An International Tax Attorney Resource Guide for Offshore Compliance

An International Tax Attorney Resource Guide for Offshore Compliance

International Taxation Summary Guide

In recent years, the IRS has significantly increased enforcement of international tax reporting and compliance. There are many facets to international tax and reporting compliance, including:

  • whether the taxpayer qualifies as a US person or non-resident;

  • is there a tax return filing requirement;

  • is there an appllicable tax treaty;

  • do the taxpayers have foreign accounts, assets, or income;

  • are the foreign accounts and assets out of IRS compliance; and (most importantly)

  • what can they do to safely get back into compliance?

With the recent surge in penalty assessments, it is important for taxpayers with foreign money and accounts to have a general understanding of the US tax requirements. 

Resident or Non-Resident for US Tax

When dealing with individuals for US tax, one of the key important factors in determining whether that person qualifies as a resident of the United States or a non-resident of the United States. This will have an important impact on the extent and ability of the United States to tax that individual on either just their US-sourced income or on their worldwide income.

Resident (Worldwide Income and Reporting)

When a person is considered a resident of the United States, they are subject to US tax on their worldwide income and also required to disclose their global assets to the IRS and FinCEN. This is true even if a person resides in a foreign country and earns all their income from a foreign country. It is important to note that the term US person is not limited to just US citizens, but also includes Lawful Permanent Residents and foreign nationals who meet the Substantial Presence Test.

Non-Resident (FDAP & ECI)

When a person is a non-resident of the United States — which typically means they do not fall into one of the above-referenced US Person categories (or if they do, they qualify to be treated as a Non-Resident by either tax treaty or the closer connection exception), then the tax is limited to income earned in the United States. There are two main categories of US income that nonresidents are taxed on. The first one is FDAP (Fixed, Determinable, Annual, and Periodic) and the second is ECI (Effectively Connected Income). FDAP is withheld at a 30% tax rate, although based on various tax treaties, the withholding amount may be reduced or eliminated (oftentimes by filing a W8-BEN). ECI is taxed at a person’s individual tax rate, although, unlike FDAP, the taxpayer can take deductions and expenses such as if they make an election to treat their US rental property income as ECI instead of the default category of FDAP.

Annual Tax Return (Unless Not Required)

When a person is considered a US person, they are required to file an annual tax return on IRS Form 1040. If they are non-resident aliens, then they file Form 1040-NR instead of Form 1040. For purposes of the tax return form 1040, the filing dates are as follows:

      • April 15: Original Due Date

      • June 15: Original Due Date (Foreign Resident)

      • October 15: Automatic Extension

      • December 15: Potential Extension

F-1 (M or Q) Visa (5 Years)

When a person is in the United States on an F-1 visa, then generally they are not subject to US tax on their worldwide income or the onerous international information reporting requirements until they have been on an F-1 visa for at least five years. In other words, for the first five years, a person is on an F-1 Visa and does not otherwise qualify as a US person, so they are not considered a US person for tax purposes simply because they reside in the US and are on an F1 visa.

Teachers Relocating From Abroad

Many different tax treaties allow for teachers (and other similar positions) who relocate from a Treaty Country to avoid being a US person for the first two or three years, depending on the specific tax treaty.

Tax Treaty

In some situations, if a person is a US Person but resides overseas, this may be sufficient to be considered a foreign resident in accordance with an overall facts and circumstances test. If there is a tax treaty in place between the United States and that foreign country, they may even qualify to be treated as a non-resident for tax purposes. Thus, the US person would not be taxed on their worldwide income but rather just their US-sourced income. There are various pitfalls and dangers to be aware of when making this type of election (which is typically done on a Form 8833), so you may consider speaking with a tax specialist first before making the election.

Closer Connection Exception

If a person resides in the United States and meets the Substantial Presence Test, they are subject to US tax on their worldwide income and are required to disclose their global assets. Nevertheless, if they can show they have a closer connection with a foreign country or countries, then they may qualify for the Closer Connection Exception to the Substantial Presence Test and avoid being taxed on their worldwide income or having to report their global assets.

International Return Reporting

When a person is considered a US person, they are required to report their global assets, accounts, and investments on a myriad of different international information reporting forms to the IRS and FinCEN. The IRS seemingly has a different international form for each type of reporting requirement, including:

      • FBAR (Foreign Bank Accounts aka FinCEN Form 114)

      • Form 3520 (Foreign Gifts and Trusts)

      • Form 3520-A (Foreign Trusts)

      • Form 5471 (Foreign Corporations)

      • Form 5472 (Foreign Shareholders of US Entities)

      • Form 8621 (Passive Foreign Investment Companies)

      • Form 8865 (Foreign Partnerships)

      • Form 8938 (Foreign Account Tax Compliance Act aka FATCA)

It is important to note that these forms have different threshold requirements — and the forms have different filing due dates – aka they are not all due on the same day. In addition, some forms are on automatic extension (FBAR); some forms go on extension with the taxpayer filing an IRS Form 4868 (Form 8938 or Form 3520); and other forms on extension require the filing of an IRS Form 7004 (Form 3520-A), which is used to report ownership of a foreign trust.

Missed Reporting & Offshore Tax Compliance (Pre-Penalty) 

If a US person fails to timely report their international assets and accounts to the Internal Revenue Service, they may become subject to fines and penalties. These penalties can be significant, especially with the recently increased enforcement of matters involving FBAR and FATCA. In order to minimize or avoid these penalties, taxpayers may qualify for one of the IRS international tax amnesty (aka offshore tax compliance programs) such as:

Delinquent FBAR Submission Procedures (DFSP)

When a Taxpayer does not have to make any substantive changes to their tax return involving unreported income, they may qualify for the Delinquent FBAR Submission Procedures. This program is typically limited to Taxpayers who have no unreported income and are not required to file other delinquent forms in addition to the FBAR. For Taxpayers who qualify for these submission procedures, there is generally no penalty applied for prior-year noncompliance.

Delinquent International Information Return Submission Procedures (DIIRSP) 

Up until November of 2020, Taxpayers who had no unreported income (but missed filing international information reporting forms) could sidestep any offshore penalties by filing delinquent forms under DIIRSP. In November of 2020, the IRS rules changed and the IRS does not guarantee that filing delinquent forms will circumvent penalties — although with the right set of facts and circumstances, the Taxpayer may avoid penalties by showing reasonable cause (see further below).

Streamlined Domestic Offshore Procedures (SDOP)

The Streamlined Domestic Offshore Procedures are IRS procedures designed for Taxpayers who do not qualify as foreign residents, are non-willful, and filed their original tax returns timely. Under these procedures, a Taxpayer can opt to pay a 5% Title 26 Miscellaneous Offshore Penalty in lieu of all the other delinquent FBAR and FATCA penalties.

Streamlined Foreign Offshore Procedures (SFOP)

The Streamlined Foreign Offshore Procedures are probably the best of all the offshore tax programs for Taxpayers who qualify as eligible. This is because if a Taxpayer qualifies as a foreign person and is non-willful, they can avoid all offshore penalties under these procedures. In addition, Taxpayers can file original tax returns.

IRS Voluntary Disclosure Program (VDP) for Delinquent FBAR & FATCA

The IRS Voluntary Disclosure Program (VDP) has been in existence for many years. From 2009 to 2018, there was an offshoot of the VDP program — which was referred to as the Offshore Voluntary Disclosure Program (OVDP) — and was primarily for Taxpayers with undisclosed foreign income and assets.  In 2018, the IRS closed this program — but also expanded the traditional voluntary disclosure program on matters involving foreign and offshore income and asset disclosures.

Under the prior version of OVDP for delinquent FBAR, FATCA, etc. — even non-willful Taxpayers would submit to the program in order to both receive a closing letter and almost always avoid an audit (unless they opted-out). The new version of the VDP program is geared primarily for Taxpayers who are willful or are unable to certify under penalty of perjury that they are non-willful. It is still a great program in which Taxpayers can almost always avoid criminal prosecution — and it rarely if ever would have any impact on a person’s immigration status (unless the Taxpayer was also “criminally” willful and the government pursued that criminality against the Taxpayer, which is extremely rare).

Reasonable Cause for Delinquent FBAR and FATCA

In general, a taxpayer cannot be subject to penalties for missing the filing of delinquent FBAR and other international information reporting forms if they can show reasonable cause and not willful neglect. This is not a program per se but rather an alternative submission package in which the taxpayer seeks to avoid or minimize penalties without formally going through the programs listed above, while also avoiding making a quiet disclosure. If you are considering a reasonable cause submission, you should speak with a Board-Certified Tax Lawyer Specialist about your different options.

Avoid Making a Quiet Disclosure

Instead of following IRS international compliance protocols and submitting to one of the approved offshore disclosure programs, some taxpayers will attempt to sneak behind the IRS’s back and amend their returns by submitting a quiet disclosure in order to try and circumvent the reporting rules. A Quiet Disclosure will usually include either “mass-filing” prior year international reporting forms and tax returns and/or just beginning filing forward in the current year, hoping the IRS does not learn about the prior noncompliance. The Internal Revenue Service has made it known that if they believe a taxpayer intentionally sought to avoid reporting by submitting a quiet disclosure, the taxpayer may become subject to willfulness penalties, along with a possible IRS special agent investigation. 

Penalties & Abatement (Post-Penalty)

If a taxpayer has already been penalized before they had the opportunity to submit to one of the offshore disclosure programs, they can still seek to have that penalty abated (removed) or reduced. The general process for doing this is referred to as penalty abatement or penalty removal. In general, taxpayers must show that they acted with reasonable cause and not willful neglect in order to eliminate or reduce offshore penalties.

Golding & Golding: About Our International Tax Law Firm

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

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