Firstly, for international businesses.
We have often commented on the pressures facing growing international businesses. If you want to hear more, come to the educational seminar of the International Business Structuring Association in Tel Aviv on Wednesday (details from firstname.lastname@example.org).
Secondly, for offshore Americans, including those in Israel. On June 3, when IRS Commissioner John Koskinen was speaking at an Organization for Economic Cooperation and Development forum in Washington, DC, he announced that a new compliance program for United States taxpayers residing abroad would be released in the coming weeks. The program would apply to US citizens abroad who are non-compliant with their tax obligations but who are not willfully evading taxes.
“We are well aware that there are many US citizens who have resided broad for many years, perhaps even the vast majority of their lives,” Koskinen said. “We have been considering whether these individuals should have an opportunity to come into compliance that doesn’t involve the type of penalties that are appropriate for US resident taxpayers who were willfully hiding their investments overseas.”
Koskinen was reported as saying that the new program would be an expansion of the Offshore Voluntary Disclosure Program, which was announced in 2009 and extended in 2011 and 2012. “We’ve modified the program a couple of times already, and so this will be an extension of it, but we won’t be starting from scratch,” he said.
Koskinen also stated that “[w]e are also aware that there may be US-resident taxpayers with unreported offshore accounts whose prior noncompliance clearly did not constitute willful tax evasion but who, to date, have not had a clear way of coming into compliance that doesn’t involve the threat of substantial penalties.”
While we wait for details for the new program to be released, the IRS should be rewarded for publicly stating the obvious.
Not everyone with noncompliance willfully evaded tax.
Then what is the problem? Ever since the introduction of the 2009 Offshore Voluntary Disclosure Program, members of the IRS and Department of Justice have warned taxpayers with unreported foreign accounts that failure to participate in the program would expose them to harsher penalties. In truth, this has not been the case for the taxpayers who will benefit from the new program.
The 2009 program featured a 20 percent penalty and required taxpayers to correct tax returns from 2003-2008.
When the 2011 Offshore Voluntary Disclosure was announced, it “featured” a 25% penalty and required taxpayers to correct tax returns from 2003-2010. The 2011 program, however, introduced two groups of taxpayers who could qualify for a 5% penalty.
These taxpayers included: (1) FAQ 52.2: “taxpayers who are foreign residents and who were unaware they were US citizens; and (2) FAQ 52.3: taxpayers who are foreign residents and who meet all three of the following conditions for all of the years of their voluntary disclosure: (a) taxpayer resides in a foreign country (perhaps Israel); (b) taxpayer has made a good faith showing that he or she has timely complied with all tax reporting and payment requirements in the country of residency; and (c) taxpayer has $10,000 or less of US source income each year.”
For taxpayers in the second category only, the penalty was limited to the value of their bank accounts and did not extend to nonfinancial assets. The IRS also permitted taxpayers who participated in the 2009 program but who qualified for either 1 or 2, above, to qualify for the reduced penalty.
On December 7, 2011, IRS Fact Sheet 2011-13 was released titled “Information for US Citizens or Dual Citizens Residing Outside the US.” The fact sheet indicated that the IRS was aware that some taxpayers who were dual citizens and resident of a foreign country had failed to file FBARs, and many of these taxpayers were now aware of the requirement to do so. As a result, the fact sheet reviewed a number of filing obligations and indicated that “penalties will not be applied in all cases.”
Fact Sheet 2011-13 issued more than two years after the introduction of the 2009 program marked the first time the IRS indicated that penalties may not apply in all circumstances where a taxpayer had noncompliance that included the failure to file an FBAR. There was no opportunity for a taxpayer who participated in either the 2009 or 2011 program to benefit from the terms of the FBAR fact sheet.
In January 2012, the IRS introduced the creation of the 2012 Offshore Voluntary Disclosure Program. The 2012 program “featured” a 27.5% penalty but operated similar to the 2011 program in that it required taxpayers to correct eight years of tax returns and included the same 5% penalty categories.
For those taxpayers who felt that penalties, even at 5%, were inappropriate, the 2009, 2011 and 2012 programs have featured an “opt out” process by which taxpayers could have their case handled under the standard audit procedures.
Why would inviting an audit be preferable? The answer is simply because the IRS agents have discretion as to when to assess penalties. The income tax is rarely the focus for taxpayers, as the arbitrary and capricious penalties that are imposed under the voluntary disclosure program are the concern. Taxpayers with favorable facts are generally those for whom an opt out makes sense.
Then on September 1, 2012, the IRS introduced a new streamlined filing compliance program for “Non-Resident, Non-Filer US Taxpayers.” This provided a means for certain taxpayers to come into compliance and avoid the draconian penalties associated with FBARs and other information returns. For those taxpayers who qualify, the streamlined program requires them to file three years of income-tax returns with all required information returns as well as six years of FBARs. Most notably, there would be NO penalties associated with non-filed FBARs or information returns. The program is available “for non-residents including, but not limited to, dual citizens who have not filed US income tax and information returns.”
The IRS has yet to announce a means by which taxpayers who participated in the 2011 program and received a closing agreement could seek a refund of their penalty were they otherwise able to qualify for the streamlined program. However, for taxpayers in the 2011 program whose cases were not yet resolved, and those in the 2012 program, they were eligible to participate in the streamlined program.
The IRS did not make it easy for such taxpayers, by automatically reviewing the file in conformity with the streamlined procedures. Instead, taxpayers had to opt out of the voluntary disclosure program so that they could go into the streamlined program. This process entails the IRS sending taxpayers a letter that includes an exhibit summarizing a number of potential penalties regardless as to whether any of the penalties actually apply to the taxpayers’ particular facts.
Beyond the absurdity of scaring eligible taxpayers for the streamlined program, the IRS further penalized these taxpayers because they were required to submit eight years of tax returns instead of three.
We have to wait for details to be released to understand the scope of the new compliance program. But the US government needs to create a procedure by which those taxpayers who have already entered and/or completed their voluntary disclosure will have an opportunity to benefit from the abatement of penalties. Failure to do so will cause credibility issues for the IRS.
What does this mean for US citizens and green-card holders resident in Israel? Not much if they are up to date with their US tax filings and FBAR returns. But if there are any US reporting gaps, they should watch out for the unveiling of the new program. US federal and state tax may then be creditable against any Israeli tax on US-source income and gains, pursuant to comprehensive rules of the US-Israel tax treaty. But US penalties cannot be credited in Israel.
As always, consult experienced tax advisers in each country at an early stage in specific cases.