Compliance options

 Understanding compliance options

It is important to note that what is referred to as U.S. tax compliance, requires compliance in two areas.

1. Tax compliance – reporting your income and paying tax on that income.

2. Information return compliance – reporting information, whether or not tax is owed. (The FBAR is the most well known example of an information return.)

Compliance requires both tax and information-return compliance.

There are typically three circumstances under which U.S. citizens abroad are not compliant with U.S. tax laws. In the following chart only the top scenario is an example of complete compliance. The bottom three are not.

Tax             Information         How likely is this for U.S. citizens abroad?

Y                  Y                       Complete Compliance – Not likely for long term expats.

Y                  N                       Common, until 2009 few people knew about FBAR.

N                  Y                       A logical possibility, but very unlikely.

N                  N                       By far the most common scenario.

Note: The fact that tax returns have been filed does NOT guarantee that they are correct. For example, it is quite possible and normal for U.S. citizens abroad to NOT have known about PFICs, Subpart F income or that the sale of a principal residence is taxable in the U.S.

It is important to note that there is nothing you can do to change your past behavior. Clearly, it is desirable and in your best interests to seek compliance on a “going forward” basis. What should you do about past problems of non-compliance? Because the IRS may not allow you to simply “fix the situation” without threatening massive penalties, you need to consider your course of action very carefully.

It is impossible to advise anybody without an honest and comprehensive assessment of their individual situation. An analysis of your situation necessarily includes an assessment of your anxiety and tolerance for risk. Remember that there is nothing you can do about the past. What does this mean? It means that filing old returns and FBARs will NOT in and of itself mean that you have “fixed the problem”. To put it another way, if you have not been filing your tax returns, the fact that you file some old returns today, does NOT change the fact that you failed to file returns when they were due.

How To Deal With Past Compliance Issues:

There is no one right way to deal with this problem. Before doing anything, you need to determine your possible tax liability. This will ensure that you know, what if anything you owe in taxes. A knowledge of your tax liability is vitally important information in determining your course of action.

Here is a spectrum of possibilities for how to come into compliance:

1. Forget the past – file accurately on a “going forward” basis. Obviously you are playing the “audit lottery”. This is probably most appropriate for those with little or no income or other downside risk.

2. File the past tax returns and information returns along with the payment of taxes and interest.  You are playing the “audit lottery”. It’s just that this time, the issue will be the accuracy of the returns filed and not whether you have filed the returns. (If you are reading this site, you may have read other sites and may recognize this as a “Quiet Disclosure”.) This may or may not increase your risk of an audit. Many lawyers and accountants advise against this, some for reasons that I believe are valid and some for reasons that I believe are not valid.

3. Traditional Voluntary Disclosure.

“Hello IRS I am notifying you that I have become aware that I have not been tax compliant, here are my reasons, amended returns, taxes and interest.”

You are obviously filing the FBARs as well with the appropriate “reasonable cause” letter(s). This is different from “2″ above in that you are specifically notifying the IRS that you are filing the returns. In “2″ you are trying to “clean up the past” without letting the IRS know. Talk to your adviser about the importance of filing the tax returns before filing the information return(s).

4. Enter the OVDP (“Offshore Voluntary Disclosure Program”) of 2012. I would advise this in only three cases:

A. You have no emotional tolerance for uncertainty. But, you will pay a very hefty price for certainty.

B. The specific circumstances of your situation demonstrate that it is financially advantageous for you to take this route. There are good reasons to use OVDP, but they don’t apply to many people.

C. You have a “material risk” of facing criminal charges. If you believe this is a possibility, you should consult a criminal lawyer who specializes in this kind of work. OVDP will, in general, mean that there will be no criminal prosecution. But, I am including this discussion only for logical completeness. Few U.S. citizens abroad fall into this category.

5. Enter OVDP and then do an “opt out”

This is a logical option. That said, why enter OVDP if you are going to “opt out”?

Your circumstances will dictate your best route to compliance. This is NOT “one size fits all” (and that is one of the reasons why you should beware of the Offshore Voluntary Disclosure Program).

6. The Streamlined Compliance Procedures for Non- US Residents

These were announced on August 31, 2012. The process was amended in June of 2014 and “clarified” in October 2014.

7. The Streamlined Compliance Procedures for U.S. Residents

This has been an option since June of 2014. It is a “welcome addition for “Green Card” holders.

You should choose your “road to compliance” in careful consultation with a lawyer with a competent adviser.

 


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