The IRS recently announced a new procedure to help U.S. citizens, dual residents and other U.S. taxpayers residing overseas to catch up with tax filing obligations, in particular those who have failed to timely file U.S. federal income tax returns or Reports of Foreign Bank and Financial Accounts (FBARs). This new procedure will help address the simpler tax returns, but will most likely not apply to non-reporting where significant disclosures and income have been omitted from prior years' returns.
This plan may be very beneficial to taxpayers who want to reduce the risk of IRS audits for prior years. If returns have not been filed for prior years, the IRS is not barred from auditing these years. Rather than being subject to an audit, this new program will allow these taxpayers to file returns without the risk of additional penalties. While any additional amounts of tax due will be subject to normal penalties, the severe penalties which might otherwise apply will be avoided if there is "reasonable cause" for not filing previously.
This new procedure will go into effect on September 1, 2012.
The IRS stated that while details are not yet finalized, as currently contemplated, taxpayers utilizing the new procedure will be required to file delinquent tax returns, with appropriate related information returns, for the past three (3) years and to file delinquent FBARs for the past six (6) years. This compares with the existing Offshore Voluntary Disclosure Program (OVDP) that requires FBARs and tax returns for the past eight (8) years.
All submissions will be reviewed, but, as discussed below, the intensity of review will vary according to the level of compliance risk presented by the submission. For those taxpayers presenting low compliance risk, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. Submissions that present higher compliance risk will be subject to a more thorough review and possibly a full examination, which may include more than three years.
Tax, interest and penalties, if appropriate, will be imposed in accordance with U.S. federal tax laws based on a review of the submission.
Compliance risk determination:
The IRS claims that it will determine the level of compliance risk presented by the submission based on certain information provided on the returns filed, and based on certain additional information that will be required as part of the submission. Low risk will be predicated on simple returns with little or no U.S. tax due. Absent high risk factors, if the submitted returns and application show less than $1,000 in tax due in each of the years, they will be treated as low risk.
It is contemplated that the risk level will rise as the income and assets of the taxpayer rise, if there are indications of sophisticated tax planning or avoidance or if there is material economic activity in the United States. Information regarding the specific factors the IRS will use to assess the level of compliance risk will be released prior to the effective date of the new procedure.
How taxpayers will be able to take advantage of the new procedure:
Taxpayers wishing to use the new procedure will be required to submit:
(1) delinquent tax returns, with appropriate related information returns, for the past three years, (2) delinquent FBARs for the past six years, and (3) any additional information regarding compliance risk factors required by future instructions. Payment of any federal tax and interest due must accompany the submission. More information about the application process, including where submissions should be sent, will be provided prior to the effective date.
Tax year 2011 individual tax returns that are not otherwise timely filed can be filed through this procedure.
Any taxpayer claiming reasonable cause for failure to file tax returns, information returns, or FBARs will be required to submit a dated statement, signed under penalties of perjury, explaining why there is reasonable cause for previous failures to file.
Factors in favor of reasonable cause include reliance upon the advice of a professional tax advisor, account established for a legitimate purpose and no indications of efforts taken to intentionally conceal the reporting of income or assets, and no or de minimis tax deficiency related to the unreported foreign account. No single factor is determinative.
Factors weighing against reasonable cause include taxpayer’s personal and educational background indicate the taxpayer having knowledge of the FBAR reporting requirements, and tax deficiency related to the unreported foreign account was due to the taxpayer failing to disclose the existence of the account to the person preparing his tax return. Again, no single factor is determinative.
This new procedure does not provide protection from criminal prosecution if the IRS and Department of Justice determine that the taxpayer’s particular circumstances warrant such prosecution. Taxpayers concerned about significant income understatements related to offshore activities or possible criminal prosecution because of their particular circumstances should consult with an advisor to evaluate whether participating in the existing OVDP is the best course of action.
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