIC rules as part of the Tax Reform Act of 1986, U.S. investors in overseas funds would only have taxable income when they sold their stock or received a dividend. This gave investors in overseas funds significant advantages over similarly situated investors in domestic funds. Page 107

108 108 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC For many, such mutual funds were acquired while living abroad or through an inheritance from foreign relatives. Others may have purchased the funds based on advice from financial planners. Notwithstanding, many taxpayers encountered PFIC issues for the first time in the process of coming forward under one of the Treasury Department's voluntary disclosure programs for undisclosed foreign financial accounts. Often, these taxpayers ceded control of their foreign assets to overseas bank personnel, and were not fully aware that they owned foreign mutual funds. Page 108

109 109 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC U.S. investors report their PFIC holdings on Forms 8621 Return by Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, which are filed with their annual return. A separate Form 8621 is filed for each PFIC investment required to be reported in a given year. Page 109

110 110 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC With the enactment of the PFIC rules in 1986, U.S. shareholders of overseas funds were given a choice of two taxing mechanisms. 2 years later, Congress made a third option available. Next time, in order of preference to the taxpayer, the three possible methods now are: 1) Qualified Electing Fund; 2) Mark to market; or 3) Excess Distributions. Page 110

111 111 VIII. PFIC QUALIFYING ELECTING FUND (QEF) PFICs that meet certain Treasury Department reporting requirements can be elected as QEFs that are taxed as if they were U.S. investments. Gains or losses are calculated as the difference between the purchase cost and the amount received upon disposition of the stock. Any income is taxed as long or short term capital gain. To qualify, the PFIC provide its U.S. shareholders with a "PFIC Annual Information Statement" that contains or allows the calculation of the taxpayer's share of the corporation's ordinary earnings and net capital gain for the taxable years. Further, a copy of the Statement must be attached to the Form 8621 and filed along with the taxpayer's annual return. In reality, very few foreign mutual funds provide the documentation necessary to allow a QEF election. Page 111

112 112 VIII. PFIC MARK-TO-MARKET (MTM) Recognizing that few shareholders had been able to obtain the information necessary to make a QEF election, in 1997, Congress enacted the Mark to Market ( MTM ) election. Here, tax is computed at the end of each year on the difference between the fair market value (FMV) of the shares at the beginning of the year, and the FMV at the end of the year. Page 112 The MTM method may be used for investments in PFICs that meet the definition of "marketable stock". Generally, this means that the mutual fund must be regulated by a government agency and listed on a national securities exchange that publishes the price of the fund's shares at least weekly. However, the deadline for making such an election is the due date, including extensions, of the electing person's U.S. income tax return for the year.

113 113 VIII PFIC - EXCESS DISTRIBUTIONS When neither the QEF nor MTM elections are available, the Excess Distributions method is used. Under the Excess Distributions method, taxes are paid when you sell the stock or receive an "excess distribution", i.e. an extraordinary dividend. An excess distribution is defined as an amount distributed in excess of 125% of the average amount received by the investor over the immediately preceding three year period. In other words, a mutual fund will give rise to an excess distribution when it pays dividends over the tax year that are at least 25% greater than the average that it paid for the previous 3 years. Thus, for each fund investments one files a Form 8621 in each year that all or part of one s holdings were sold as well as potentially be required to file a Form 8621 in years dividends were distributed. Page 113

114 114 VIII. PFIC EXCESS DISTRIBUTIONS To determine the amount of tax payable, the excess distribution or gain on sale is spread over the shareholder's holding period. Amounts allocated to the taxable year are treated as ordinary income. Any gain allocated to years before the taxable year will be charged at the highest ordinary income rates in effect for those years. Page 114 In addition to the tax, there is an interest charge applied to the gains from years prior to the taxable year. The interest is compounded daily and computed at the IRS' rates for underpayment of tax, which are revised quarterly. The rate is currently set at 4% and has varied between 4% and 8% since The high tax rate for prior years in combination with the compounded interest tends to make it the least favorable option for the taxpayer. 8 See Rev. Rul Internal Revenue Bulletin

115 115 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC Page 115 The IRS offered participants in their most recent Offshore Voluntary Disclosure Initiative (OVDI) a special MTM method for calculation of their PFIC taxes. Without the opportunity of this "alternative resolution", affected taxpayers would be forced to use the Excess Distributions method for their prior year amended returns as the deadline for regular MTM or QEF elections would have lapsed. The alternate resolution MTM calculation operates much the same as the regular MTM method under I.R.C but with two key differences. First, the tax on the gain for all years is computed at a standard rate of 20% regardless of the taxpayer's tax bracket in that year. Second, in lieu of an interest charge on the underpayments for the prior years' returns, an additional 7% is due for the first tax year in the program (usually 2003)

116 116 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC A lack of historical information on the cost basis and holding period of many PFIC investments makes it difficult for taxpayers to prepare statutory PFIC computations and for the Service to verify them. Page 116

117 117 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC The Service is offering taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in Internal Revenue Code 1296 but will not require complete reconstruction of historical data. Page 117

118 118 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS The initial MTM computation of gain or loss under this methodology will be for the first year of the OVDP application, but could be made after that year depending on when the first PFIC investment was made. Page 118

119 119 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS A tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the voluntary disclosure period under the OVDP, in lieu of the rate contained in IRC 1291(a)(1)(B) for the amount allocable to the current year and IRC 1291 ( C ) (2) for the deferred tax amount(s) allocable to any other taxable year. Page 119

120 120 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS A rate of 7% of the tax computed for PFIC investments marked to market in the first year of the OVDP application will be added to the tax for that year, in lieu of the interest charge mechanism described in IRC 1291 ( C ) and 1296 (j). Page 120

121 121 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment by investment basis in the same manner as IRC Page 121

122 122 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS MTM losses will be treated as ordinary losses (IRC 1296( C )(1)(B) and the tax benefit is limited to the tax rate applicable to the MTM gains derived during the voluntary disclosure period (20%). Page 122

123 123 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS MTM and/or disposition losses in any subsequent year on PFIC assets with basis that was adjusted upward as a result of the alternate resolution in voluntary disclosure years, will be treated as capital losses. Page 123

124 124 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS Any unreversed inclusions at the end of the voluntary disclosure period will be reduced to zero and the MTM method will be applied to all subsequent years in accordance with IRC 1296 as if the taxpayer had acquired the PFIC stock on the last day of the last year of the voluntary disclosure period at its MTM value and made an IRC 1296 election for the first year beginning after the voluntary disclosure period. Page 124

125 125 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS Any subsequent year losses on disposition of PFIC stock assets in excess of unreversed inclusions arising after the end of the voluntary disclosure period will be treated as capital losses. Page 125

126 126 VIII. PASSIVE FOREIGN INVESTMENT COMPANIES PFIC - TERMS Regular and Alternative Minimum Tax are both to be computer without the PFIC dispositions or MTM gains and losses. The tax from the PFIC transactions (20% plus the 7% for the first year, if applicable) is added to (or subtracted from) the applicable total tax (either regular or AMT, whichever is higher). The tax and interest (i.e. the 7% for the first year of the voluntary disclosure) computer under the OVDP alternative MTM can be added to the applicable total tax (either regular or AMT, whichever is higher) and placed on the amended return in the margin, with a supporting schedule. Page 126