Foreign Account Reporting in a Nutshell

When I first started preparing tax returns in the late 90’s, foreign account reporting was not really a concern. Rarely was there a need to check yes to the question on Schedule B (Interest and Dividend Income) of Form 1040, to indicate the taxpayer had an interest in or signature authority over a foreign account. No more. The times, as they say, are a’changing.

In the last decade the IRS has started a real push to identify U.S. taxpayers who are hiding assets offshore. Just read some of the IRS’ press releases  regarding foreign accounts (see here, here and here) and it is easy to see that the IRS believes its efforts are bearing fruit. The IRS is not alone in this. The Financial Crimes Enforcement Network is also part of the enforcement effort. Combined both agencies are putting a lot of pressure on taxpayers to come clean. The two major programs dealing with foreign asset reporting are FBAR and FATCA, which stand for “Report of Foreign Bank and Financial Accounts”, and “Foreign Account Tax Compliance Act”, respectively. Taxpayers who run afoul of either reporting requirement can face severe penalties (at a minimum) or criminal prosecution (at worst), so I thought it worth a quick explanation. Not that many of my clients are of the wealthy jet-set who fly their private jets to the Caymens for sun, sin and financial shenanigans…yet.

FBAR

If you possess an interest in or have signature authority over a financial account located in a foreign country then you may need to file a FinCen114 report through the Financial Crimes Enforcement Network (link is here). FinCen114 is due April 15th of each year and which is filed electronically. If you cannot meet this deadline then you can get an extension up to October 15th. The FBAR applies to both individuals and businesses (unlike FATCA, which applies only to individuals).

You are required to file under FBAR if you have an ownership interest in or signature authority over a foreign account, with an aggregate value of all such foreign accounts exceeding $10,000 US dollars, at any point, on a given day during the calendar year.

A foreign financial account is defined rather broadly and includes bank accounts, brokerage accounts, mutual funds, and trusts which are located in a foreign country. It doesn’t have to be a foreign bank to be considered located in a foreign country. So long as the branch, where the account is opened and held, is located in a foreign country it has to be reported, regardless if the branch is of a US or foreign company.

Aggregate value means the total value of all accounts over which a taxpayer has an interest in or signature account over during the year. If, on any given day, the aggregate balance of the accounts exceeds $10,000 (in terms of U.S. dollars) then a FinCen114 report needs to be filed. The taxpayer computes the aggregate amount based on 100% of the value of the account, whether or not the taxpayer’s actual ownership equal 100% of the account or not. If the account has a value denominated in a foreign currency, the taxpayer will use the conversion rates promulgated by the US Treasury to determine the value in U.S. dollars. You can find the link here for the Treasury Reporting Rates for FBAR.

Penalties for failure to file a FinCen114 or to prepare the return correctly are as follows. The IRS may assess a penalty, indexed for inflation, not to exceed $12,459 per violation for non-willful violations (meaning unintentional); if the violation is willful then this penalty increases to the greater of $124,588 or 50 percent of the balance in the account at the time of the violation, for each violation. Beyond the financial penalties, there is the potential for criminal prosecution for tax evasion, depending on the egregious nature of the violation.

FATCA

FATCA or the Foreign Account Tax Compliance Act is designed to prevent tax evasion by identifying individuals who possess an interest in certain foreign financial assets. To comply with FATCA, the taxpayer submits Form 8938, Statement of Specified Foreign Financial Assets, along with his or her tax return, which is due on April 15th of each calendar year (which can be extended to October 15th). FATCA has some very complicated filing requirement, making explanation in a short blog post difficult but I will try to distill it down as best I can.

FATCA applies to certain specified U.S. taxpayers holding specified foreign financial assets outside the United States (I know that sounds redundant but that’s the IRS’ formulation and not mine). If the aggregate value of these foreign financial assets exceeds a certain dollar threshold then the taxpayer must report such assets on IRS Form 8938, as stated above.

First, FATCA applies only to specified individual, such as US citizens; resident aliens who live in the United States for any part of the tax year; nonresident aliens who elect to be treated as resident alien for purposes of filing a joint income tax return; and nonresident aliens who are bona fide residents of American Samoa or Puerto Rico. So FATCA applies to US citizens, at home and abroad, and to certain foreign citizens residing in the US, American Samoa or Puerto Rico.

Second, the specified individual must possess an interest in specified foreign financial assets. These assets are divided into two categories: either a financial account maintained by a foreign financial institution (unless it is a US Bank or the institution has a US presence) or other foreign financial assets held for investment (that are not held in an account maintained by a US or foreign financial institution). Good examples of the second category of assets are: stock or securities issued by a foreign company; an interest a foreign entity (akin to a partnership or other non-corporate interest); and a financial instrument or contract which has a foreign individual or entity as the other party or issuer.

The final requirement is that the aggregate value of the specified foreign financial assets exceeds certain thresholds established under the law. For unmarried taxpayers living in the US, the aggregate value has to exceed $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year. Married taxpayers living in the US (who file a joint return) must file a report if the aggregate value exceeds $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year (married taxpayers filing separately have to use the lower unmarried taxpayer threshold of $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year). If the taxpayer lives abroad (so US citizens only) then the thresholds increases considerably (the rules regarding taxpayers abroad can complicated so I won’t go into any detail).

Valuing foreign financial assets can be complicated and so taxpayers are allowed some leeway. For brevity purposes, I will not go into detail of how to value specified foreign financial assets; generally taxpayers are allowed to make reasonable estimates regarding an assets worth when determining whether he or she needs to make a report under FATCA.

Failure to file Form 8938 carries with it certain penalties. You can be penalized up to $10,000 for failure to file the report plus an addition $50,000 if you continue to properly file a report after the IRS notifies you. If that wasn’t enough, the IRS can assess an additional 40 percent penalty on an understatement of tax attributable to non-disclosed assets. Like the FBAR, the same threat of criminal prosecution applies depending on the circumstances.

In Conclusion

As you can probably guess, there are areas where both FBAR and FATCA reporting requirements can apply to a single foreign financial asset. Based on what I discussed above, you can well imagine that the cost of complying with both reporting requirements can be expensive but there is no exception for a taxpayer who meets the filing requirements of both.

I suspect that most of you who are reading (this probably all of you) will never own a secret Swiss bank account or hide assets in a Cayman trust but the rules are worth reviewing. I hope you found it interesting (even if probably a bit overwhelming). You never know when that nice Nigerian prince will finally get his money out of the country. He keeps emailing me to let me know that one more check should do it… Bahamas, here I come!

You Have Rights When Dealing with the IRS!

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When dealing the the U.S. Government, you have rights such as the right against unreasonable search and seizure and the right to free speech as guaranteed by the Bill of Rights. Dealing with the IRS is no different but in addition to the rights guaranteed to you by the Constitution you have certain additional rights, aptly named the Taxpayer Bill of Rights. Nina Olsen, the National Taxpayer Advocate, advocated for years to have the IRS explain in plain simple terms the rights that each taxpayer has when dealing with the IRS and so in 2014, the IRS published the aforementioned rights, grouped into ten broad categories, such as the Right to be Informed.

While most of these rights tend to be aspirational, such as language used by the IRS to explain the Right to Quality Service which states that the IRS will provide taxpayers with “prompt, courteous, and professional assistance in their dealings with the IRS….” Still the idea is sound, which is to provide taxpayers with an understanding of what they can expect when dealing with the IRS and in that regard it works. Listed below are the Rights and a brief description of each:

The Right to Be Informed. You have the right to know what is required to comply with the Tax Code. To that end, you are entitled to clear explanations of the tax laws by the IRS, to include IRS procedures, forms, instructions, publications, notices and correspondence. Finally, the IRS must inform you about any decisions it makes regarding your account and to receive a clear explanation of the outcome of their decisions.

The Right to Quality Service. You have the right to prompt, courteous and professional assistance from IRS staff. Similar to the Right to Be Informed, you have the right to receive communications from the IRS that is clear and easily understood; if you receive inadequate service, you have the right to speak to a supervisor.

The Right to Pay No More than the Correct Amount of Tax. You have the right to pay the right amount of tax (to include penalties and interest) and no more. You also have the right to expect the IRS will apply all of your tax payments properly.

The Right to Challenge the IRS’s Position and Be Heard. You have the right to challenge any IRS determination in your case. You are to be provided an opportunity to provide additional documents in response to any formal or proposed action by the IRS. If you do object, the IRS needs to consider your timely objections and additional documentation in a prompt and fair manner; if the IRS disagrees with your objection, you have the right to receive a response from the IRS.

The Right to Appeal an IRS Decision in an Independent Forum. You have the right to appeal an adverse IRS decision, whether it be to the IRS Office of Appeals or to court.

The Right to Finality. You have the right to know how long you have to challenge an IRS decision. Conversely, you have the right to know how long the IRS has to audit your tax return or collect any taxes, interest and penalties due; if the IRS is auditing your return, you have the right to know the audit is finished.

The Right to Privacy. You have the right to expect the IRS will respect your privacy. The IRS’ inquiry, examination or enforcement action must comply with the law and be no more intrusive than necessary.

The Right to Confidentiality. You have the right to be protected from unauthorized disclosure of your tax information unless authorized by you or by law. If the IRS or third parties disclose your tax information you should expect the IRS will take appropriate action to punish wrongful disclose or misuse  your information.

The Right to Retain Representation. You have the right to be represented when dealing with the IRS, whether it be by an enrolled agent, CPA or attorney.

The Right to a Fair and Just Tax System. You have the right to a tax system which considers all of the facts and circumstances in your situation fairly and which provides for a just result. If you are having difficulty dealing the IRS, you have the right to seek assistance from the Taxpayer Advocate Service.

While this explanation does not put much meat on the bone, you can see in a nutshell what rights you can assert if the IRS takes an aggressive position in your case or unnecessarily delays action on your matter. I will leave a more in-depth exploration of these rights to a future post but if you want to know more about each of these rights you can follow this link to the Taxpayer Advocate’s website and read about each in more detail.

If you feel you are not being treated fairly by the IRS, you should contact my office to learn about your rights. You can call my office at 207-299-0515 or by email using my contact form.

Photo courtesy of Eugene Chan at flickr.

What to Know if the IRS Levies Your Assets.

If you owe money to the IRS, you face possible seizure of your assets such as wage garnishment or a bank levy. In some rare cases, the IRS can even foreclose on your home. This post is intended to give you some basic knowledge of what an IRS levy is and what you can do if your are the target of an IRS levy. To keep things simple, I will confine my discussion to wage garnishments and bank levies. Just be aware that the IRS can levy on almost every asset imaginable.

What is a levy?

A levy is simply a seizure of a taxpayer’s assets to pay a tax debt. It should not be confused with a tax lien, which is a claim placed on real estate or personal property. Liens are passive collection measures; the IRS will place the lien on your property and then wait for you to sell it, at which point the IRS will be paid. Levies, on the other hand, are an active collection measure; the IRS can take action immediately to seize property to satisfy your tax debt. Often levies are intended to be a wake-up call to delinquent taxpayers, the idea is to encourage the taxpayer to take immediate steps to address their tax liability. I can tell you from personal experience that a levy does indeed get a client’s attention.

Under what circumstances can the IRS levy my assets?

As I said earlier, the IRS uses tax levies to either get assets to pay any taxes due or to force the taxpayer to enter into some payment arrangement to address the delinquency. So in deciding whether or not to levy a taxpayer’s assets the IRS will consider the following circumstances:

  • The taxpayer’s financial condition, including whether the levy will create an economic hardship for the taxpayer
  • The taxpayer’s responsiveness to attempts at contact and collection
  • The taxpayer’s filing and paying compliance history
  • The taxpayer’s effort to pay the tax
  • Whether current taxes are being paid

As you can see, you are more likely to face a levy if you have not been reactive to prior attempts to settle your tax debt. Even more so if you are in the habit of not being compliant with filing your tax returns and paying any taxes due.

Once the IRS has identified a taxpayer who is fit for a levy, the IRS will take certain steps to encourage the taxpayer to get compliant and avoid the levy. First, the IRS will ensure that were sent CP 501, a Notice and Demand for Payment regarding you tax liability. Second, the IRS will confirm that you either failed or refused to pay the tax due. Finally, the IRS sent you CP 90, a Final Notice of Intent to Levy and Notice of Your Right to A Hearing (levy notice) at least 30 days before the levy.

TIP – Often taxpayer will tell me that they had no idea the IRS intended to levy their assets. It is a very rare circumstance that the IRS levies on a taxpayer without prior notice. So don’t ignore any IRS notices! Attempt to resolve your tax debts and make sure to do your taxes on time and pay any amounts due. This will significantly reduce the likelihood of a levy. You can see a sample notice here.

What happens after the IRS determines my assets should be levied?

After the IRS determines a levy is appropriate and it confirms that it has followed all the required steps, the IRS will send paperwork to your employer or bank informing them that there is a levy in place.

Where the IRS garnishes your wages, the IRS will take a portion of your wages each pay period until you make arrangements with the IRS, the taxes are paid in full or the levy is otherwise released. Your employer will receive information on how much should be withheld from your paycheck and forwarded to the IRS.

To properly determine the amount to withhold, your employer is required to provide you with a Statement of Exemptions and Filing Status to complete and return within three days. Failure to return the statement within the required time frame means the employer is required to withhold the maximum amount possible. You also need to be aware that if you are to receive a bonus then 100% of the bonus may be payable to the IRS! This depends on whether or not you were paid in the same pay period as the bonus payment.

In the case of a bank levy, your bank will receive a levy notice from the IRS, requiring it to hold the balance of your account for 21 days. The reason for the hold is to allow you, the taxpayer, time to make payment arrangements or contest the levy. After the 21 days have passed the bank will pay the funds seized, as of the date of the levy, to the IRS. Funds subsequently deposited into your account, after the date of the levy, are not seized and so you can use the funds as you did before the levy. For example, if you have $1,000 in your account on the date of the levy, with another $1,000 deposited the following day, then the bank will hold the first $1,000 for 20 days; the remaining $1,000 is free to use by you.

What can I do to have the levy released?

The IRS will release the levy under the following circumstances:

  • You pay what you owe
  • The time period for collection ends
  • You enter into a payment arrangement with the IRS
  • The levy creates an economic hardship
  • The value of the seized asset is sufficient to cover any tax due and releasing the levy will not hinder the collection of the tax due

Economic hardship requires some explanation. It does not mean you are inconvenienced by the levy or that you can’t pay all your bills. Instead, economic hardship means the IRS has determined the levy prevents you from meeting basic, reasonable living expenses. Emphasis on the IRS determination. You will need to provide proof that you qualify for economic hardship before the levy will be released.

The best way to have a levy released is to not allow the levy in the first instance. The notice of intent to levy provides appeal rights, which means you have an opportunity to work something out with the IRS or challenge the IRS’ determination to levy your assets. The key is to be proactive before the levy is filed.

Is there anything else I can do?

Yes, call a tax professional immediately. If you owe taxes and the IRS has filed a levy against your wages or bank account you are at risk of future levies. Quick action is demanded to obtain the return of your money or to stop any wage garnishments. You should not take a levy action lightly!