Offshore Tax Compliance Enforcement Priorities
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Offshore Tax Compliance Enforcement Priorities
When US Taxpayers think about offshore tax compliance and what aspects of international reporting the IRS focuses on — the two key acronyms that come to mind are the FBAR (Foreign Bank and Financial Account Reporting aka FinCEN Form 114) and Form 8938 (Foreign Account Tax Compliance Act aka FATCA). And, while these are two very important international reporting forms for US persons who have foreign accounts, assets, investments, and income to be aware of –– it is just the tip of the iceberg. There are many aspects to international tax that US persons — especially those that hold assets in foreign countries – have to be aware of in order to try to stay on the straight and narrow with the Internal Revenue Service (IRS) and Financial Crimes Enforcement Network (FinCEN). Here are some of the more important offshore tax compliance enforcement priorities that some Taxpayers should be aware of in order to avoid unnecessary fines and penalties:
Form 3520/3520-A
Form 3520 refers to foreign gifts and trust reporting, while Form 3520-A refers to the reporting of foreign trusts with a US owner. Oftentimes, Taxpayers will be penalized heavily for noncompliance for not timely nor accurately reporting these forms — even in a year in which there is no unreported income. Compounding the confusion for Taxpayers and Form 3520 is the fact that while there are exceptions to reporting such as for reporting foreign pension trusts — the exceptions to reporting are overly broad. For example, in 2020, the IRS published Revenue Procedure 2020–17 which is designed to minimize duplicative reporting for foreign retirement and non-retirement deferred trusts on the Form 3520/3520-A, FBAR, and FATCA — but due to several ambiguities in the language of the Revenue Procedure, it is unclear exactly which foreign pensions meet the exception. Based on the fact that a taxpayer can get hit with a 5%, 25%, or 35% penalty depending on the type of missed reporting, this makes it more nerve-racking for taxpayers. And with the recent appellate court ruling in US v. Wilson — which confirms that the IRS is not limited to just one 5% penalty when a Taxpayer is both the beneficiary and owner of their trust, there is an ongoing concern with being compliant for 3520 purposes.
Malta Personal Pension Retirement Schemes
In late 2021, a CAA agreement was entered into between the United States and Malta clarifying issues involving personal retirement schemes in Malta, by certain US persons. Due to ambiguities within the tax treaty, some tax practitioners were treating these Malta personal pension plans similar to a Roth IRA but with no maximum contribution amount — while contributing appreciated assets. Imagine a situation in which a very wealthy taxpayer takes appreciated assets, contributes them to a Malta personal pension scheme, pension, and then staggers distribution (after the age of 50) so that they are not paying any tax on the growth — while circumventing various other taxes. As you can imagine, the IRS was not too keen on this strategy and plans on cracking down heavily in 2022.
Offshore Syndicated Conservation Easement Transactions
Syndicated conservation easement transactions – – especially those overseas – – are high on the IRS list. These types of transactions are quite complex and we have a separate conservation easement article to assist you on how these easements are created. Essentially the conservation easement is appraised for an incredibly high amount, which is then gifted to a tax-exempt entity, in which the deduction trickles down to the investors who participate in the scheme by way of a flow-through entity — and the artificially high tax deduction lands smack dab on their tax return. While some conservation easements are of course, totally legitimate, the IRS is concerned that for many of these syndicated conservation easement transactions the appraised value far exceeds the actual value of the easement, resulting in a windfall for the taxpayer.
FIRPTA
FIRPTA is the Foreign Investment in Real Property Tax Act. The purpose of the act is to ensure that foreign nationals who are non-tax residents of the United States pay tax on the sale of their US property. Other types of US-based capital gains generated by a nonresident are not subject to tax, but US real estate owned by a foreign national non-resident is subject to US capital gains tax. Since non-residents do not have to file US tax returns unless they have FDAP or ECI, the IRS is concerned that they are not paying taxes on the sale of their US home and other property. Therefore, FIRPTA requires the parties involved to withhold a certain amount of the sale price (not the computed again) and forward it to the IRS. In fact, the withholding may be excessively high in situations in which the gain was not high. To avoid FIRPTA withholding, Taxpayers can apply for a withholding certificate to reduce the withholding, but this can take some time for the IRS to process — especially if the IRS is running far behind. When the IRS cannot complete the proposed 90-day turnaround this can significantly impact the sale and lead to a buyer walking away before escrow closes, to the detriment of the seller.
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