Paying Taxes on Offshore Accounts
When filing their taxes, U.S. citizens must report worldwide income from all sources, including foreign accounts, and pay taxes on income from those accounts at their individual rates. While there are numerous legitimate reasons for holding offshore accounts, U.S. taxpayers may not use offshore accounts, such as foreign bank and securities accounts as well as trusts, to avoid U.S. tax liabilities.
In most cases, affected taxpayers need to fill out and attach Schedule B to their tax returns. Part III of Schedule B asks about the existence of foreign accounts and usually requires U.S. citizens to report the country in which each account is located. Certain taxpayers may also have to fill out and attach to their return Form 8938, Statement of Foreign Financial Assets, if the aggregate value of those assets exceeds certain thresholds that vary depending on filing status and whether the taxpayer lives abroad. Additional filing requirements apply to those with foreign trusts.
Separately, taxpayers with foreign accounts whose aggregate value exceeds $10,000 any time during the year must file a Form 114, Report of Foreign Bank and Financial Accounts (FBAR). The FBAR is not filed with a federal tax return and must be filed by April 15th each year.
Potential Civil Penalties for Offshore Tax Avoidance
Failure to report the existence of offshore accounts or pay taxes on these accounts can lead to civil and criminal penalties. As described by the IRS, civil penalties may include, but are not limited to:
- Failure to file FBAR: The civil penalty for willfully failing to file can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
- Failure to file Form 8938: Failing to report the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D also results in hefty fines. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
- Failure to file Form 3520: Taxpayers also face penalties for failing to report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
- Failure to file Form 3520-A: Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
- Failure to file Form 5471:S. residents who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
- Failure to file Form 5472: Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
- Failure to file Form 926: Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
- Failure to file Form 8865:S. persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Taxpayers may also face underpayment and fraud penalties. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that essentially amount to 75 percent of the unpaid tax. Failing to file a tax return may also result in a penalty of five percent of the balance due, plus an additional five percent for each month or fraction thereof during which the failure continues may be imposed. However, the penalty may not exceed 25 percent. In addition, if a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent. Taxpayers may also face an accuracy-related penalty on any underpayments, which, depending on the circumstances, may be 20 percent or 40 percent.
Criminal Charges for Tax Evasion
Taxpayers who fail to disclose and pay taxes on foreign assets may also face criminal prosecution. The potential criminal charges related to tax matters include tax evasion, filing a false return, and failure to file an income tax return. Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
In some case, the charges may result in significant fines and even prison time. A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
Message for Taxpayers
Given the risk of significant penalties including criminal protection taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns should consult with an experienced tax professional and legal counsel. In many cases, it may be advisable to take advantage of the OVDP program before it expires.