The Internal Revenue Service (IRS) Streamlined Procedures of 2014 are still available for taxpayers with tax noncompliance issues that involve unreported income from a foreign financial asset. The Procedures can help taxpayers who have not filed certain information returns associated with the foreign asset (e.g., Form 8938; Form 5471 pertaining to ownership in a foreign corporation; Form 8865 pertaining to ownership of an interest in a foreign partnership) as well as those who have not filed FBARs. My blog posts here and here give you more details about the tax forms and you can learn all about FBAR here.
The Streamlined Procedures have been around for a number of years now. This means far less people are using the Procedures since they have already corrected their filings. It also means that the IRS is looking more carefully at the “non-willful” statements (Statement) that must accompany a taxpayer’s submission. The agency is scrutinizing the facts more carefully. This is in part because less people are using the Procedures, and with the passage of time, there is now greater public knowledge about the tax compliance issues associated with overseas assets. It becomes more difficult for a taxpayer to assert he or she was unaware of certain requirements and the IRS may counter with an argument of “reckless disregard” or “willful blindness”.
Today’s post will explain how I approach Streamlined filings in light of these concerns. In all the years, with hundreds of submissions, I have never had any IRS question or pushback with any of my clients’ cases. If you need tax help, send an email firstname.lastname@example.org and let’s schedule a consultation.
Overview of the Streamlined Procedure
The Streamlined procedure is generally, a friendlier and less costly approach to bring non-compliant Americans (whether living overseas or living in the USA) back into the tax filing system. Let’s quickly review the major points:
- Different procedures exist for taxpayers abroad (Streamlined Foreign Offshore Procedure, or “SFOP”) than for taxpayers in the USA (Streamlined Domestic Offshore Procedure, or “SDOP”) . A non-residency requirement must be met by taxpayers wishing to join SFOP. The requirement is satisfied if, in any one or more of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed, the individual did not have a US abode and the individual was physically outside the United States for at least 330 full days.
- In both SDOP and SFOP taxpayers will be required to file only 3 years of back tax returns and 6 years of FBARs. If IRS agrees that the taxpayer is eligible for the SFOP, no penalties will be assessed for the late or corrected tax filings. US residents will pay a 5% miscellaneous offshore penalty in SDOP.
- For both procedures, tax compliance failures must be the result of “non-willful” conduct and a detailed factual Statement must be provided under penalty of perjury explaining the reasons for any compliance failures. 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 procedures will not provide protection from possible civil penalties if IRS considers such penalties should apply and it will not provide protection from possible criminal prosecution if the IRS and Department of Justice determine that the taxpayer’s particular circumstances warrant such prosecution. Taxpayers who are unsure of their potential for such sanctions should seek advice from a qualified US tax professional with significant international experience.
- Taxpayers without a Social Security Number will not receive the beneficial penalty relief offered in the Streamlined procedures.
Reliance on a Tax Professional
Many taxpayers relied on tax professionals to prepare their tax returns. Unfortunately, many professionals did not prepare the returns properly to take into account foreign financial assets (such as foreign bank accounts, brokerage accounts, pensions, mutual funds); many did not file FBARs (yes, this is still happening today!). The Statement, among other things, must explain in detail the relationship and interactions with the tax professional who got things wrong. Here is an excerpt from FAQ 6 of the IRS SFOP FAQs:
“If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice. Also provide background such as how you came into contact with the advisor and frequency of communication with the advisor.”
As part of preparing the Statement, I try to set the stage to explain why the taxpayer had “reasonable cause” for the failures and in particular why the taxpayer’s reliance on the tax professional was justified. Preparing the Statement in this manner will be extra helpful to abate any penalties if, for some reason, the IRS does not accept the Streamlined submission. This could possibly happen for example, if the submission involves 5 years of returns (rather than 3 years) for a client who is planning to expatriate, or a submission for a client who has already expatriated but not yet filed the final dual status return and Form 8854. It is best to be prepared and to have a “reasonable cause” argument laid out from the start. At least, that is my view.
I use guidance from the Tax Court to help strengthen the position of reasonable cause reliance on a professional. In the case of Neonatology Associates, P.A. v. Commissioner, 114 T.C. 43 (2000), the taxpayers contended that they were not liable for accuracy-related penalties because they relied upon their tax professionals for their reporting positions.
After reviewing relevant law, the Tax Court in the Neonatology case set forth a three-pronged test that taxpayers must meet to show reasonable cause reliance on a tax professional. These three prongs are:
- Whether the adviser was a competent professional who had sufficient expertise to justify reliance? I look for the preparer’s qualifications (e.g., EA, CPA etc.; does the professional have a website that sets out the qualifications and areas of expertise?)
- Whether the taxpayer provided necessary and accurate information to the adviser? – Here, one should establish that the taxpayer told the tax return preparer about foreign accounts, or provided him information about them – e.g., perhaps certain foreign bank or financial account statements were sent over with other information. I am still seeing tax professionals who are not sending tax organizers to clients. Bad business practice and a red flag to the taxpayer. Without other evidence, at a minimum, one may be able to say that the tax professional knew the client lived and worked overseas and this fact alone should prompt the advisor to ask about foreign accounts as these are necessary to take salary and pay bills living abroad.
- Whether the taxpayer actually relied in good faith on the adviser’s judgment? (I have found this to be true in all my cases).
A recent decision from the Tax Court demonstrates that the Neonatology case can be useful for cases involving foreign assets and US international tax issues. In Kelly v. Commissioner, 18 T.C. Memo. 2021-76 (2021), the taxpayer had created a Cayman Islands company for which he was the sole owner, but failed to file Forms 5471. As a result, the IRS assessed additional taxes and penalties. The taxpayer argued that he had reasonable cause for not filing the Forms 5471, based on the fact that he had relied upon his CPA tax-return preparer to advise him about international tax reporting requirements. The IRS, of course, disagreed. In fact, the IRS contended that it was not enough for the taxpayer to inform his return preparer that the Cayman corporation was a foreign entity; IRS implied that the taxpayer should have advised the preparer that Form 5471 was required. (Seriously?)
The Tax Court citing the Neonatology case found that the taxpayer had shown reasonable cause reliance on a tax professional. The Tax Court noted that the taxpayer had properly provided his CPAs with information to put them on notice that he had ownership of a company created in a foreign country. Although the CPAs did not timely file the Forms 5471, the Tax Court determined that the taxpayer’s reliance was reasonable and in good faith; he was not required to second guess the decisions of the CPAs.
There are avenues to correct tax noncompliance, but you really need the right tax pro to make sure you take the right road. There are many claiming to be proficient in the international taxation context, but I see so many errors by these “professionals”. US international tax takes decades to learn, understand and apply. It involves layer upon layer of complexity and integration of the tax code sections. Don’t be duped – get the best tax help. I am available to assist. Email me at email@example.com
Posted June 30, 2022
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