Editor: Michael D. Koppel, CPA/PFS/CITP, MSA, MBA
Foreign Income & Taxpayers
For many individual tax clients, April 15 is the day when returns must be filed. For millions of other taxpayers, another deadline remains on the horizon. June 30 is the deadline for U.S. taxpayers (including green card holders) to report foreign financial accounts. The National Taxpayer Advocate has estimated that 5 million to 7 million Americans live abroad and many more living in the United States may have foreign accounts (Taxpayer Advocate Service, 2012 Annual Report to Congress, p. 134). That presents both an opportunity and a challenge.
The requirement to report offshore holdings dates back to 1970 and the passage of the Bank Secrecy Act, P.L. 91-508 (also known as the Currency and Foreign Transactions Reporting Act). The law was passed as a method of combating money laundering and drug trafficking. By requiring banks to report transactions involving more than $10,000 in cash and other suspicious transactions, the federal government hoped to make it more difficult for criminal enterprises, such as drug dealers, to move their money.
Under the Bank Secrecy Act, U.S. persons may also be required to annually file a Report of Foreign Bank and Financial Accounts (FBAR). (This was formerly Treasury Form TD F 90-22.1; now there is no form, and FBARs must be filed electronically through the Financial Crimes Enforcement Network’s BSA e-filing system.) U.S. persons who have a financial interest in or signatory authority over foreign financial accounts that in the aggregate exceed $10,000 at any time during the year must report the accounts by June 30 of the following calendar year. For example, a taxpayer who had two foreign accounts totaling $15,000 in 2012 was required to file an FBAR by June 30, 2013. As noted above, merely having a signatory interest in an account can trigger an FBAR requirement. Often, clients have signature authority over accounts for elderly parents or children residing overseas.
What Constitutes a Foreign Financial Account?
Bank accounts are an obvious example of foreign financial accounts, but other types of foreign investments and instruments also must be reported, including brokerage accounts, certificates of deposit, and annuities. In certain instances, insurance policies with an investment component must also be reported. This applies also to commodities accounts where investors can purchase physical gold or sterling silver and leave it with the foreign investment company for safekeeping. Today’s investment world marketplace offers thousands of derivative investments. Tax advisers need to think outside the box and remember that the FBAR requirement involves far more than offshore bank accounts.
For example, in some countries, foreigners can’t own real estate but can own property through a trust whose interests may be reportable. The same is true for certain retirement-type accounts. (Treaties between the United States and the country where the account is held should be consulted when examining retirement vehicles.)
The penalties for noncompliance can be staggering. In some instances, taxpayers may receive a mere warning letter if the IRS determines the violation was mitigated by reasonable cause. A “nonwillful” violation carries a civil penalty of up to $10,000 per year per account. If the IRS determines a violation was willful, the civil penalty can jump to the greater of $100,000 or 50% of the highest account balance per year per account.
Foreign accounts must also be reported on Schedule B, Interest and Ordinary Dividends, of Form 1040, U.S. Individual Income Tax Return. Many taxpayers and their accountants fail to check the appropriate box on Schedule B indicating the taxpayer has an interest in, or signature authority over, a foreign account. The IRS believes such a failure can be evidence of “willful blindness,” subjecting the taxpayer to the highest penalty classification (see Internal Revenue Manual §188.8.131.52.5.3(6) and Williams, 489 Fed. Appx. 655 (4th Cir. 2012)). Unfortunately, this often means unhappy clients and claims against the preparer.
The general public thinks of wealthy American business owners with numbered secret Swiss accounts when the term “offshore account” is mentioned. In reality, millions of Americans were born outside the United States or legally work here through resident alien status. Add dual nationals and U.S. citizens living overseas, and the number of taxpayers and businesses with offshore accounts is staggering.
Tax advisers need to always think about the many ways in which offshore reporting requirements could be triggered. They should always ask clients whether they have offshore interests and document the response.
This item touches on FBARs, but many other offshore reporting requirements are in the Code, including the new Foreign Account Tax Compliance Act sections (Secs. 1471–1474, which were passed as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147) (note that the definitions of qualifying foreign financial accounts are different), offshore gift reporting, foreign partnerships, foreign trusts, and requirements of the Foreign Investment in Real Property Tax Act, P.L.96-499, just to name a few.
Any tax adviser who has clients with offshore businesses or interests and lacks the requisite experience should consider teaming with another practitioner or firm that has such experience, or with a knowledgeable tax attorney. The IRS has demonstrated a willingness to impose penalties against accountants who overlook foreign reporting requirements and expose their clients to risk and has reminded them of their duties under Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10), when their clients have an FBAR filing duty . In several cases, the IRS Office of Professional Responsibility has even brought actions against CPAs who negligently failed to file FBARs on behalf of clients.
Michael Koppel is with Gray, Gray & Gray LLP, in Westwood, Mass.
For additional information about these items, contact Mr. Koppel at 781-407-0300 or firstname.lastname@example.org.
Mr. Mahany is a Preferred Provider to CPAmerica members. Mahany & Ertl LLC is not a member of CPAmerica.