This article is for US residents, citizens and green card holders.
For the last three years the United States Internal Revenue Service (IRS) has been aggressively pursuing U.S. persons (including U.S. citizens and green card holders) who have failed to report foreign income on their U.S. income tax returns and/or failed to report foreign bank and investment accounts on a Foreign Bank Account Report (FBAR). On December 19, 2008, IRS Associate Chief Counsel (International), Steve Muser, stated that his top priority will be ‘‘compliance, compliance, compliance‘‘.
Past US Amnesties:
As a result, in 2009 and again in 2011, the IRS implemented two Amnesty programs encouraging U.S. persons to come forward and declare their undisclosed foreign income and assets. Since 2009 over 30,000 people have come forward to voluntarily comply; at least 30 have been criminally indicted; and the IRS has netted a total of $4.4bn in unpaid taxes, interest and penalties.
However, the IRS knows that there are still many out there who have not yet come forward. The State Department estimates that more than 6 million citizens live overseas, excluding those in the military, yet the IRS receives only 1.6 million tax returns each year with foreign addresses. And only a little over half million FBARs were filed in 2009.
On 9 January, the IRS announced a 3rd Amnesty, formally known as the Offshore Voluntary Disclosure Program. It is substantially the same as the 2011 Amnesty (aka 2011 OVDI) with some exceptions:
(1) There is no deadline to apply to the program, although the IRS reserves the right to change the terms at any time going forward. For example, they state they have the right to increase the penalties…
(2) The top penalty is 27.5% (increased from 25%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the 8 full tax years prior to disclosure. If you disclose in 2012, you must include 2004-2011.
(3) Some will be eligible for a lower penalty of either 12.5% or 5%, which is the same as the 2011 Amnesty.
One of the problems with the IRS‘s attitude in all of this is that they are treating all U.S. persons as if they all exist in one box; so they do not distinguish between John Smith, residing in Baltimore, Maryland, who is hiding his ill-gotten gains in a Swiss bank account, from Moishe Peloni, residing in Beersheva, Israel, who has an account with Bank HaPoalim in Beersheva because he resides in that city.
In June 2011, the IRS, for the first time, officially recognized that a U.S. person living in a foreign country should be treated slightly differently than the U.S. person residing in the United States. As part of the 2011 Amnesty, if the U.S. person living in a foreign country met certain very restricted conditions, his penalty was reduced to 5% of liquid foreign assets as opposed to 25% of all foreign assets. But still a penalty was imposed! For many dual nationals in Israel that meant 5% (or 25%) of their pensions and Keren Hishtalmut.
New Fact Sheet:
On December 13, 2011, the IRS issued a ‘‘Fact Sheet‘‘ and took one step closer to recognizing that a U.S. person or dual national living in a foreign country should have a different status than the U.S. person residing in the U.S. The Fact Sheet sets out the facts and circumstances under which a U.S. citizen or dual national residing outside the U.S. could report previously undisclosed foreign income and assets with reduced or no penalties.
If no tax is due, the Fact Sheet specifies that no penalties will be imposed for coming forward now and filing the tax returns. Likewise, if no tax is due, or a de minimis amount is due, the IRS most likely will not impose any penalties for filing the FBARs if reasonable cause exists for the noncompliance.
While it states that no single factor is determinative, it gives two examples of reasonable cause that they apparently will accept:
(1) that taxpayer relied upon the advice of a professional tax advisor ‘‘who was informed of the existence of the foreign financial accounts, that the unreported account was established for a legitimate purpose, and there were no indications of efforts taken to intentionally conceal the reporting of income or assets.‘‘; or
(2) taxpayer filed delinquent tax returns and FBARs after learning of his obligation from ‘‘recent press‘‘ and taxpayer ‘‘had a legitimate purpose for maintaining the foreign accounts, there were no indications of efforts taken to intentionally conceal the reporting of income and assets, and no tax was due.‘‘
What if you owe US tax?
The Fact Sheet does not really address this issue. Less than a month later, the 3rd Amnesty comes along. But the potentially onerous penalties are still present.
For many, the 3rd Amnesty may still be the best way to resolve delinquent tax issues. If accepted, there is no criminal prosecution and you know going into the program what it will cost you. If you do not use the program, you have the uncertainty of the final amounts due. Don‘t forget to factor in foreign tax credits and the Section 911 exclusion (limited exemption) where applicable, Also, you always have the option to ‘‘opt out‘‘ of the program, if you do not like the final IRS agreement.
However, you are exposed at this point.
Hence, the expatriate living in Israel (or other countries) is left with a quandary. However, in the 3rd Amnesty announcement, the IRS declares that it will continue to develop procedures by which dual citizens ‘‘may come into compliance with U.S. tax law.‘‘ Lets hope that the IRS will indeed make it more palatable for US citizens living abroad to come in from the cold.
It also states that the ‘‘IRS is committed to educating all taxpayers so that they understand their U.S. tax responsibility.‘‘ If the IRS embarks on a worldwide publicity campaign, it will be impossible for most US taxpayers to claim ignorance.
If you have not been filing US tax returns or have not reported foreign source income and assets, doing nothing may no longer be an option.
More US Reporting Requirements:
Starting with the 2011 U.S. income tax return, you must now attach a new form 8938 to disclose all foreign financial assets (FFA). For those living in a foreign country this form is required if your FFA exceeds:
(a) if not filing a joint return, $200,000 on the last day of the year, or $300,000 at any time during the year;
(b) if filing a joint return, $400,000 on the last day of the year, or $600,000 at any time during the year. Failure to file a complete and correct form 8938 by the due date of the return can be subject to a penalty of $10,000.
Also starting with the 2011 U.S. tax return, there is now a separate line in the address section to report the foreign country in which you live.
Similarly, you must now answer ‘‘Yes‘‘ to the question on Schedule B (Interest and Dividend Income) that you have a financial interest or signature authority in a foreign account even if the aggregate balance is less than $10,000.
Starting in 2013, under FATCA rules every bank in the world will have to have a written agreement with the IRS to furnish information about accounts held by US persons. If the bank does not comply, it will suffer certain monetary penalties and possible criminal prosecution. The information will include your name, address, US social security number and all the transactions in the account.
So it seems the US reporting problem simply will not go away. It may be in your best interest to come forward before the IRS finds you, in which case the penalties most likely will be more severe.
And in Israel?
Israel and the US have unrelated tax systems and never the twain shall meet between them. This past November, the Israeli Tax Authority (ITA) also offered a tax amnesty. Until 30 June 2012, you can file Israeli tax returns to report previously undisclosed foreign source income. Unlike the IRS, the ITA should not charge any interest or penalties and possibly reduce indexation charges. The ITA will also forgo criminal prosecution. All this assumes you meet certain criteria.
To sum up:
For Israeli residents (including U.S. dual nationals residing in Israel) who have not reported foreign source income and assets, there is a short window to come clean in both countries.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
Don Shrensky is a U.S. and Israeli CPA; managing partner in Don Shrensky & Co, CPAs
Leon Harris is a UK and Israeli CPA and international tax specialist at Harris Consulting & Tax Ltd.