The taxation of Americans and long term green card holders (permanent residents) who expatriate from the United States has gone through many changes over the years. The latest version of these changes will tax expatriating Americans on their accumulated un-taxed wealth prior to their leaving the United States, along with their earned income that has not been paid and will be paid in the future.

In addition, the United States tax laws will tax expatriating Americans at draconian rates, for Americans that die owning United States wealth (the “Estate Tax”) and that make significant gifts (the “Gift Tax”) after they have given up their United States citizenship.

Tax planning is a must for all Americans who are planning to make the transition.

Summary of the Expatriation Laws

Tax on Gain

Americans expatriating from the U.S. face several different U.S. taxes, when they expatriate and after they expatriate. These taxes apply to wealthy Americans who are referred as “Covered Expatriates”.

Generally a tax is imposed a mark-to-market regime on wealthy expatriates by providing that all property owned by a covered expatriate is treated as sold on the day before the expatriation date for its fair market value. Any gain arising from the deemed sale is taken into account for the taxable year of the deemed sale notwithstanding any other provisions of the Code. Generally, any loss from the deemed sale is taken into account for the taxable year of the deemed sale to the extent otherwise provided in the Code. There is a minimum amount of gain that can be earned of $600,000, which amount is to be adjusted for inflation for calendar years after 2008 (the “exclusion amount”). A taxpayer may elect to defer payment of tax attributable to property deemed sold.

Tax on Compensation

The mark-to- market regime

(1) does not apply to deferred compensation items,

(2) specified tax deferred accounts, and

(3) interests in a nongrantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date.

However, there is a law that applies to “eligible deferred compensation items” and to other deferred compensation items (“ineligible deferred compensation items”).

In the case of “eligible deferred compensation items,” generally the payor of the compensation must deduct and withhold from any taxable payments to a covered expatriate with respect to those compensation items. This is a tax equal to 30 percent of the amount of those taxable payments. In the case of “ineligible deferred compensation items” a covered expatriate generally is treated as having received an amount equal to the present value of the covered expatriate’s accrued benefit on the day before the expatriation date. Here the tax is delayed until payment of the deferred compensation.

If a covered expatriate holds any interest in a “specified tax deferred account” on the day before the expatriation date, such covered expatriate is treated as having received a distribution of the covered expatriate’s entire interest in such account on the day before the expatriation date. Here the tax is delayed until payment of the deferred compensation.

If a covered expatriate has an interest in a trust, any direct or indirect distribution of property to a covered expatriate from a non grantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date will be taxed at 30% and the trustee must deduct and withhold from the distribution an amount equal to 30 percent of the taxable portion of the distribution. Furthermore, if the fair market value of the property distributed exceeds its adjusted basis in the hands of the trust, gain shall be recognized to the trust as if the property had been sold by the trust and the proceeds distributed to the covered expatriate.

The Covered Expatriate

COVERED INDIVIDUAL

An “Expatriate” means any U.S. citizen who relinquishes his or her citizenship.

It also includes any long term resident of the United States who ceases to be a lawful permanent resident of the United States. (“Green Card”). This is limited to an individual who is a green cardholder for a minimum of 8 taxable years during the period of 15 taxable years that end and include the long term residents’ expatriation date.

Exception to Covered Expatriate Rules

An expatriate will not be treated as a “covered expatriate”

(i) if the expatriate had a second citizenship due to his or her birth; and on the expatriate date continues to be a citizen and tax resident of that other country, and has been a U.S. resident for not more than 10 taxable years during the 15 taxable year period prior to expatriation, or

(ii) the expatriate became at birth a U.S. citizen of another country and, as of the expatriation date, continues to be a citizen of, and is taxed as a resident of, such other country, and has been a U.S. resident for not more than 10 taxable years during the 15 taxable year period ending with the taxable year during which the expatriation date occurs; or

The Minimum Financial Requirements

There also is a minimum wealth and income requirement that must be met before an expatriate is subject to the expatriate taxes.

Any one of the following three factors will result in taxation.

1. The expatriate must have an average annual net income tax liability that for the five preceding taxable years ending before the expatriation date; that exceeds the specified amount of $124,000 that is adjusted for inflation, or
2. The expatriate must have a net worth of $2 Million or more as of the expatriation date (the “net worth test”) or if
3. The expatriate does not certify under penalties of perjury that he or she has been in compliance with all U.S. Federal tax obligations for the five taxable years preceding the taxable year.

This means that the expatriate must have filed the proper income tax returns the day before the expatriation date. There are exceptions to this definition.

Expatriation Date

The term “expatriation date” is the date an individual relinquishes U.S. citizenship or, in the case of a long term resident of the United States, the date on which the individual ceases to be a lawful permanent resident of the United States.

A citizen will be treated as relinquishing his or her U.S. citizenship on the earliest of four possible dates:

1. The date of the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the United States pursuant the Immigration and Nationality Act
2. The date the individual furnishes to the United States Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in the Immigration and Nationality Act.
3. The date the United States cancels a naturalized citizen’s certificate of naturalization, or
4. If a long term resident ceases to be a lawful permanent resident because (i) the privilege of residing permanently in the United States as an Immigrant has been revoked or has been determined to have been abandoned, or if (ii) the individual either commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, and does not waive the benefits of the treaty applicable to residents of the foreign country, and notifies the Secretary of such treatment.

A taxpayer may elect to defer payment of tax attributable to property deemed sold under certain circumstances.

The Mark to Market Regime

The covered expatriate is deemed to have sold any interest in property that he or she is considered to own with certain exceptions. For purposes of computing the tax liability under the mark-to-market regime, a covered expatriate is considered to own any interest in property that would be taxable as part of his or her gross estate for Federal estate tax purposes, as if he or she had died on the day before the expatriation date as a citizen or resident of the United States. In addition, for this purpose, a Covered Expatriate also is deemed town his or her beneficial interest(s) in each trust (or portion of a trust), that would not constitute part of his or her gross estate as described in the preceding sentences.

In computing the tax liability under the mark-to-market regime, a covered expatriate must use the fair market value of each interest in property as of the day before the expatriation date in accordance with the valuation principles applicable for purposes of the Federal estate tax.

A covered expatriate must determine the fair market value of his or her beneficial interest in each trust, other than a non grantor trust to the extent the trust would not be included in the expatriate’s gross estate.

Allocation of the Exclusion Amount

There is exclusion for the first $600,000 adjusted for inflation. The exclusion amount must be allocated among all built in gain, property that is subject to the mark-to-market regime and is owned by the covered expatriate on the day before the expatriation date. Specifically, the exclusion amount must first be allocated pro rata to each item of built in gain property (“gain asset”) by multiplying the exclusion amount by the ratio of the built-in gain with respect to each gain asset over the total built in gain of all gain assets. The exclusion amount allocated to each gain asset may not exceed the amount of that asset’s built-in gain.

Each individual is eligible for only one lifetime exclusion amount. Thus, if a covered expatriate becomes a U.S. citizen or long-term resident, and then loses such citizenship or ceases to be a lawful permanent resident and thereby becomes a covered expatriate subject again, the exclusion amount with respect to the individual on a second expatriation is limited to the unused portion of his or her exclusion amount remaining (if any) after the first expatriation, as adjusted for inflation.

Adjustment to basis of Property Subject to the Mark-to-Market Regime

Proper adjustments are to be made in the amount of any gain or loss subsequently realized with respect to an asset for the amount of gain or loss taken with respect to that asset. In making such adjustment, the basis of this asset will be adjusted by the amount of gain or loss taken

In-Bound Step-Up in Basis for Nonresident Aliens Becoming Resident Aliens

A special rule applies for determining that tax on a nonresident alien, who becomes a resident after (Green Card Holder) and then later gives up their Green Card. Solely for purposes of determining the tax imposed by the expatriation tax, property held by a nonresident alien on the day that individual first became a permanent resident of the United States will be treated as having a basis on such date of not less than the fair market value of such property on such date. A covered expatriate to whom this basis adjustment rule applies may make an irrevocable election, on a property-by-property basis, not to have such rule apply.

Election to Defer Tax

Though the tax is incurred on gain on the deemed sale date, a Covered Expatriate may elect to defer the tax liability with respect to property subject to deemed sale treatment. The tax may be deferred until the taxable year the expatriate actually sells the disposition of the property.

The deferral cannot extend beyond the due date of the return for the taxable year in which the covered expatriate dies.

There are a number of conditions on the availability and cost of the deferral.

A. Interest will accrue on the deferred tax at the underpayment of tax rate;
B. Security must be provided with respect to the Property.
C. The covered expatriate must make an irrevocable waiver of any right under any tax treaty that would preclude assessment or collection of the tax; and a
D. A U.S. agent must be appointed.

The election to defer taxes applies only to the specific property with respect to which it is made and irrevocable.

Adequate security/Tax Deferral Agreement.

In order to make a deferral election with respect to any asset, the covered expatriate must provide adequate security with respect to such asset. The term “adequate security” means (1) a bond that is furnished to, and accepted by, the Secretary, that is conditioned on the payment of the tax (and interest thereon) or (2) another form of security for such payment (including letters of credit) that meets such requirements as the Secretary may prescribe.

Appointment of U.S. agent. In order to make a deferral election, a covered expatriate must appoint a U.S. person to act as the covered expatriate’s limited agent for purposes of accepting communication related to the tax deferral agreement from the IRS on behalf of the covered expatriate.

Deferred Compensation Items

To mark to market regime applies to untaxed gains on property or essentially a tax on unrealized and unrecognized accretions to wealth. The tax under the mark-to-market regime does not apply to deferred compensation items. These items on income are subject to a different method of taxation.

Compensation is considered to be “eligible deferred compensation items” or “ineligible deferred compensation items”.

Deferred compensation items are interests in retirement plans, compensation for services that are subject to tax deferral and any other items of deferred compensation. Deferred compensation items are divided into two categories, eligible and non-eligible. For eligible deferred compensation items, there is no deferred sale. Instead there is a 30% tax that is withheld by the payors when the taxable deferred compensation items are paid.

An “item of deferred compensation” is any amount of compensation if, under the terms of a plan, contract or other arrangement providing for such compensation (compensation arrangement), the Covered Expatriate has a legally binding right as of the expatriation date to such compensation; the compensation has not been actually or constructively received on or before the expatriation date; and pursuant to the compensation arrangement the compensation is payable to (or on behalf of) the covered expatriate on or after the expatriation date.

In the case of an “eligible deferred compensation item;” the U.S. payor of the deferred compensation must deduct and withhold a tax equal to 30 percent of any taxable payment to a covered expatriate with respect to such an item.

Eligible deferred compensation items require the tax to be paid as the deferred compensation is paid and that it be in the form of a 30% withholding tax for which the payor is responsible.

Ineligible Deferred Compensation

In the case of “ineligible deferred compensation items” a covered expatriate generally is subject to taxation on the ineligible deferred compensation item as if received by the covered expatriate on the day before the expatriation date whether it has been in fact received or not.

In General

In the case of “ineligible deferred compensation items,” the law provides that a covered expatriate generally is subject to taxation on the ineligible deferred compensation item as if received by the covered expatriate on the day before the expatriation date.

Taxation of Eligible Deferred Compensation Items

If a deferred compensation item qualifies as an eligible deferred compensation item, the payor must deduct and withhold a tax equal to 30 percent of any taxable payment to a covered expatriate with respect to such an item. The law provides that a taxable payment is any payment to the extent it would be included in gross income of the covered expatriate if such person continued to be subject to tax as a citizen or resident of the United States. Because the covered expatriate must waive his or her right to claim treaty benefits with respect to an eligible deferred compensation item, the 30 percent withholding tax cannot be reduced or eliminated by treaty. However, an amount of deferred compensation that is attributable to services performed outside the United States while the covered expatriate was not a citizen or resident of the United States is not subject to this tax.

Taxation of Ineligible Deferred Compensation Items

With respect to any ineligible deferred compensation, an amount equal to the present value of the covered expatriate’s accrued benefit is treated as having been received by the covered expatriate on the day before the expatriation date as a distribution under the plan and must be included on the covered expatriate’s U.S. individual tax return for the portion of the taxable year that includes the day before the expatriation date.

The person paying the ineligible deferred compensation item must advise the covered expatriate of the present value of the covered expatriate’s accrued benefit to the deferred compensation item on the day before the expatriation date.

In the case of certain defined contribution plans, until further guidance is issued, the present value of the covered expatriate’s accrued benefit is the account balance.

Deferred compensation items include:

(1) any interest in a plan or arrangement described in Section 219(g)(5);

(2) any interest in a foreign pension plan or similar retirement arrangement or program;

(3) any item of deferred compensation; and

(4) any property or right to property, which the individual is entitled to receive in connection with the performance of services to the extent not previously taken into account under Section 83 or in accordance with Section 83.

The “specified tax-deferred accounts” are the following:

(1) an individual retirement plan, other than any arrangement described in Section 408(k) or (p);

(2) a Section qualified tuition program;

(3) a Section 530 Coverdell education savings account;

(4) a Section 223 health savings account; and

(5) a Section 220 Archer MSA. A covered expatriate is required to treat these accounts as being entirely distributed on the day before the date of the expatriation , thus terminating the accounts. However, no early distribution tax is to apply by reason of this treatment.

Trust Distributions

Rather than being deemed sold or distributed, a grantor trust interest treated as owned by the expatriate, is subject to withholding and payment by the trust of a 30% tax on the “taxable portion” of actual distributions when they occur. The determination of whether and how much of a trust is not treated as a grantor trust is made immediately before the date of expatriation and the taxable portion of the each distributing is the portion that would be includible in the covered expatriate’s gross income if such expatriate had continued to be a U.S. citizen or resident. The covered expatriate is treated as waiving any reduction in withholding under a U.S. treaty unless the covered expatriate agrees to such other treatment as the IRS may require.

In addition, if the fair market value of any distributed property exceeds its adjusted basis in the hands of the trust, gain must be recognized to the trust as if such property were sold to the expatriate as its fair market value.

Estate and Gift Taxation under Section 877A

If a U.S. citizen or resident receives property directly or indirectly either by or from, or by reason of the death of, a person who at the time of the acquisition or death was a covered expatriate, then the transfer is subject to a tax equal to the value of the property multiplied by the highest rate of tax for federal estate tax or federal gift tax purposes. The tax is payable by the recipient.

For purposes of Section 2801, there are reductions in the value for a gift in the amount of the annual gift tax exclusion although there is no unified credit amount in the case of a transfer by reason of death.

There are, however, also exceptions for transfers reported on a timely filed return and otherwise subject to federal estate or gift tax and for a transfer to a spouse or charity that would qualify for a deduction if the donor or decedent were a U.S. person. The amount of the tax is also subject to reduction for any gift or estate tax paid to a foreign country with respect to the property transfer. Finally, there are special rules treating a domestic trust as a U.S. citizen for this purpose (with the tax being payable by the trust) and treating distributions from a foreign trust as a U.S. citizen or resident as taxable (with an election available to the foreign trust as treated as a domestic trust).

Ineligible

With respect to any ineligible deferred compensation item not described in section of this notice, until further guidance is issued, the present value of the covered expatriate’s accrued benefit is determined by applying principles in Prop. Treas. Reg. Section 1.409A-4, except as provided herein.

Where such proposed regulations provide for a determination to be made as of the end of the taxable year, such determination shall be made as of the day before the expatriation date. For the purposes of this section, the present value of the covered expatriate’s accrued benefit is determined without regard to any substantial risk of forfeiture.

Filing and Reporting Requirements

Income tax returns

Initial filing obligations for the year of expatriation. A covered expatriate tax must file a dual status return if he or she was a U.S. citizen or long term resident for only part of the taxable year that includes the day before the expatriation date. A dual status return requires the covered expatriate to file a Form 1040NR with a Form 1040 attached as a schedule. If the covered expatriate’s expatriation date is January 1, then he or she will not be required to file a dual status return.

Filing obligations for subsequent years.

A covered expatriate must file Form 1040 NR. If the covered expatriate tax is fully withheld upon at source for a particular taxable year and has no income effectively connected with the conduct of a trade or business in the United States for that year, then he or she will not be required to file a Form 1040NR for those years.

NOTICES TO PAYORS
Form W-8CE Notice to Payor

A covered expatriate who has a deferred compensation item, a specified tax deferred account or an interest in a nongrantor trust must file Form W-8CE with the relevant payor on the earlier of (1) the day prior to the first distribution on or after the expatriation date or (2) 30 days after the covered expatriate’s expatriation date as defined in section (3).

Eligible deferred compensation item. In the case of an eligible deferred compensation item, the Form W-8CE provides notice to the payor that the individual is a covered expatriate who has waived treaty benefits with respect to the eligible deferred compensation item, with the result that taxable payments will be subject to 30 percent withholding.

Ineligible deferred compensation item.

In the case of an ineligible deferred compensation item described in section, Form W-8CE provides notice to the payor that the individual is a covered expatriate who is treated as receiving an amount equal to the present value of his or her accrued benefit on the day before the expatriation date and with respect to which appropriate adjustments must be made to subsequent distributions to reflect the tax imposed by reason of such treatment. Within 60 days of receipt of Form W-8CE, the payor must provide a written statement to the covered expatriate setting forth the present value of the covered expatriate’s accrued benefit on the day before the expatriation date.

Specified tax deferred account.

In the case of a specified tax deferred account, Form W-8CE provides notice to the payor that the individual is a covered expatriate who is treated as receiving a distribution of his or her entire interest in the account on the day before his or her expatriation date and with respect to which appropriate adjustments must be made to subsequent distributions to reflect the tax imposed by reason of such treatment. Within 60 days of receipt of Form W-8CE, the payor must provide a written statement to the covered expatriate settling for the amount of the covered expatriate’s account balance on the day before the expatriation date.

Interest in Non grantor trust.

In the case of an interest in a nongrantor trust of which the covered expatriate was a beneficiary on the day before the expatriation date, Form W-8CE provides notice to the trustee that the individual is a covered expatriate. The covered expatriate will be deemed to have waived treaty benefits with respect to future distributions from the trust unless the covered expatriate checks a box on Form W-8CE certifying that he or she will elect on Form 8854 to pay tax currently on the value of his or her interest in the trust.

Transfer Tax on Gifts and Bequests Received from Covered Expatriates

Congress has tried in vain on several occasions to tax gifts and estates of expatriate Americans.
The new regime makes another attempt at this. If a U.S. citizen or resident receives a covered gift of bequest from a covered expatriate (including a distribution from the income or corpus of a foreign trust attributable to a covered gift or bequest made to a foreign trust), the transfer is subject to tax.

A “covered gift or bequest is property” acquired directly or indirectly by gift from, or by reason of the death of, a person who at the time of the acquisition or death was a covered expatriate. A covered gift or bequest does not include (1) a taxable gift by a covered expatriate if reported on a timely filed gift tax return; (2) property included in a covered expatriate’s gross estate and reported on a timely filed estate tax return; and (3) transfers to which an estate tax charitable deduction or a gift tax or estate tax marital deduction would be allowable if the donor or decedent were a U.S. person.

The tax, which is payable by the recipient, is equal to the value of the gift or bequest multiplied by the highest estate tax rate or, if greater, the highest gift tax rate. The tax is imposed only to the extent the recipient receives covered gifts and bequests during the calendar year valued in excess of the annual gift tax exclusion. The tax on a covered gift or bequest is reduced by any foreign gift or estate tax paid on such gift or bequest. THE TAX IS NOT REDUCED BY THE GIFT TAX UNIFIED CREDIT OR THE ESTATE TAX UNIFIED CREDIT.

Tax Planning - Green Card Holders – Do They Need the Green Card

A green card as opposed to a temporary visa of one sort or another, which may achieve the same ends, in substance, while avoiding the green card. If one is able to stay in the United States for the desired duration without tripping the eight year/15 year wire, he or she will have much more flexibility when transferring his or her wealth. And, depending on the circumstances, of course, one must consider leaving the United States before the culmination of eight years of residency – especially if there is no plan to return.

Income Stream

If an NRNC cannot be dissuaded from obtaining a green card, and likely is staying for at least eight years in the United States but will give up U.S. residency (upon retirement or a child’s graduation, for instance), and e.g. will leave U.S. gift recipients and/or U.S. beneficiaries behind, then transferring assets before entering the United States would clearly avoid both the general transfer tax limitations on U.S. citizens/residents and the Section 2801 tax. Discussing pre immigration transfers is absolutely vital as an NRA can make unlimited transfers of non U.S. situs assets with virtually unlimited flexibility – subject to none of the limitations vis a vis the FET exemption, lifetime FGT exemption, annual gift tax exclusion and marital deduction. Once the NRNC establishes a domicile in the United States, he or she will most likely need many years’ worth of exemptions and exclusion amounts to transfer what could have been transferred in one year as an NRA.

A major silver lining to the HEART Act is that U.S. residents who are no green card holders are no longer subject to any transfer tax consequences when they exit the United States

For those who have been in the United States for many years with a green card, a simple change in immigration status may also prove to be important estate planning. Such people may indeed want to consider becoming and remaining U.S. citizens, for instance – to avoid the exit tax when leaving the United States while still have the ability to live abroad and use the normal rules (including any transfer tax treaties for avoiding double transfer taxation.) Or they may consider giving up the green card before the eight year trigger pulls and remain in the United States on a temporary visa.

U.S. citizens that wish to expatriate and avoid the HEART Act’s expatriation tax regime have far fewer options – other than to just fade away. An option in some circumstances is to make exemption sheltered, pre expatriation gift(s) to reduce the subject’s net worth until it is under the net worth threshold (this is effective, assuming he or she would also be underneath the tax liability threshold and able to make the compliance certification), therefore preventing application of the rules in the first place. Similarly, another possibility is to time the expatriation when the valuation of the worldwide assets is lowest (in a down market for example). In any case, it involves numbers crunching and, in many cases, the cost of the exit and/or inheritance taxes now or later will be less than a lifetime of the various taxes suffered as a U.S. citizen.

A related, final note is that, in a lot of cases, the expatriation inclined person would do well to take the plunge now rather than wait for Congress to further tinker with the rules, which history teaches is only a matter of time.

If you need Expatriation assistance please contact Richard S. Lehman Esq.

I.R.S. Makes Changes To Offshore Bank And Foreign Asset Disclosure Programs

By Richard S. Lehman, Tax Attorney

The Internal Revenue Service announced major changes in its offshore voluntary compliance programs, providing new options to help both taxpayers residing overseas and those residing in the United States. These changes will provide thousands of people a new avenue to come into compliance with their U.S. tax obligations. The expanded streamlined procedures are intended for U.S. taxpayers whose failure to disclose their offshore assets are non willful.

This is an extremely important and valuable I.R.S. Program. It allows almost every American who has been afraid to step forward and disclose their foreign assets to the U.S. taxing authorities to do so with minimized penalties on unpaid taxes and unfiled information returns.

Purpose of the streamlined procedures: The streamlined filing compliance procedures are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. The streamlined procedures are designed to provide to taxpayers in such situations:

1. a streamlined procedure for filing amended or delinquent returns and
2. terms for resolving their tax and penalty obligations. These procedures will be available for an indefinite period until otherwise announced. This means that just as the Internal Revenue Service has suddenly announced this highly beneficial “settlement tool”, the Internal Revenue Service can withdraw the program. Eligible taxpayers need to act quickly.

General eligibility for the streamlined procedures: The streamlined filing compliance procedures, (the “Streamlined Procedures”), are designed for only individual taxpayers, including estates of individual taxpayers. The Streamlined Procedures are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States.

Taxpayers using either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will be required to certify, in accordance with the specific instructions set forth below, that the failure to report all income, pay all tax and submit all required information returns, including FBARs, was due to non willful conduct.

Audit of Returns

Taxpayers who choose the “Streamlined Procedures” to report offshore income will not be able to enter the existing I.R.S. Offshore Voluntary Disclosure Program (OVDP).

Most important, taxpayers who choose this Streamlined Procedure must be sure their disclosures are complete and in good faith. This is because returns submitted under the Streamlined Procedures will not be subject to IRS audit automatically. However, they may be selected for audit under the existing audit selection processes applicable to any U.S. tax return and may also be subject to verification procedures in that the accuracy and completeness of submissions may be checked against information received from banks, financial advisors, and other sources.

Thus, returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties and even criminal liability, if appropriate.

Not Eligible

Not all taxpayers will be eligible for the streamlined procedures.

Taxpayers who are already under a civil examination of a taxpayer’s returns for any taxable year, (regardless of whether the examination relates to undisclosed foreign financial assets), will not be eligible to use the streamlined procedures. Taxpayers under examination may consult with their agent. Similarly, a taxpayer under criminal investigation by IRS Criminal Investigation is also ineligible to use the streamlined procedures.

Quiet Disclosures

Taxpayers eligible to use the Streamlined Procedures who have previously filed delinquent or amended returns in an attempt to address U.S. tax and information reporting obligations with respect to foreign financial assets (so called “Quiet disclosures”) may still use the streamlined procedures. However, any penalty assessments previously made with respect to those filings will not be abated.

Receipt of the returns will not be acknowledged by the IRS and the streamlined filing process will not culminate in the signing of a closing agreement with the IRS. However, the check will be cashed. No formal confirmation of acceptance will be provided by the I.R.S.

The Offshore Voluntary Disclosure Program

If a Taxpayer is concerned that his or her failure to report income, pay tax and submit required information returns was due to willful conduct and who wants more assurances that they will not be subject to criminal inability and/or substantial monetary penalties, that taxpayer should consider participating in the Offshore Voluntary Disclosure Program (OVDP) and should consult with their professional tax or legal advisers.

This Offshore Voluntary Compliance Program is a separate I.R.S. Program that waives certain serious penalties but asserts a much higher overall penalty than the Streamlined Procedure and it assures taxpayers that they will have a perfectly clean slate.

Coordination with treatment under OVDP

Once a taxpayer makes a submission under either the Streamlined Foreign Offshore Procedures of the Streamlined Domestic Offshore Procedures, the taxpayer may not participate in OVDP.

Similarly, a taxpayer who submits an OVDP voluntary disclosure letter on or after July 1, 2014, is not eligible to participate in the streamlined procedures.
A taxpayer eligible for treatment under the Streamlined Procedures who submits, or has submitted, a voluntary disclosure letter under the OVDP (or any predecessor offshore voluntary disclosure program) prior to July 1, 2014, but who does not yet have a fully executed OVDP voluntary disclosure letter on or after July 1, 2014, is eligible to participate in the streamlined procedures.

The Streamlined Procedures will apply to all United States taxpayers that are residing both within and without the United States. The rules are slightly different for U.S. taxpayers who reside without the United States.

Eligibility Procedures and requirements are for these taxpayers.

U.S. TAXPAYERS RESIDING IN THE UNITED STATES

U.S. Residents

1. The taxpayer must be a U.S. tax resident in the U.S. (for joint return filers, one or both of the spouses must be tax residents.
2. The taxpayer must have previously filed a U.S. tax return (if required) for each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed;
3. The taxpayer must have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR and or one or more international information returns, such as forms reporting gifts from foreign persons, forms for U.S. taxpayers that have ownership in foreign corporations and forms disclosing all of the taxpayers foreign income producing assets.
4. Such failures must have resulted from non willful conduct. Non willful conduct is 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.

The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty. A finding of willfulness must be supported by evidence of willfulness. The burden of establishing willfulness is on the Internal Revenue Service and if it is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.

The Benefits Of The Streamlined Procedure

A taxpayer who is eligible to use these Streamlined Foreign Offshore Procedures and who complies with all of the instructions will not be subject to failure to file and failure to pay penalties, accuracy related penalties, information return penalties, or FBAR penalties.

Specific Instructions for the Streamlined Foreign Offshore Procedures

Failure to follow these instructions or to submit the items described below will result in returns being processed in the normal course without the benefit of the favorable terms of these procedures.

1. For each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) has passed: If a U.S. tax return has been filed previously, submit a complete and accurate amended tax return using Form 1040X, Amended U.S. Individual Income Tax Return, together with the required information returns (e.g., Forms 3520, 5471 and 8938) even if these information returns would normally be filed separately from the Form 1040 had the taxpayer filed a complete and accurate original return.
2. Include at the top of the first page of each delinquent or amended tax return and at the top of each information return “Streamlined Foreign Offshore” written in red to indicate that the returns are being submitted under these procedures.

Filing of Returns

Taxpayers must file Form 1040X, Amended U.S. Tax Return, together with any required information returns and musty Include at the top of the first page of each amended tax return the words “Streamlined Domestic Offshore Procedures” written in red to indicate that the returns are being submitted under these procedures. This is critical to ensure that your returns are processed through these special procedures.

The Certification

Taxpayers must complete and sign a statement on the Certification by U.S. Person Residing in the U.S. certifying:

1. that you are eligible for the Streamlined Domestic Offshore Procedures;
2. that all required FBARs have now been filed (see instruction 9 below);
3. that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non willful conduct; and that the miscellaneous offshore penalty amounts is accurate.
4. Together with the required accurate returns, the taxpayer must submit payment of all tax due as reflected on the tax returns and all applicable statutory interest with respect to each of the late payment amounts. The taxpayer’s identification number must be included on the check and the taxpayers may receive a balance due notice or a refund if the tax or interest is not calculated correctly.
5. Submit payment of miscellaneous offshore penalty as defined above.
6. For each of the most recent 6 years for which the FBAR due date has passed, file delinquent FBARs according to the FBAR instructions and include a statement explaining that the FBARs are being filed as part of the Streamlined Filing Compliance Procedures.

The Title 26 miscellaneous offshore penalty is equal to 5 percent of the highest aggregate year-end balance / value of the taxpayer’s foreign financial assets that are subject to the miscellaneous penalty.

A taxpayer who is eligible to use these Streamlined Domestic Offshore Procedures and who complies with all of the instructions below will be subject only to the Title 26 miscellaneous offshore penalty and will not be subject to accuracy related penalties, information return penalties or FBAR penalties.

Complete and sign a statement on the Certification by U.S. Person Residing Outside of the U.S. certifying (1) that you are eligible for the Streamlined Foreign Offshore Procedures; (2) that all required FBARs have now been filed; and (3) that the failure to file tax returns, report all income, pay all tax, and submit all required information returns, including FBARs, resulted from non willful conduct.

Submit payment of all tax due as reflected on the tax returns and all applicable statutory interest with respect to each of the late payment amounts. Your taxpayer identification number must be included in your check.

U.S. Taxpayers Residing Outside The United States

Eligibility for the Streamlined Foreign Offshore Procedures

For the most part Taxpayer’s residing outside of the U.S. will have the same requirement as those residents in the U.S. However, there are certain differences.

1. Taxpayers must meet the applicable non-residency requirements; and
2. have failed to report the income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR with respect to a foreign financial account, and such failures resulted from non willful conduct.

Individual U.S. citizens or lawful permanent residents, or estate of U.S. citizens or lawful permanent residents will meet the applicable non residency requirement if, in any one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the individual did not have a return due date (or properly applied for extended due date) has passed, the individual did not have a U.S. abode and the individual was physically outside the United states for at least 330 full days.

THE CONCEPT OF WILLFULNESS

In tax law “willfulness” has its own definition and it is an important definition for every taxpayer That is because a taxpayer who “willfully” filed or did not file accurate tax information can be subjected to numerous very expensive penalties and even criminal liability.

As mentioned, a taxpayer who wishes to be in the Streamlined Program must not have “willfully failed to report income from any foreign asset and/or failed to file an FBAR Information form.

The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty. A finding of willfulness must be supported by evidence of willfulness. The burden of establishing willfulness is on the Internal Revenue Service and if it is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.

According to the IRS Manual, the innocent failure of an unsophisticated Taxpayer to know the filing requirements for international transactions, coupled with other factors, such as the lack of any efforts taken to conceal the existence of the accounts could not lead to a conclusion that the violation was due to willful blindness. The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.

Willfulness can rarely be proved by direct evidence, since it is a state of mind. It is usually established by drawing a reasonable inference from the available facts. The government may base a determination of willfulness in the failure to file the FBAR on inference from conduct meant to conceal sources of income or other financial information. For FBAR purposes, this could include concealing signature authority, interests in various transactions, and interest in entities transferring cash to foreign banks

The Service has given its agents great discretion when the evidence shows that there is not a certain degree of culpability necessary for willfulness and has suggested certain mitigating factors that may determine that a penalty is not appropriate or that a lesser penalty amount than the guidelines would otherwise provide is appropriate or that the penalty should be increased (up to the statutory maximum). These factors to consider can include the fact that a taxpayer was cooperating with the I.R.S.

Internal Revenue Service Document

The Service issued a legal memorandum in connection with its international enforcement programs. One of the issues addressed was the proper interpretation of the “willfulness” standard in the context of civil FBAR penalties. The Service’s directness on this point was remarkable. “The first question was whether the phrase willful violation (or willfully causes any violation) has the same definition for both the civil penalty and the criminal penalty. The answer by the I.R.S. was “yes”.

The IRS’s own internal guidance in the Internal Revenue Manual (IRM) on the willful FBAR penalty states that “[t]he test for willfulness is whether there was a voluntary, intentional violation of a known legal duty”. . . it acknowledges that “[t}he mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.” Rather, to establish willful blindness the IRS directs its agents that they must show that the taxpayer “has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements”.

The regulations further state that “[w]hether a person knowingly or willfully fails to file timely or fails to include correct information is determined on the basis of all the facts and circumstances in the particular case.” Factors to consider in determining intentional disregard include, but are not limited to:

(i) Whether the failure to file timely or the failure to include correct information is part of a pattern of conduct by the person who filed the return of repeatedly failing to file timely or repeatedly failing to include correct information;

(ii) Whether correction was promptly made on discovery of the failure;

(iii) Whether the filer corrects a failure to file or a failure to include correct information within 30 days after the date of any written request from the Internal Revenue Service to file or correct; and

(iv) Whether the amount of the information reporting penalties is less than the cost of complying with the requirement to file timely or to include correct information on an information return.

GLOSSARY OF STATEMENTS FROM DECIDED CASES RE WILLFULNESS

CASE LAW

Since willfulness can be somewhat elusive to define, the following is a Glossary of statements from various authorities that will shed more light on the meaning of willfulness.

In the course of one of the first cases involving willfulness, the court advised the jury that, to prove “willfulness,” the Government must prove the voluntary and intentional violation of a known legal duty, a burden that could not be proved by showing mistake, ignorance, or negligence. The court further advised the jury that an objectively reasonable good-faith misunderstanding of the law would negate willfulness.

A second court not only repeated this standard for willfulness; it went even further to distinguish tax offenses from the general rule of law that “ignorance of the law is no defense”. Since the tax laws are so complex, ignorance of the law is a factor in the determination of willfulness.

The Supreme Court has long held that, in tax cases, “willfulness” requires proof of an intentional violation of a known legal duty, meaning that there must be some evidence beyond recklessness that a taxpayer was aware of the relevant reporting requirements. A showing that the defendant acted with “careless disregard” is not adequate. Willfulness is an entirely subjective determination.

Another court in (affirming criminal conviction for willful tax fraud where tax preparer “closed his eyes to” large accounting discrepancies, willful was said to be proven through reference from conduct meant to conceal or mislead sources of income or other financial information” and it “can be inferred from a conscious effort to avoid learning about reporting requirements. Similarly, willful blindness may be inferred where “a defendant was subjectively aware of a highly probability of the existence of a tax liability and purposefully avoided learning the facts point to such liability.

The word willful “retains its traditional meaning that violation of the Act must be deliberate, voluntary and intentional.” [Other cases] urge upon us still another meaning: that “willful” requires bad purpose as an element of the violations.

Under some statutes, an act is “willful” only if done malevolently, wickedly and criminally. Under other types of statutes, it suffices that the act was performed consciously and voluntarily, rather than inadvertently or accidentally. Betwixt these two formulations, “willful” has been given various other meanings, although shades of difference ofttimes diminish when the probe extends beneath the surface. Because of its inherent instability, only the most careful consideration of the term “willful” in its legislative context can provide satisfactory assurance that eventually it will take on its proper cast.

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This topic does qualify for CLE accredited tax law credits for Florida Attorneys.

Mr. Lehman believes in sharing his knowledge to those who are interested in the complex topic of United States taxation. These CLE credits are offered at no cost and are available on-demand to all who would like to learn more. All seminars are Florida Bar Accredited.

• IRS New Streamlined Filing Compliance Procedures (1.0 CLE Credit)
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  The IRS makes changes to the offshore bank and foreign asset disclosure programs. View this presentation and resources here.
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In tax law “willfulness” has its own definition and it is an important definition for every taxpayer. That is because a taxpayer who “willfully” filed or did not file accurate tax information can be subjected to numerous very expensive penalties and even criminal liability.

A taxpayer who wishes to be in the Streamlined Program must not have “willfully” failed to report income from any foreign asset and/or failed to file an FBAR Information form.

The IRS test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.

A finding of willfulness must be supported by evidence of willfulness. The burden of establishing willfulness is on the Internal Revenue Service and if it is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.

According to the IRS Manual, the innocent failure of an unsophisticated Taxpayer to know the filing requirements for international transactions, coupled with other factors, such as the lack of any efforts taken to conceal the existence of the accounts could not lead to a conclusion that the violation was due to willful blindness. The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.

Willfulness can rarely be proved by direct evidence, since it is a state of mind. It is usually established by drawing a reasonable inference from the available facts.

The government may base a determination of willfulness in the failure to file the FBAR on inference from conduct meant to conceal sources of income or other financial information. For FBAR purposes, this could include concealing signature authority, interests in various transactions, and interest in entities transferring cash to foreign banks.

The Service has given its agents great discretion when the evidence shows that there is not a certain degree of culpability necessary for willfulness and has suggested certain mitigating factors that may determine that a penalty is not appropriate or that a lesser penalty amount than the guidelines would otherwise provide is appropriate or that the penalty should be increased (up to the statutory maximum). These factors to consider can include the fact that a taxpayer was cooperating with the I.R.S.

In determining the qualifications for mitigation, the Internal Revenue Service Manual lists the following requirements.

1. The person has no history of criminal tax or BSA convictions for the preceding ten years and has no history of prior penalty assessments;
2. No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose.
3. The person cooperated during the examination; and
4. IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in foreign accounts.

Glossary Of Statements From Decided Cases Regarding Willfulness

– CASE LAW –

Since willfulness can be somewhat elusive to define, the following is a Glossary of statements from various authorities that will shed more light on the meaning of willfulness.

In the course of one of the first cases involving willfulness, the court advised the jury that, to prove “willfulness,” the Government must prove the voluntary and intentional violation of a known legal duty, a burden that could not be proved by showing mistake, ignorance, or negligence. The court further advised the jury that an objectively reasonable good-faith misunderstanding of the law would negate willfulness.

A second court not only repeated this standard for willfulness; it went even further to distinguish tax offenses from the general rule of law that “ignorance of the law is no defense”. Since the tax laws are so complex, ignorance of the law is a factor in the determination of willfulness.

The Supreme Court has long held that, in tax cases, “willfulness” requires proof of an intentional violation of a known legal duty, meaning that there must be some evidence beyond recklessness that a taxpayer was aware of the relevant reporting requirements. A showing that the defendant acted with “careless disregard” is not adequate. Willfulness is an entirely subjective determination.

Another court in affirming criminal conviction for willful tax fraud where tax paperer “closed his eyes to” large accounting discrepancies, willful was said to be proven through reference from conduct meant to conceal or mislead sources of income or other financial information” and it “can be inferred from a conscious effort to avoid learning about reporting requirements. Similarly, willful blindness may be inferred where “a defendant was subjectively aware of a highly probability of the existence of a tax liability and purposefully avoided learning the facts point to such liability.

The word willful “retains its traditional meaning that violation of the Act must be deliberate, voluntary and intentional.” [Other cases] urge upon us still another meaning: that “willful” requires bad purpose as an element of the violations.

Under some statutes, an act is “willful” only if done malevolently, wickedly and criminally. Under other types of statutes, it suffices that the act was performed consciously and voluntarily, rather than inadvertently or accidentally. Betwixt these two formulations, “willful” has been given various other meanings, although shades of difference ofttimes diminish when the probe extends beneath the surface. Because of its inherent instability, only the most careful consideration of the term “willful” in its legislative context can provide satisfactory assurance that eventually it will take on its proper cast.

Value can be lost without good professional advice. Contact Richard S. Lehman today, an experienced tax lawyer.

These new IRS modifications are very significant.

It is absolutely critical to understand these important IRS changes, please contact veteran tax attorney Richard S. Lehman Esq., today. The new Internal Revenue Service ruling greatly reduces offshore voluntary disclosure procedure for Americans with un-reported foreign bank accounts.

New IRS Announcement can be found here: http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures

U.S. Taxpayers Residing in the United States

• The following streamlined procedures are referred to as the Streamlined Domestic Offshore procedures and can be found here: http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-in-the-United-States

U.S. Taxpayers Residing Outside the United States

• The following streamlined procedures are referred to as the Streamlined Foreign Offshore Procedures and can be found here: http://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-Outside-the-United-States

Updated Offshore Voluntary Disclosure Program Frequently Asked Questions

• The IRS’s Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers can be found here: http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised

All IRS Tax Information For International Businesses can be found here: http://www.irs.gov/Businesses/International-Businesses

Be knowledgeable and know your legal rights.

Most U.S. taxpayers are now aware of all of the new requirements for U.S. Information Returns that will alert the Internal Revenue Service to the amounts and nature of most foreign assets and foreign bank deposits owned by U.S. taxpayers. An Information Return is not a tax return. It simply notifies the Internal Revenue Service of foreign assets; both individual and corporate.

However, the failure to file information returns and disclose various foreign assets to the Internal Revenue Service can result in very severe and expensive tax penalties for U.S. taxpayers.

In order to avoid these significant penalties, the Information Returns must be timely filed. For those U.S. taxpayers who have not timely filed the proper U.S. tax returns and/or the proper U.S. Information Returns; the Internal Revenue Service has provided an Overseas Voluntary Disclosure Initiative (“OVDI” or “Amnesty Program”). This permits U.S. taxpayers with foreign bank deposits and other assets that have not been disclosed and/or taxed to pay their taxes for prior years and avoid serious penalties.

Under this “Amnesty Program”, United States taxpayers may voluntarily disclose their unreported offshore assets without being subject to any criminal liability and limiting the U.S. taxes and civil penalties that could be applied.

However, if the I.R.S. is investigating a Taxpayer, it is too late for the Taxpayer to enter the Amnesty Program.

This Amnesty Program can be expensive and includes a high penalty on unreported bank deposits. The Taxpayer must pay the proper tax on all U.S. unreported income for the last eight years and pay a 20% accuracy penalty for unreported taxes plus interest.

Reduction of Penalties – The “Opt Out” Program

Under certain circumstances the penalties may be reduced. If this is the case, the Taxpayers that have been permitted to enter Amnesty Program, may “Opt Out” of the Amnesty Program if they believe lower penalties should be applied under the Taxpayer’s special circumstances.

If you have additional questions, contact Richard S. Lehman

We are having success in getting penalties eliminated or reduced.

I want to make you aware of the best guidance that one can get regarding the new IRS open-ended Amnesty program. These questions from the IRS deal with the Amnesty program. They will be very helpful.

EXAMPLE:

Questions 17 in the IRS question which does say if you have no taxable income and you’ve paid all your taxes on your taxable income, there’s not going to be the substantial FBAR penalty violation that comes with a willful FBAR violation. That being the case, with no taxes due, you don’t need to be in the amnesty program. What we had found is people have gone in the amnesty program, and then because of either loss, carry-forwards, or foreign tax credits on foreign income or whatever may arise in these individuals’ situations, that at times even though there’s been foreign bank deposit investment income not reported, we have been able to show that there has been no taxable income. So that’s one area where there is some deviation if it’s handled in a sophisticated way.

We’ve had success in that area too, at looking carefully at whether there has been a willful violation in the past of the failure to file the FBAR. We take a very, very careful look at everyone who joins the amnesty program, not just to provide a really excellent product which is the key to the amnesty program but also it’s important to know that we take a look to make sure that we’re not paying more than any taxpayer should be paying under the amnesty program.

There are procedures, there’s very good guidance on how the procedures need to be followed and what procedures need to be followed, and procedures on how to expand for an institution to make sure that all of its branches are covered without doing the extra work.

If you need help with the new IRS open-ended Amnesty or any of the new IRS laws we can help.

Please fill out the form below and you will be contacted.

New United States tax laws require strict reporting of foreign assets and establish a new program granting Amnesty from criminal tax prosecution for offshore delinquent taxpayers.

The United States has finally caught up with the Global world when it comes to taxation. Three new laws are now in place to insure, as much as possible, that individual Americans and resident aliens will pay tax on their worldwide income.

Under the first new law known as the Foreign Accounts Compliance Act (“FATCA”), (“Foreign Asset Reporting”) beginning with the year 2011 annual income tax returns, there are new reporting requirements in place for U.S. individual taxpayers and U.S. entities. These laws require specified foreign assets that must be disclosed and reported on an information return that is filed together with the Federal income tax return.

At the same time that these more stringent disclosure of offshore assets is being demanded; the IRS has agreed to an open ended continued amnesty program for taxpayers who have not properly reported or paid tax on their worldwide income (the “Amnesty”). Unlike previous Amnesties, there is no time period to this latest program. However, I.R.S. has warned it can stop the Amnesty Program whenever it wants. The Amnesty Program charges a harsh fine but permits a taxpayer to avoid criminal penalties and a number of wealth destroying civil penalties that can be imposed on a U.S. Taxpayer who has not paid U.S. taxes on foreign bank deposits and other foreign assets.1/

This article is in two portions. The first portion considers the Amnesty program for unreported foreign income and the second portion considers the Foreign Asset Reporting Requirements.1/

PART I – THE AMNESTY

A U.S. Taxpayer (the “Taxpayer”) with undisclosed foreign accounts or entities and other assets, should make a voluntary disclosure because it enables the Taxpayer to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

Penalties Avoided

The following is a list with a short explanation of each potential civil and criminal penalty that is avoided by accepting the Amnesty terms.

Civil Penalties

1. There is a penalty for failing report a direct or indirect financial interest in, or signature authority over any financial account maintained with a financial institution located in a foreign country that exceeds $10,000.
2. There is a penalty for failing to file an Annual Return to Report large foreign gifts and transactions with Foreign Trusts.
3. There is a penalty for failing to report any ownership interest in foreign trusts.
4. A penalty for certain United States persons who are officers, directors or shareholders in certain foreign corporations who do not report such information to the United States.
5. There is a penalty for U.S. persons that fail to file and report ownership of foreign partnerships

There are Fraud Penalties that result only in Civil Penalties. These penalties can be almost as high as the tax that has been avoided.

1. A fraud penalty for failing to file a tax return.
2. A fraud penalty for failing to pay the amount of tax shown on the return.
3. An accuracy-related penalty on underpayment of tax.

Criminal Penalties

The failure to report and pay taxes on foreign income and bank account by US. Taxpayer can also result in Criminal Penalties.

1. Possible criminal charges related to tax returns include filing a false return and failure to file an income tax return.
2. A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000.
3. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000.

All of this can be avoided by entering into the I.R.S. Amnesty Program. However, the cost is high.

The present Amnesty program provides a tax, interest and penalty framework. Individuals must pay their taxes on any unreported income, 20% penalty on the total unpaid taxes and interest on the amounts due. In addition, individuals must pay a onetime penalty of 27.5 percent of the highest aggregate balance at any one point in time of their foreign bank accounts or entities during an eight (8) year period prior to the disclosure. Some taxpayers will be eligible for 12.5 percent penalties instead of the 27.5% penalty.

The Taxpayer must:

1. Provide copies of previously filed original or amended federal income tax returns for all tax years covered by the voluntary disclosure. The voluntary disclosure period can be a period of eight (8) years preceding the disclosure time.
2. File complete and accurate original or amended offshore-related information returns.
3. Cooperate fully with the voluntary disclosure process which includes providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing tax and penalties.
4. Pay all taxes due as a result of the disclosure.2/
5. Pay a 20% accuracy-related penalty on the full amount of the underpayment of tax for all years.
6. Pay a penalty for the failure to file a tax return if tax return was not filed.
7. Pay, in lieu of all other penalties that may apply, a penalty equal to 27.5% (or in limited cases 12.5% or 5% of the highest aggregate balance in foreign bank accounts/entitites or value of foreign assets during the period covered by the voluntary disclosure.
8. Pay all interest on the outstanding amount.

ELIGIBILITY

Taxpayers who have undisclosed offshore accounts or assets are eligible to apply for IRS Criminal Investigation’s Voluntary Disclosure Practice and penalty regime for an eight year maximum disclosure period.

Corporations, partnerships, and trusts and other entities are eligible to make voluntary disclosures.

Amnesty Not Available – Investigation Commenced

However, if the IRS has initiated a civil examination, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities, the taxpayer will not be eligible to come in under the Amnesty. Taxpayers under criminal investigation are also ineligible. The taxpayer or the taxpayer’s representative should discuss the offshore accounts with the agent.

The purpose for the voluntary disclosure practice is to provide a way for taxpayers who did not report taxable income in the past to come forward voluntarily and resolve their tax matters. Thus, if you, reported and paid tax on all table income but did not file FBARs, do not use the voluntary disclosure process.3/

Taxpayers who reported and paid tax on all their taxable income for prior years but did not file FBARs should file the delinquent FBAR reports according to the FBAR instructions and attach a statement explaining why the reports are filed late. The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities,

Notice of Qualification for Amnesty

Taxpayers or representatives may file to the Criminal Investigation Lead Development Center identifying information (name, date of birth, social security number and address) and an executed power of attorney (if represented) to request pre clearance before making an offshore voluntary disclosure.

Criminal investigation will then notify taxpayers or their representatives via fax whether or not they are cleared to make an offshore voluntary disclosure.

Taxpayers deemed cleared should take the steps within 30 days from receipt of the fax notification to make an offshore voluntary disclosure. Pre clearance does not guarantee a taxpayer acceptance. Taxpayers must still truthfully, timely and completely comply with all provisions of the offshore voluntary disclosure program.

PAYMENT

The terms of the Amnesty require the taxpayer to pay the tax, interest and accuracy related penalty and other penalties with their submission. However, it is possible for a taxpayer who is unable to make full payment of these amounts to request the IRS to consider other payment arrangements.

The burden will be on the taxpayer to establish inability to pay, to the satisfaction of the IRS, based on full disclosure of all assets and income sources, domestic and offshore, under the taxpayer’s control. Assuming that the IRS determines that the inability to fully pay is genuine, the taxpayer must work out other financial arrangements acceptable to the IRS to resolve all outstanding liabilities in order to be entitled to the penalty relief under this initiative.

Amnesty Documents

1. Copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for tax years covered by the voluntary disclosure.
2. Complete and accurate amended federal income tax return (for individuals, Form 1040X or original Form 1040 if delinquent for all tax years covered by the voluntary disclosure, with 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, entities or trusts.
3. A completed Foreign Account or Asset Statement for each previously undisclosed foreign account or asset during the voluntary disclosure period. For those applicants disclosing offshore financial accounts with an aggregate highest account balance if any year of $1 million or more, a completed Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer has undisclosed accounts or transactions during the voluntary disclosure period
4. A check payable to the Department of Treasury in the total amount of tax, interest, accuracy-related penalty, and if applicable, the failure to file and failure to pay penalties, for the voluntary disclosure period. The total amount of tax, interest and penalties as described above cannot be paid, submit a proposed payment arrangement and a completed Collection Information Statement.
5. 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. 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.
6. Properly completed and signed agreements to extend the period of limitations.
7. In a striking new approach to the Amnesty Program, the Program now extends the penalty beyond just offshore financial assets; if the assets are not acquired with after tax income. The offshore penalty is intended to apply to offshore assets that are related to tax on compliance. Thus, if offshore assets were acquired with funds that were subject to U.S. tax but on which no such tax was paid, the offshore penalty would apply regardless of whether the assets were producing current income. Assuming that the assets were acquired with after tax funds or from funds that were not subject to U.S. taxation, if the assets have not yet produced any income, there has been no U.S. taxable event and no reporting obligation to disclose. The taxpayer will be required to report any current income from the property or gain from its sale or other disposition at such time in the future as the income is realized.

The penalty applies to all assets directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets, tangible assets such as real estate or art and intangible assets such as patents or stock or other interests in a U.S. or foreign business, if the assets were acquired with funds that evaded the payment of U.S. taxes. Whether such assets are indirectly held or controlled by the taxpayer through an entity or alter ego, the penalty may be applied to the taxpayer’s interest in the entity or, if the Service determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying assets.

Amnesty Program – Modifications

The Amnesty cannot be taken in parts. If any part of the offshore penalty is unacceptable to the taxpayer the case will be examined and all applicable penalties will be imposed. After a full examination, any tax and penalties imposed by the Service on examination may be appealed.

Voluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing. However, because the 27.5% percent offshore penalty is a proxy for the FBAR penalty, other penalties imposed under the Internal Revenue Code, and potential liabilities for the voluntary disclosure years, there may be cases where a taxpayer making a voluntary disclosure would owe less if the especial offshore initiative did not exist. Under no circumstances will taxpayers be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes.

The 5% Penalty

Taxpayers who meet all four of the following conditions will entitled to the reduced 5% offshore penalty (a) did not open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of an existing account, upon the death of the owner of the account; (b have exercised minimal, infrequent contact with the account, for example, to request the account balance, or update accountholder information such as a change in address, contact person, or email address, (c) have, except for a withdrawal, closing the account and transferring the funds to an account in the United States, not withdrawn more than $1,000 from the account in any year for which the taxpayer was on compliant, and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).

The 12.5% Penalty (Deminimus)

A taxpayer that does not qualify for a lesser payment or a 5 percent offshore penalty, but taxpayers whose highest aggregate account balances in each or the voluntary disclosure years is less than $75,000 will qualify for a 12.5 percent offshore penalty.

FOOTNOTES:

1/ While the Amnesty Program has no time deadline; there is in fact a practical deadline. The third law, which does not come into effect until 2014 will require foreign institutions to report all U.S. investors to the I.R.S. Once a Taxpayer is under I.R.S. investigation, the Amnesty Program is no longer available.

2/ PFIC Special Taxation. A significant number of investments involve Passive Foreign Investment Companies (“PFIC”). These investments will often add to the taxable income calculation since there may be accrued gains to account for. 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. In order to not unduly delay matters, the I.R.S. has offered taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market methodology but will not require complete reconstruction of historical data.

3/ Some Taxpayers can breathe a sigh of relief and can avoid the Bank Deposit penalty and other penalties if they reported their offshore income even though it was never disclosed in Information Returns.

Value can be lost without good professional advice. Contact Richard S. Lehman, Today.

Introduction

Americans have become used to the idea that certain payments made to Foreign individuals, (Aliens) and Foreign Corporations require the American payor to withhold the U.S. taxes that must be paid by the foreign recipient of the U.S. income payment. This insures the taxes are paid. The law holds that if the American payor does not hold back, (withhold), the taxes due by the foreigner payee and pay these taxes to the U.S., the American payor is responsible to pay for the tax.

The United States has now passed a new law (the “New Law”) that is effective starting in 2014. This law that will require American payors to be responsible for a similar withholding tax on payments made by American Payors to American payees with accounts in certain Foreign Financial Institutions and Foreign Non Financial Entities that have substantial U.S. owners.1/

1/ Almost 50% of the New Law is used to provide definitions for all of the new “tax terms” that are used to describe the new tax concepts represented by the New Law.

The definitions have been provided to help better explain the overall pattern that the Treasury has tried to accomplish. Several of the definitions have been provided in the initial portion of this Article.

The New Law

The New Law generally requires Foreign Financial Institutions (FFIs) to provide information to the Internal Revenue Service (IRS) regarding the Foreign Financial Institutions’ United States accounts (U.S. accounts). It also requires certain Nonfinancial Foreign Entities (NFFEs) to provide information on their substantial United States owners (substantial U.S. owners).

The New Law requires that United States payors vs. Withholding Agent that make payments to Foreign Financial Institutions and Non Financial Foreign Entities to withhold the taxes payable by any U.S. persons who may be responsible for taxes to the United States on these payments.

The law takes a second step and imposes the same withholding tax on certain Foreign Financial Institutions for payments those institutions make to certain accounts that are owned by U.S. taxpayers or presumed to be owned by U.S. taxpayers.

The reasons for the new law are made quite plain in the preamble to the Regulations Governing the New Law. The United States is finally fully aware of the cost of offshore tax evasion and intends to stop it. The Preamble states:

As a result of recent improvements in international communications and the associated globalization of the world economy, U.S. taxpayers’ investments have become increasingly global in scope. Foreign Financial Institution (“FFI”) now provide a significant proportion of the investment opportunities for, and act as intermediaries with respect to the investments of, U.S. taxpayers. Like U.S. financial institutions, FFIs are generally in the best position to identify and report with respect to their U.S. customers. Absent such reporting by FFIS, some U.S. taxpayers may attempt to evade U.S. tax by hiding money in offshore accounts. To prevent this abuse of the voluntary compliance system and address the use of offshore accounts to facilitate tax evasion, it is essential in today’s global investment climate that reporting be available with respect to both the onshore and offshore accounts of U.S. taxpayers. This information reporting strengthens the integrity of the voluntary compliance system by placing U.S. taxpayers that have access to international investment opportunities on an equal footing with U.S. taxpayers that do not have such access or otherwise choose to invest within the United States.

[The New Law] extends the scope of the U.S. information reporting regime to include FFIs that maintain U.S. accounts. [It] also imposes increased disclosure obligations on certain Non Foreign Financial Institutions that present a high risk of U.S. tax avoidance. In addition, [it] provides for withholding on Foreign Financial and Non Financial Institutions that do not comply with the reporting and other requirements of [The New Law].

The New Law is codified in Internal Revenue Code Sections 1471 through 1474. This article will review each of those Code Sections.

Code Section 1471(a) of the Internal Revenue Code (“Section”) requires any person required to withhold taxes, (a “Withholding Agent”) to withhold 30 percent of any withholdable payment to a Foreign Financial Institution that does not meet certain requirements.

A withholdable payment is defined to mean

(i) any payment of interest, dividends rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income if such payment is from sources within the United States (Fixed Income) and

(ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States. (“Sale Income”).

The types of U.S. income that are identified as being subject to the 30% withholding tax, when that income is paid to Foreign Financial Institutions, is the type of income known as fixed or determinable income. Also included is gains from the sale of certain capital assets. This is different than the withholding tax on payments by Americans to non resident aliens and foreign corporations because gains from the sales of capital assets are not included in the existing withholding rules.

However, while the New Law requires withholding on certain items to any Foreign Financial Institution and Foreign Non Financial entities, the Foreign Institutions can avoid the responsibility to withhold these taxes. The withholding on payments to and by a Foreign Financial Institution or a Non Financial Foreign Entity can be avoided if the Foreign entities comply with new U.S. Treasury requirements. To comply, the U.S. now wants full disclosure of every U.S. account holder in that Foreign Institution and on every substantial shareholder in the Non Foreign Financial Enterprise.

The U.S. Treasury has now made foreign banks, brokers and companies similar to U.S. bankers and brokers, when it comes to supplying information about U.S. taxpayers.

In order to avoid the withholding tax a FFI must enter into an agreement (“FFI Agreement”) with the IRS to perform certain obligations and meet requirements prescribed by the Treasury Department and the IRS.

The best way to provide an understanding of the overall purpose of the new statute and what it is all about is to start off with a list of new terms that are now going to show up as a result of this new law. After the reader has mastered these few terms, the article provides a summary of the purpose of the statute, the mechanics of the statute and the practical ramifications of what international banking is going to look like starting in the year 2014.

DEFINITIONS

U.S. Account:

A U.S. Account is any financial account maintained by a financial institution that is held by one or more specified U.S. persons or U.S. owned foreign entities. An account generally is considered to be held by the person listed or identified as the holder of such account with the financial institution that maintains the account, even if that person is a flow-through entity.

For accounts held by a grantor trust, the grantor is treated as the owner of the account or assets. For accounts held by agents, investment advisors, and similar persons, the person on whose behalf such person is acting is treated as the account holder. Each joint holder of a joint account will be treated as owning the account. Accounts that are insurance and annuity contracts consider the account holder is the person who can access the cash value of the contract or change the beneficiary, or, if there is no such person, the accountholder is the beneficiary.

Financial Account:

The term financial account means, with respect to any financial institution, any depository account maintained by such financial institution; any custodial account maintained by such financial institution; and any equity or debt interest in such financial institution (other than interests which are regularly trade on an established securities market). In addition, the Secretary may prescribe special rules addressing circumstances in which certain categories of companies, such as insurance companies, are financial institutions or the circumstances in which certain contracts of policies, for example annuity contracts or cash value life insurance contracts, are financial accounts

Depository Account:

A depository account is defined to include a commercial, checking, savings, time or thrift account, an account evidenced by a certificate of deposit or similar instruments, and any amount held by an insurance company under an agreement to pay interest. A custodial account is defined to include an account that holds any financial instrument or contract held for investment for the benefit of another person.

Debt/Equity:

The proposed regulations also provide guidance on the treatment of debt or equity as a financial account. An equity interest includes a capital or profits interest in a partnership and beneficial interests in the case of a trust.

U.S. Owned Foreign Entity:

Any foreign entity that has one or more substantial U.S. owners. An owner-documented FFI will be treated as a U.S. owned foreign entity if it has one or more direct or indirect owners that are specified U.S. persons, whether or not it has a substantial U.S. owner.

Financial Institution (FFI)

FFI means any financial institution that is a foreign entity

The term financial institution means any entity that (i)accepts deposits in the ordinary course of a banking or similar business; (ii) holds as a substantial portion of its business financial assets by the account of others; or (iii) is engaged (or holding itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interest, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interest or commodities.

The types of entities that constitute “financial institutions” lists the activities that constitute a “banking or similar business” for a deposit-taking institution, and clarifies that entities engaged in a banking or similar business include, but are not limited to, entities that would qualify as a “bank” under [I.R.S. Rules] The proposed regulations provide that the determination of whether an entity conducts a banking or similar business is based on the character of the business conducted, and the fact that the entity is subject to local regulation is relevant, but not necessarily determinative.

An entity is engaged primarily in the business of investing, reinvesting, or trading securities and other relevant assets if the entity’s gross income from those activities is at least 50 percent of the entity’s total gross income over the testing period.

An entity that is an insurance company and issues (or is obligated to make payments with respect to): a cash value insurance policy or an annuity contract is a financial institution.

Excluded Foreign Entities:

Many Foreign Entities are excluded from the definition of a financial institution or are treated as Non Financial Institutions that do not need to meet any of the withholding and/or reporting requirements. These entities include certain nonfinancial holding companies, certain startup companies, nonfinancial entities that are liquidating or emerging from reorganization or bankruptcy, hedging/financial centers of a nonfinancial group, and charitable entities.

Recalcitrant Account Holder:

A recalcitrant account holder is defined as any holder of an account maintained by a Participating FFI if the account holder is not an FFI and the account holder either (i) fails to comply with the Participating FFI’s request for documentation or information to establish whether the account is a U.S. account, (ii) fails to provide a valid Form W-9 upon the request of the Participating FFI, (iii) fails to provide a correct name and TIN upon request of the FFI after the Participating FFI receives notice from the IRS indicating a name/TIN mismatch or (iv) fails to provide a valid and effective waiver of foreign law if foreign law prevents reporting with respect to the account holder by the Participating FFI.

Pass thru Payments:

A pass thru payment is any withholdable payment and any foreign pass thru payment

Withholdable Payments to Non Financial Foreign Entities (NFFEs)

A withholding agent must withhold tax of 30 percent of any withholdable payment made to an NFFE, unless the beneficial owner is an NFFE that does not have any substantial U.S. owners or as an NFFE that has identified its substantial U.S. owners and the withholding agent reports the required information with respect to any substantial U.S. owners.

Substantial U.S. Owner:

Generally, the term substantial U.S. owner means any specified U.S. person that owns, directly or indirectly, more than ten percent of the stock of a corporation, or with respect to a partnership, more than ten percent of the profits interests or capital interests in such partnership. For trust, a substantial U.S. owner is any specified U.S. person that holds, directly or indirectly, more than ten percent by value of the beneficial interests in such trust, or with respect to a grantor trust, any specified U.S. person that is an owner of such grantor trust. There are attribution rules to determine indirect ownership of stock.

Specified U.S. Person:

There are several categories of U.S. payees whose payments are not subject to tax and therefore would not inure a withholding tax. This list includes a corporation the stock of which is regularly traded on an established securities market; corporations that are affiliates of such corporation; organization that are exempt from tax; individual retirement plans; real estate investment trust; regulated investment companies; common trust funds; regulated investment companies; common trust funds; dealers in securities; commodities or notional principal contracts; dealers in securities, commodities, or notional principal contracts and brokers. The United States and its wholly owned agencies or instrumentalities are also excluded, as are the States, the District of Columbia, the U.S. territories and any political subdivision or wholly owned agency or instrumentality of any of the foregoing.

Summary

The rules relating to the requirement to withhold U.S. tax on certain payments apply principally to U.S. and foreign financial institutions or withholding agents. The general rule is that with certain exceptions, a withholding agent must withhold on a withholdable payment made after December 31, 2013, to an FFI regardless of whether the FFI receives the withholdable payment as a beneficial owner or intermediary.

Under certain circumstances, a participating FFI will be permitted to make an election to be withheld upon rather than meet requirements to withhold on a pass thru payment.

As will be explored, the withholding requirement is met by an FFI Agreement. Furthermore, no withholding is required when the withholding agent lacks control, custody or knowledge of the payments.

The answer for the Foreign Financial Institutions on how to avoid the withholding tax is to do as the I.R.S. requires and (i) to collect all of the information necessary to determine the U.S. payees of the Institution’s accounts (ii) to report regularly in compliance with I.R.S. requirements on these U.S. accounts and (iii) withhold taxes on payment being made to a Nonparticipating FFI or a recalcitrant account.

The FFI Agreement:

An FFI is defined as any financial institution that is a foreign entity, other than a financial institution organized under the laws of a possession of the United States. A financial institution is defined generally as any entity that: (i) accepts deposits in the ordinary course of a banking or similar business: (ii) as a substantial portion of its business, holds financial assets for the account of others; or (iii) is engaged (or holding itself out to being engaged) primarily in the business of investing, reinvesting or trading in securities, partnership interests, commodities, or any interest in such securities, partnership interests, or commodities.

The FFI Agreement requires the FFI to identify its U.S. accounts and comply with verification and due diligence procedures prescribed by the Treasury. A “Participating FFI” is an FFI that has entered into an FFI Agreement.

A U.S. account is defined as any financial account held by one or more specified United States persons, or United States owned foreign entities (U.S. owned foreign entities) with certain exceptions. A financial account means generally any depository account, any custodial account and any equity or debt interest in an FFI, other than interests that are regularly traded on an established securities market. A U.S. owned foreign entity is any foreign entity that has one or more Substantial U.S. owners.

A Participating FFI that enters into the Agreement is required to report certain information on an annual basis to the IRS with respect to each U.S. account and to comply with requests for additional information with respect to any U.S. account. The information that must be reported with respect to each U.S. account includes: (i) the name, address and taxpayer identifying number (TIN) of each account holder who is a specified U.S. person (or, in the case of an account holder that is a U.S. owned foreign entity), the account number;(iii) the account balance or value; and (iv) the gross receipts and gross withdrawals or payments from the account (determined for such period and in such manner a the Secretary may provide).

Furthermore, if the foreign law of the country where the FFI is located prevents the FFI from reporting the required information, the U.S. account holder must agree to waive any provision of foreign law within a reasonable period of time. If the information is not provided, the FFI is required to close the account.

Even if the Participating FFI has complied with all reporting requirements, there are still withholding requirements on payments to the FFI and from the FFI on two occasions.

(1) A participating FFI must withhold 30 percent of any pass thru payment to a recalcitrant account holder or

(2) to an FFI that is not a Participating FFI. A pass thru payment is defined as any withholdable payment or other payment to the extent attributable to a withholdable payment.

The FFI Agreement applies to the U.S. accounts of the participating FFI and to the U.S. accounts of other FFI’s that are a member of the same affiliated group.

Excluded Payments

Exempt Payments to Certain beneficial Owners

There are certain foreign beneficial owners of U.S. payments that are exempt and no withholding is required. The classes of persons treated as exempt beneficial owners are: foreign governments, political subdivisions of a foreign government, and wholly owned instrumentalities and agencies of a foreign government, international organizations and wholly owned agencies or instrumentalities of an international organization; foreign central banks of issue; governments of U.S. territories; and certain foreign retirement plans.

Certain foreign retirement funds will qualify as exempt beneficial owners. Specifically, a fund that is eligible for the benefits of an income tax treaty with the United States with respect to income that the fund derives from U.S. sources and that is generally exempt from income tax in that country is an exempt beneficial owner if it operates principally to administer or provide pension or retirement benefits.

Withholding on a Non Financial Foreign Entity

In order to gain full disclosure to U.S. holdings in other types of assets, the New Law also makes payments to and from Non Foreign Financial Entities (NFFE) potentially subject to withholding.

However, the manner in which an NFFE can avoid the withholding obligation is much less stringent than that of a Foreign Financial Institution.

The New Law requires a withholding agent to withhold 30 percent of any withholdable payment to Non Financial Foreign Entities (“NFFE”), if the payment is owned by the NFFE or another NFFE. An NFFE is any foreign entity that is not a financial institution.

However, there is no withholding requirement if the NFFE is: (i) the beneficial owner or payee provides the withholding agent with either a certification that such beneficial owner does not have any substantial U.S. owners, or the name, address and TIN of each substantial U.S. owner; (ii) and the withholding agent does not know or have reason to know that any information provided by the beneficial owners or payee is incorrect; and (iii) the withholding agent reports the information provided to the Secretary.

 

As with all withholding taxes, there is the ultimate penalty if the party who is supposed to withhold taxes for the United States does not do so; the New Law provides that every person required to withhold and deduct any tax is made liable for such tax and is indemnified against the claims and demands of any person for the amount of any payments made in accordance with the New Law.

The Verification Process

The FFI Agreement must comply with the IRS’s verification process for determining whether a participating FFI’s compliance with its FFI Agreement. A participating FFI must meet the following standards: (i) adopt written policies and procedures governing the participating FFI’s compliance with its responsibilities under the FFI agreement; (ii) conduct periodic internal reviews of its compliance (rather than periodic external audits, as is presently required for many [intermediates]; and (iii) periodically provide the IRS with a certification and certain other information that will allow the IRS to determine whether the participating FFI has met its obligations under the FFI agreement. The Treasury Department and the IRS intend to include the requirements to conduct these periodic reviews and to provide their certifications in the FFI agreement or in other guidance.

Withholding Requirements under the FFI Agreement

Even when the requirements of the FFI Agreement are met. Participating FFIs are required to withhold on any pass thru payment that is a withholdable payment made to a Recalcitrant Account Holder or a Nonparticipating FFI.

There is also a special withholding rule for dormant accounts, under which a participating FFI that withholds on pass thru payments (including withholdable payments) made to a recalcitrant account holder of a dormant account, may, in lieu of depositing the tax withheld, set aside the amount withhold in escrow until the are that the account cease to be a dormant account.

Identification of Account Holders under the FFI Agreement

There are general requirements with respect to the procedures to identify account U.S. holders that determine the status of an account holder and to associate an account with valid documentation and establish the standards of knowledge for reliance on documentation.

A participating FFI is required to review all information collected under its existing account opening procedures to determine whether the account holder has U.S. Indicia.

There are special identification requirements for high value accounts. A participating FFI must perform an additional enhanced review of high value accounts. A high value account is any account with a balance or value that exceeds $1,000,000 at the end of the calendar year. As part of the enhanced review, the participating FFI must identify all high value accounts for which a relationship manager has actual knowledge that the account holder is a U.S. person.

This does not apply to cause enhanced reviews of any high-value accounts for which the participating FFI has obtained documentary evidence to establish that the account is not held by a U.S. person but instead establishes the foreign status of the account holder.

Furthermore, the law requires a responsible officer of a participating FFI to make certain certifications to confirm that with respect to its preexisting accounts that are high value accounts, within one year of the effective date of the FFI agreement the participating FFI has completed the required review and to the best of the responsible officer’s knowledge, after conducting a reasonable inquiry.

Reporting Requirements of Participating FFIs

Under the FFI Agreement there are reporting responsibilities of Participating FFIs with respect to U.S. accounts and accounts held by recalcitrant account holders.

The participating FFI that maintains the account is generally responsible for reporting the account for each calendar year.

A participating FFI that maintains an account held by a financial institution that it has identified as an owner-documented FFI must report information with respect to each owner of the owner documented FFI that is a specified U.S. person.

Accounts held by specified U.S. persons and accounts held by U.S. owned foreign entities must be reported. These rules prescribe the information to be reported with respect to accounts required to be treated as U.S. accounts, the time and manner of filing the required form and procedures for requesting an extension to file such forms. There is guidance on the information required to be included in the U.S. account for determining the account balance or value

Accounts held by recalcitrant account holders are reported in aggregate but in separate categories. The separate categories of accounts held by recalcitrant account holders are accounts with U.S. indicia, or other recalcitrant account holders, and dormant accounts.

Expanded Affiliated Group Requirements

Today’s Foreign Financial Institutions can be found to have branches and subsidiaries all over the world; all of which may be opening U.S. accounts or accounts for foreign entities owned by U.S. shareholders.

The FFI Agreement makes provisions for this by allowing for “Affiliated Groups” to be covered by the FFI Agreement. The general rule is that, for any member of an expanded affiliated group to be a Participating FFI that is compliant with the Agreement, each FFI that is a member of the group must be either a Participating FFI or Registered Deemed Compliant FFI.

Each FFI that is a member of an expanded affiliated group must complete a registration form with the IRS and agree to all the requirements for the status for which it applies with respect to all of the accounts it maintains.

An FFI that is a member of an expanded affiliated group can obtain status as a Participating FFI notwithstanding that one or more members of the group cannot satisfy the requirements of the Agreement.

The Treasury Department and the IRS intend to require all Qualified Intermediaries that are FFIS to become Participating FFIs.

Adjustments for Over withholding and Under Withholding of Tax

There are certainly going to be situations in which there is over withholding as a result of the New Law requirements. Some U.S. Taxpayers are going to be claiming refunds.

The New Law provides for the potential that amounts may be over withheld by a withholding agent and if this is the case, tax refunds and credits should be available. This can result from a U.S. taxpayer whose tax rate is lower than the 30% withholding tax for many reasons. For example, a dividend from a U.S. company to a U.S. person’s foreign account that would normally be taxed at 15% may be withheld at 30%.

The New Law provides the procedures for adjustments for over withholding and under withholding of tax. If an overpayment of tax results from the withholding of tax under the New Law, the beneficial owner of an amount subject to withholding may claim a refund or credit for the overpayment of tax subject to certain requirements and limitations.

In order to obtain a reimbursement and/or set off for any over withheld amount, the withholding agent must obtain valid documentation from the beneficial owner or payee to identify its status and determine that withholding was not required.

The beneficial owner of the income or payment to which the withheld tax is attributable is allowed a credit against such beneficial owner’s income tax liability in the amount of tax actually withheld. If the tax required to be withheld is paid by the beneficial owner, payee, or withholding agent, the IRS may not collect from any other, regardless of the original liability for the tax.

To the extent the overpayment of tax was paid by a withholding agent out of its own funds, such amount may be credited or refunded to the withholding agent.

This is an updated video about the new IRS Streamlined Compliance Procedures announced by the IRS during the summer of 2014.

If you have questions regarding Foreign Financial Institution reporting - please contact Richard S. Lehman Esq.

NEW U.S. TAX LAW Seminar Series: 5.5 hours FREE Continuing Education Course Credits

These seminars cover a complete range of topics dealing with legal and practical advice for foreign investors that invest in United States businesses, United States real estate and United States securities; and aliens that immigrate to the United States. This includes income, estate and gift tax planning for nonresident alien individuals and foreign entities such as foreign corporations, foreign trusts and foreign partnerships. Special sections are devoted to foreign investors in United States Real Estate, Tax Planning and Pre Immigration Tax Planning.

Also included in this group of seminars is a thorough study of the United States tax laws governing the tax deductions and tax refunds available for victims of Ponzi Schemes and other theft losses under the Internal Revenue Code Section 165. www.ustaxlawseminars.com

WATCH A SHORT OVERVIEW OF SEMINAR FORMAT:

By Richard S. Lehman, Tax Attorney

Introduction

The “Offer in Compromise” is the typical way for Americans to resolve outstanding tax liabilities that they are unable to meet.¹

It is a reasonably fair process with levels of Taxpayer protections. However, it is not as is often advertised, a procedure that produces the miracle of reducing $50,000 in tax liability to $5,000 without extraordinary circumstances. Right now, any Taxpayer that has the ability to meet a portion of their outstanding tax liabilities, if they have a breathing period of several years, should give an Offer in Compromise serious consideration. Offer in Compromise settlements are based upon the Taxpayer’s assets and overall financial situation. The worse the Taxpayer’s financial situation looks, the better the settlement with the I.R.S. The bad economy is one reason why now is the time to consider an Offer in Compromise.

Offers in Compromise

The IRS has the authority to accept less than full payment and to compromise a taxpayer’s tax liabilities if it is unlikely that the IRS can collect the tax liability in full.

The basis for a settlement for less than the full amount of the liabilities by the I.R.S. must be either

(1) There is a dispute as to the amount that the taxpayer owes (Doubt as to Liability);

(2) There is doubt that the liability can be collected in full. (Doubt as to collectability); or

(3) If a settlement of a tax liability will promote effective tax administration.

Doubt as to Collectability

The IRS will accept an offer in compromise if it achieves the collection of an amount that is potentially collectible at the earliest possible time and at the least cost to the government. In order to accomplish the goal, the Internal Revenue Code provides the offer in compromise as the exclusive method for compromising all taxes, penalties, and interest for the periods and taxes covered by the offer.

An offer is legally sufficient to be accepted due to doubt as to collectability of the full tax liability if it closely approximates the amount that the IRS could reasonably collect by other means, including through an administrative or judicial proceeding. The I.R.S. will consider four components in determining doubt of collectability (i) net equity in assets, (ii) present and future income, (iii) amounts collectible from third parties, and (iv) amounts that the taxpayer should reasonably be expected to raise from assets available to the taxpayer but beyond the reach of the IRS.

In calculating the maximum collectible amount from a taxpayer, the IRS determines if the taxpayer’s assets and present and future income are less than the full amount of the assessed liability. In determining ability to pay, the IRS permits taxpayers to retain sufficient funds to pay basic living expenses. Basic living expenses are based upon an evaluation of the individual facts and circumstances of each case, taking into account published guidelines on national and local living expenses standards.

Effective Tax Administration

If there are no grounds for compromise based on doubt as to liability or doubt as to collectability, the IRS may accept an Offer to Compromise to promote effective tax administration. Generally, this means that the I.R.S. will settle for a compromised tax liability if the collection of the full liability is possible, but will create economic hardship.

The following are examples of this category:

Economic Hardship: Long-term Illness

• Taxpayer has assets sufficient to satisfy the tax liability. The Taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the Taxpayer will need to use the equity of her assets to provide for adequate basic living expenses and medical care for her child. The Taxpayer’s overall compliance history does not weigh against compromise.

Economic Hardship: Liquidation of Assets

• The Taxpayer is retired and his only income is from a pension. His only asset is a retirement account and the funds in the account are sufficient to satisfy the liability. However, the liquidation of the retirement account would leave the Taxpayer without an adequate means to provide for basic living expenses. His overall compliance history does not weigh against compromise.

The Proposal to Compromise

The Form 656 is the starting point for an offer in compromise. The taxpayer must indicate the facts and reasons why the IRs should accept the offer and which of the three categories, (doubt as to liability, doubt as to collectability, or effective tax administration); apply to the Taxpayer’s situation.

A Taxpayer seeking to compromise a liability based on doubt as to collectability or effective tax administration must also submit a Form 433-A (Financial Statement for Individuals) and any other financial statement prepared by the Taxpayer signed under a penalty of perjury.

Taxpayers that submit an offer to compromise individual income tax liabilities and who also have substantial business interests may also be required to submit a Form 433-B for the business.

The taxpayer may make a cash offer or a deferred payment offer.

The taxpayer is responsible for initiating the first specific proposal for compromise. A taxpayer must make partial payments to the IRS while the taxpayer’s offer is being considered. For lump sum offers, taxpayers must make a down payment of 20% of the offer with the application. For these purposes, a lump sum offer includes single payments as well as payment made in five or fewer installments. If the taxpayer proposes to pay in installments, the first installment must accompany the offer, and the taxpayer must comply with the proposed payment schedule while the offer is being considered (or the IRS will consider the offer withdrawn).

Application Process

The Taxpayer wants to make sure the offer is in an acceptable form or it will be rejected if it cannot be processed. In such instances, the IRS will contact the taxpayer to indicate and request the information that is missing or needs to be corrected.

Some items to double check before an offer in compromise is submitted are:

• The taxpayer must identify the tax liabilities and years to be compromised;
• The taxpayer must make a financial offer; and the
• Payment terms must be specified;
• The pre-printed terms of the Form 656 must not be altered and it must fully disclose assets and liabilities owed jointly and owned individually;
• The taxpayer’s taxpayer identification number must be correctly stated;
• The offer must be signed;
• Necessary financial statements – Form 433-A and/or 433-B – must be completed and signed.

When the offer is submitted by a person who shares household expenses, disclosure of the non-liable individuals’ financial information can be required to determine the taxpayer’s share of the household expenses.

Collection Proceedings During Offer

Once the offer in compromise is received, the IRS will not automatically withhold collection activity. Generally, collection activity is suspended if the offer is not frivolous and if the tax liability that the taxpayer seeks to compromise is not in jeopardy.

The IRS will not make any levies to collect the liability that is the subject of the compromise during the period the IRS is evaluating whether such offer will be accepted or rejected, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.

The IRS directs the examining officer to determine processibilty of the offer as soon as possible, but within 14 days, and to then contact the taxpayer. If the IRS determines that the offer is processible but needs to be perfected, the IRS may communicate with the taxpayer by letter or by personal contact or request the additional information needed to perfect the pending offer. If the taxpayer does not respond timely, the IRS closes the offer as a return.

The IRS’s goal is to collect the tax liability a quickly as possible. In other words, immediate resolution of the liability is desired. To this end, the IRS will analyze the taxpayer’s assets to determine ways of liquidating the account. If the taxpayer has cash to pay the tax liability, the IRS will demand immediate payment. Otherwise, the IRS will consider if there are other assets which may be pledged or readily converted too cash; unencumbered assets; equity in encumbered assets; interest in estates and trust; lines of credit; and the taxpayer’s ability to obtain an unsecured loan. If there are assets with value and the taxpayer is unwilling to raise money from them, the IRS will consider enforced collection (i.e., levy and distrait). On the other hand, if the taxpayer has no borrowing power, the IRS will request that the taxpayer defer payment of certain other debts if this would allow payment of the tax liability.

Determining Maximum Collectability

Determining Equity in Assts: As part of its financial analysis, the IRS first examines the taxpayer’s equity in assets as the existence of equity may militate against the granting of an installment agreement.

When analysis of the taxpayer’s assets does not provide any obvious collection solutions, the IRS will turn to analyze the taxpayer’s income and expenses to determine the amount of disposable income available to apply to the tax liability. The IRS’ policy is that expense analysis is necessary only if it is unable to collect the liability from available assets. The taxpayer’s expenses must be reasonable in amount for the size of the family, the geographic location, and any unique individual circumstances. In some cases, the IRS will allow more than a reasonable amount on a substantiated expense if the tax liability, including projected accruals, can be fully paid within five years.

Valuation of Taxpayer Assets

Quick Sale Value: In determining whether the taxpayer’s offer is adequate in a doubt as to collectability situation, the IRS starts with the value of the taxpayer’s assets. This analysis begins with the value of the taxpayer’s assets minus the encumbrances having priority over the federal tax lien, i.e., the assets’ net realizable equity. The value assigned to these assets generally is the quick sale value (i.e., the amount that a taxpayer under financial pressures would realize on selling the assets in a short period of time). Quick sale value is defined as a value less than fair market value and greater than forced sale value, with forces sale value being no less than 75% of the asset’s fair market value

The IRS’s position in doubt as to collectability situations is that the taxpayer must offer an amount equal to the realizable equity in assets plus the value of future ability to pay, i.e., the reasonable collection potential. Thus, all assets – even those with no fair market value or those that the IRS would not attempt to collect should the offer be rejected – must be considered in determining the amount that is collectible form the taxpayer. However, if a taxpayer is not able to offer this amount due to special circumstances, the IRS may review the offer using the same factors as are used for economic hardship under effective tax administration.

The IRS examiner, therefore, conducts an investigation of the Taxpayer’s assets and income to determine if the amount offered reasonably reflects collection potential.

Allowable Expenses

Allowable expenses include necessary and conditional expenses. Necessary expenses are allowable if they are reasonable in amount.

Conditional expenses are allowable if the tax liability can be fully paid within five years through an installment agreement.

There are three types of necessary expenses: National Standards, Local Standards and Other Expenses.

Necessary Expenses – National Standards:

These establish standards for reasonable amounts for five necessary expenses: food, housekeeping, supplies, apparel and services, personal care products and services, out-of-pocket medical expenses and miscellaneous. The National Standards are available on the IRS’s website and are updated periodically.

A taxpayer who claims more than the total allowed by the National Standards must substantiate and justify as necessary each separate expense of the total. For instance, a taxpayer claiming more for food than is allowed can justify this expense if there are special prescribed or required dietary needs.

Finally, if the taxpayer can fully pay the tax liability, including projected accruals, within five years, the taxpayer may be allowed more than the amount allowed by the National Standards. To obtain the additional amount, the taxpayer must substantiate all the expenses that constitute the National Standards.

Necessary Expenses – Local Standards:

The National Standards do not adequately capture certain expenses. Housing and transportation are two such expenses. This also includes utilities and telephone expenses. Transportation includes car insurance and public transportation. Local standards for housing and utilities, and transportation may be found on the IRS’s website.

Necessary Expenses – Other:

The IRS recognizes that there are expenses other than those listed in National Standards or Local Standards that nevertheless may be necessary expenses. If the liability can be fully paid within five years, the IRS generally will allow excessive necessary and conditional expenses. If the liability cannot be fully repaid within five years, such expenses may be allowed for up to one year to give the taxpayer time to modify or eliminate the expense.

Examples of other necessary expenses include:

• Taxes;
• Charitable contributions;
• Education;
• Health care;
• Court ordered payments;
• Involuntary deductions;
• Accounting and legal fees for representing a taxpayer before the IRS;
• Secured or legally perfected debts (minimum payments); and
• Accounting and legal fees other than those for representing a taxpayer before the IRS which meet the necessary expense test of health and welfare and /or production of income.

Where other expenses are claimed as necessary, the taxpayer may have to substantiate the amounts and justify the expenses. The IRS’ general rule is that unless the tax liability will be fully paid, including projected accruals, within three years, such other expenses must be reasonable in amount. The IRS considers the following non exhaustive list of expenses under this category.

• Life Insurance;
• Disability insurance for a self-employed individual;
• Union dues;
• Education;
• Child care;
• Dependent care – elderly, invalid, or disabled; Charitable contributions;
• Repayment of loans made for payment of Federal taxes;
• Secured or legally perfected debts;
• Internet provider/email;
• Professional association dues;
• Accounting and legal fees other than those for representing a taxpayer before the IRS which meet the necessary expense test of health and welfare and/or production of income; and

Negotiating an Acceptable Offer:

Generally the amount of an acceptable offer equals: (1) the value of the taxpayer’s equity in assets subject to the IRS’s tax lien; plus (2) the present value of the taxpayer’s ability to make monthly installment payments over a five year period

If the amount offered by the taxpayer does not meet what is determined to be an acceptable offer, the taxpayer can request a conference with the IRS to discuss the amount that is acceptable as a compromise.

Settlement Discretion:

The IRS has discretion to determine to what extent to compromise a tax liability. IRS settlement offers are not legally required. However, the IRS must maintain a duty of “administrative consistency” and Taxpayer equality when rejecting offers. In settlement discretion cases, courts generally apply an abuse-of-discretion standard of review.

Appeals:

The taxpayer may appeal the rejection of the proposed offer in compromise to the Appeals office within the 30-day period beginning the day after the date of the letter of rejection.

Finality of Agreement:

An offer in compromise is considered to be accepted only when the taxpayer is notified by the IRS, in writing, of the offer’s acceptance. The acceptance of an offer in compromise conclusively settles all questions regarding the liability that is the subject of the offer. The form used to make an offer in compromise states that the taxpayer no longer may be able to contest the amount of his tax liability.

A case may be reopened even though an offer in compromise has been accepted, if the following situations exist:

• A taxpayer falsifies or conceals assets on completing Form 656 or Form 433-B
• There is a mutual mistake of a material fact sufficient to cause a contract to be reformed.

Footnotes:

1. A little used procedural method that is very helpful if the taxpayer has a good case that has not been presented properly, or if the taxpayer has new documentation to present is a Request for Audit Reconsideration which differs from an offer in compromise based upon doubt as to liability. In several types of cases the IRS may make arbitrary adjustments, usually involving the denial of the deductions or exemptions that were the subject of an audit. If there is significant new or additional convincing information not previously seen that will prove a taxpayer’ point, the taxpayer may request “audit reconsideration”. The taxpayer must provide additional information or there is no basis for reconsideration.