Own a Foreign Corporation or Trust and Failed to Report to the IRS? A Painless Cure May Be Available
U.S.-resident taxpayers who own all or part of a foreign corporation or trust may be required to attach certain international information forms, such as the Form 5471 or 3520, to their federal income tax returns. If you have not done so, you can be hit with severe penalties unless you cure your delinquency.
Recent sweeping changes to the IRS amnesty programs have left many delinquent U.S. taxpayers with unprecedented disclosure options. Importantly, the now popular program known as the “streamlined procedures” became available to taxpayers who have failed to report their offshore financial information on their U.S. tax returns but can certify that their failure did not result from willful conduct.
For U.S.-resident taxpayers who do not need to file delinquent or amended tax returns to report and pay additional tax, but who have only failed to file one or more required international information returns, such as the Form 5471 or 3520, the domestic offshore streamlined procedures seem at first like an ideal option. After all, a successful streamliner can enjoy the waiving of information return penalties (potentially to the tune of $10,000 per form per year).
However, the procedures do have a potentially significant downside for U.S.-resident taxpayers – participants must pay a penalty equal to 5% of the highest aggregate balance/value of their foreign financial assets. For those with significant accounts, this can be a hefty price to pay for coming clean with the IRS.
Many clients have therefore asked us whether a better option is available for U.S.-resident taxpayers who have only failed to file one or more required international information returns. We have found that the answer in many cases is – “yes” – that is, if the taxpayer can establish “reasonable cause” for past failures.
Under the so-called Delinquent International Information Return Submission Procedures (the “DIIRS” procedures), taxpayers who have only failed to file one or more required international information returns have the option of filing the returns potentially without any adverse effect. The return submission procedures, however, require that the taxpayer attach a reasonable cause statement to the information returns and certify that any entity for which the returns are being filed was not engaged in tax evasion. Successful participants in the return submission procedures can avoid the streamlined procedures and associated 5% penalty.
However, as with all of the IRS amnesty programs, the DIIRS procedures come with their own catch – the IRS will not automatically accept a taxpayer’s explanation of reasonable cause. If an explanation is not accepted, the IRS may impose the full penalties. This, of course, begs the question – what exactly is “reasonable cause”?
Unfortunately, the IRS has offered limited guidance in this regard. In an IRS FAQ, the IRS states simply that, “longstanding authorities regarding what constitutes reasonable cause continue to apply” and cites regulations as examples, which don’t provide much additional definitional certainty. Rather, the regulations explain that the facts and circumstances of each particular case need to be scrutinized.
In order to establish a strong case for a reasonable cause defense, an experienced tax professional should be consulted. Our professionals have helped a number of clients navigate these murky waters in order to confidently establish a winning reasonable cause defense based on direct communications with the IRS and a thorough knowledge of the Internal Revenue Code and its regulations. We have also helped clients understand additional options if a reasonable cause defense is not available.
If you are a delinquent taxpayer considering the streamlined procedures, you should carefully consider all of your options, including the DIIRS procedures, before making any final decisions. The Expat Tax Professionals are here to make sure you fully understand all of the options on the table and to help you choose wisely.
2. The procedures also require that the taxpayer is not under a civil examination or a criminal investigation by the IRS and has not already been contacted by the IRS about the delinquent information returns.
3. As a practical example, in a very recent case, a U.S. court came out in favor of the IRS’s rejection of a reasonable cause defense for delinquent FBAR filings (as a procedural matter, the court rejected the taxpayer’s motion for summary judgment against the IRS). In that case, the IRS imposed full penalties on the taxpayer for a period of four years. See James Moore v. U.S., Case 2:13-cv-02063-RAJ filed 4/1/15.
4. The IRS FAQ and cited regulations can be found at the following link: http://www.irs.gov/Individuals/International-Taxpayers/Delinquent-International-Information-Return-Submission-Procedures-Frequently-Asked-Questions-and-Answers
by Ephraim Moss, Esq. & Joshua Ashman, CPA