The Risks to USCs and LPRs – Filing Late U.S. Income Tax Returns via the so-called “Streamlined” process
I previously posted a note about the so-called “Streamlined” process the IRS [which are now gone and removed from the IRS website] had announced in June 2012, Why the so-called “Streamlined” Process is “Much Ado About Nothing” – Legally Speaking. I explained that legally speaking, there is no legal protection to the taxpayer provided by this administrative procedure.
The new “streamlined” procedure from June 2014 does not provide any additional legal protection or finality. To be blunt, the government has used the FBAR as a “trap” for the taxpayer. See, Why the Zwerner FBAR Case is Probably a Pyrrhic Victory for the Government – for USCs and LPRs Living Outside the U.S. (Part II).
If the individual did not check the right box on Schedule B, Part III, therefore the government may well argue they were “willfully blind” of the requirements of filing FBARs, even if they did not know of the filing requirements. The FBAR regulations are extremely complex and I am confident few tax experts anywhere in the world could take a basic exam of what is a “financial interest in” and “signature authority over” such accounts according to these regulations and get more than about 75% (a “C” or maybe “D” grade) of these questions rights. See, Take Caution when Completing a “Tax Organizer” Provided by Your Tax Return Preparer.
The problem with this streamlined process is there is no protection from penalties for failure to file tax returns, failure to file information returns, failure to file FBAR forms; nor from IRS audits of prior years (when the statute of limitations is still open), etc. In short, the IRS (or the Justice Department) can always fully pursue a USC or LPR who has not properly filed U.S. income tax returns, information returns on foreign assets or FBARs for prior years, as provided under the law.
In the meantime, the government will never be required to refund the so-called “5% miscellaneous offshore penalty” (which of course is not a penalty under the law in the first place), pursuant to the very terms of the Certification. The taxpayer waives ” . . . all defenses against and restrictions on the assessment and collection of the [5%] miscellaneous offshore penalty.” It is a one way street.
In addition, the individual is now subjecting themselves to potential greater liability in the event the government ever wants to challenge the certification made under penalties of perjury. Indeed, the certification is not drafted in the words of the taxpayer, but rather the U.S. federal government. Many practitioners have been analyzing and parsing the meaning of “negligence” and “inadvertence” and “mistake” that is a “good faith misunderstanding” of the requirements of the law. It’s entirely unclear how these terms will be interpreted by the government in any particular case. Certainly the vast majority of these cases that are entered into this system will not be challenged; if for no other reason the limited resources of the IRS.
However, there are so many ways they can be challenged against any particular taxpayer. What if a taxpayer threw away the monthly bank statements for the year 2012 regarding a foreign account? Will that be a breach of the Certification? Will all bets be off against the taxpayer? The terms of the certification seem to provide such a result.
I suspect we will see cases where the government will go after (selectively) some taxpayers who enter into the streamlined process. They cases they will select are the ones they think the taxpayer should have gone in under the OVDP. That will be the determination of the government, not the individual taxpayer; and hence can put the taxpayer in further jeopardy.
Finally, the most troubling issue of this program for U.S. residents, is they are agreeing to pay something that does not exist under the law and may have no correlation with any income taxes owing; i.e., the so-called “5% miscellaneous offshore penalty.” Why should a “good faith” taxpayer be paying any portion of their principal to the government, if they made an inadvertent mistake of what are typically very complex provisions in the tax law?
A basic example can demonstrate the injustice of this approach. Taxpayer Pierre, moves from France to the U.S. some 10 years ago. He was an accounting major in France and practiced as an accountant before becoming a business and property manager. His English is horrible and he relies upon a tax return preparer at “J&Q Blockhead Return Preparers” who only speaks English. His return preparer has never asked good questions, about if he has any non-U.S. assets, as he meets with him for 60 minutes each year after taking his W-2 and 1099 forms to the office as requested.
Pierre inherited from his non-U.S. citizen parents accounts in Switzerland and France with a value of US$3M and some real estate outside Paris worth approximately US$2.5M that generates rents monthly. His return preparer always sent his returns with the “No” boxes checked on Schedule B, Part III and never filed FBARs or IRS Form 8938. See, USCs and LPRs residing outside the U.S. – and IRS Form 8938. Pierre was told by his French tax advisers, who are very sophisticated, that the U.S. should not levy tax on his European assets; but rather he should only pay tax in France and Switzerland on these assets. Assume the taxes withheld at source in Europe are greater than the U.S. income tax that would be generated on this income; hence he can fully credit (with the U.S. foreign tax credit) the U.S. federal income tax, except about $700.
Pierre reads the news release on a French news website of the new “streamlined” program announced by the IRS in June 2014. He asks his return preparer about it – who has no idea what he is talking about.
What is Pierre to do? Why should Pierre pay approximately US$325,000 (5% of US$6.5M) to participate in this program when he owes less than US$1,000 of federal income tax?
When Pierre discusses this press release with the manager at “J&Q Blockhead Return Preparers”; the manager says all customers are given a (1) a package of documents and a pamphlet that says “Do you have any foreign assets?” on page 37, paragraph 3; and (2) a free coffee mug with “J&Q Blockhead Return Preparers” prominently displayed. The manager at “J&Q Blockhead Return Preparers” tells Pierre – “you are not going to pin this one on me!”
How is the payment of US$325,000 that is not contemplated under Title 26, a correct result under the law?
If Pierre does not go into the streamlined program and files amended tax returns, will the IRS and Justice Department try to “Zwerner” him (assess multiple year 50% willfulness penalties – arguing he was “willfully blind”)? What if they start an audit and investigation and ask the return preparers at “J&Q Blockhead Return Preparers” about the case with the response being “We tell all our customers they have to report their foreign assets and have it in writing. See our pamphlets and website.”
That is the risk Pierre will have to take; (1) comply with the law under Title 26 as amended returns are contemplated and risk the government will pursue him for 50% willfulness penalties (as the failure to file IRS Form 8938 – should be only for 3 years at $10,000 per year) or (2) be forced into a “streamlined” procedure that will make him pay a large portion of his family inheritance from Europe to the U.S. since he did not file IRS Form 8938 or FBARs.