FATCA and Voluntary Disclosure: What You Need to Know

Types : Alerts

Is there an IRS Voluntary Disclosure in you or your family member’s future?

The ­­­­­­­­­­Internal Revenue Service (IRS) may not know of all the rules for maintaining a kosher kitchen.  It has the mission of collecting U.S. taxes.  The IRS has now turned its attention to U.S. citizens who live in Israel, who have not filed U.S. tax returns and a Report of Foreign Bank and Financial Accounts, and U.S. citizens who live in the U.S. but who have accounts in Israel, and have not put on their tax return the income from the foreign account, and have not filed a Report of Foreign Bank and Financial Accounts.  The ability to fly under the radar screen is over and anyone who thinks they are not going to get caught should think again.  In the eyes of the IRS, failing to file tax returns and a Report of Foreign Bank and Financial Account can’t be kosher.

Pursuant to the Foreign Account Tax Compliance Act (FATCA), many countries are entering into an intergovernmental agreement (IGA) with the United States.  It has been reported that the government of Israel favors a Model 1 IGA, similar to that of the recently signed U.S.-UK IGA.  Under a Model 1 IGA, the FATCA partner will require its foreign financial institutions to report to the FATCA partner’s tax authority information that is required under FATCA.  The foreign tax authority then provides the information to the IRS.   An IGA can be reciprocal.  The U.S.-UK IGA is reciprocal.  It requires UK financial institutions to collect information required by the IRS and give it to the UK tax authorities.  The UK tax authorities are to give to the IRS, among other things, the taxpayer’s name, address, U.S. taxpayer identification number, name of the UK financial institution and the account number, the account balance as of the last day of the year, the interest and dividends earned, and the gross proceeds of sale.

U.S. citizens must file U.S. tax returns and report and pay tax on their worldwide income.  Subject to certain de minimis exceptions, if a U.S. citizen is a resident or citizen of Israel, he or she must file a U.S. income tax return and report his or her worldwide income to the IRS.  If the taxpayer owns an interest in any specified foreign financial asset including foreign bank accounts, foreign brokerage accounts or an interest in a foreign entity, the taxpayer must attach a Form 8938 entitled “Statement of Specified Foreign Financial Assets” to his or her U.S. income tax return.  In addition, the U.S. person, including a U.S. citizen, that has a financial interest or signatory authority over a foreign financial account must file a Report of Foreign Bank and Financial Accounts on Form 114 (formerly Form TDF 90-22.1), if the aggregate value of all foreign financial accounts exceed $10,000 at any time during the calendar year.  The Form 114 is an annual report that must be filed independent of a taxpayer’s tax return on or before June 30 of every year.  A person who is required to file Form 114 and fails to do so may be subject to a penalty not to exceed $10,000 per violation.  A person who wilfully fails to file or report an account may be subject to a penalty equal to the greater of $100,000 or 50 percent of the balance in the account.

Financial Crimes Enforcement Network (FinCen) now requires the Form 114 to be filed by the account holder electronically either on their website or through the use of commercial tax software.  Most major tax preparation software will have the capability to e-file the Form.  An account holder will have to provide the tax preparer with an authorization Form 114a (Record of Authorization) to electronically file the FBAR.  If the person needs to file multiple years, the filings should be done on the new Form 114 rather than the Form 90-22.1.

These filing obligations have been in existence for many years.  However, the existence of FATCA and related IGA’s increase the likelihood that the IRS will receive from a foreign government or foreign financial institution information regarding foreign accounts held by U.S. citizens.

The IRS is presently very serious about the reporting of foreign accounts and paying U.S. tax on the income earned on foreign assets.  Recently, some prominent U.S. taxpayers have been caught and are facing jail time (you may have heard about billionaire H. Ty Warner, the creator of Beanies Babies).  But it’s not only the prominent and super-wealthy that need to be careful. For example, if your child studied abroad in Israel, you may have set up a bank account there for them and he/she will need to report any income held in Israel on their U.S. tax return. If not, your child could face penalties.

Those U.S. citizens who have overseas accounts and have failed, in previous years,  to file U.S. tax returns, or failed to report income from foreign accounts or failed to file Form TDF 90-22.1 (now Form 114), should consider making a voluntary disclosure.

Taxpayers participating in the voluntary disclosure program must agree to file tax returns or file amended tax returns and Form 114 for eight years, pay any tax due and any interest due, plus a 20 percent accuracy related penalty and a special penalty for failure to file Form TDF 90-22.1 (now Form 114) equal to 27.5 percent of the highest amount of foreign assets held at any time during the prior eight years.

One cannot participate in the voluntary disclosure program if the IRS has already initiated an examination or if the taxpayer is already under criminal investigation.  Once the IRS has the taxpayer in its sights, it is too late to enter the voluntary disclosure program.

Although the tax, interest and penalties associated with a voluntary disclosure can be expensive, waiting until the IRS receives the taxpayer’s name from a FATCA partner tax authority or a FATCA partner financial institution and commences a civil audit or criminal investigation is likely to be far more expensive and can result in a child or love one facing jail time.  Once countries such as Israel enter into IGA’s and start disclosing to the IRS the names, taxpayer’s identification numbers and account information on U.S. citizens who have foreign accounts, there is a high probability that the IRS will use the data and check to see if the person has filed a U.S. tax return and Form TDF 90-22.1 or Form 114.  Once the IRS finds you, your child or loved one, it will be too late to do a voluntary disclosure.

This is not to say that all is doom and gloom.  The statute of limitations for the IRS to assess additional tax, interest and penalties is three years from the required due date (April 15, 2014 for a 2010 tax return).  The statute of limitations is six years if there is a “substantial omission of income”.  A substantial omission of income generally means an omission of more than 25 percent of the income required to be reported on a tax return.

Accordingly, if there is a relatively minor amount of unreported income due an account that the account holder was simply not aware of or overlooked then the account holder should discuss with legal counsel, as well as his/her tax adviser, to determine if it is actually necessary to go into the voluntary disclosure program.  The advisers may conclude that it would be satisfactory to simply file late FBAR returns and amend any U.S. and state or local tax returns for the omitted income.

FBAR filings are not limited to individuals.  It is quite common for U.S. corporations, partnerships, estates and trusts to have foreign accounts.  These entities must also file the FBAR returns.  A U.S. corporation with a foreign subsidiary or division where a U.S. person has signature authority on a foreign bank account with funds in excess of $10,000 must also file.

In a nutshell, it is time for your loved ones to get real about Israeli accounts and consider a voluntary disclosure before the IRS gets his or her names, social security numbers and foreign bank account information.

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Gary M. Edelson is a partner in the Tax Practice Group at Montgomery McCracken Walker & Rhoads LLP in Philadelphia. His practice concentrates on income tax, taxation of pass-through entities, estate and gift tax, mergers and acquisitions, taxation of qualified plans and tax-exempt entities that invest in pass-through entities. He may be reached at 215-772-7264 or at gedelson@mmwr.com.

Stuart A. Katz is a tax manager with Shechtman Marks Devor PC in Philadelphia. He has more than 30 years of experience providing federal, state, and local income tax compliance and planning services to businesses and individuals. His areas of emphasis include business continuation planning and multi-state taxation for families, partnerships, and S corporations. He may be reached at 215-496-9339 (ext. 142) or at skatz@smd-pc.com.