The IRS recently issued an important Fact Sheet (FS-2011-13) that applies to U.S. citizens and dual citizens residing outside of the U.S., many of whom are not aware that they are required to file U.S. income tax returns and, where applicable, the FBAR form (Form TD F 90.22-1, Report of Foreign Bank and Financial Accounts) to report foreign financial accounts. The Fact Sheet provides some important information for these taxpayers, particularly with respect to the possible elimination of penalties for taxpayers who now want to come into compliance.
In many cases, U.S. citizens and dual citizens residing abroad file returns and pay income taxes in their country of residence, but they fail to file U.S. income tax returns. In addition, these taxpayers are often unaware of the requirement to file an FBAR to report financial accounts in excess of $10,000.
In the case of income tax liabilities, the Fact Sheet confirms that there are no penalties for late filed returns if there is no income tax due, which is often the case after the Code Section 911 foreign earned income exclusion and the foreign tax credit for taxes paid in their country of residence.
In those cases where tax is due and late filing or late payment penalties would be assessed, the IRS reminds taxpayers that they can request a “reasonable cause” abatement of the penalties. The IRS states that reasonable cause relief is generally granted if a taxpayer demonstrates that he/she exercised ordinary business care and prudence in meeting the tax obligation. The IRS will consider several factors in reaching a reasonable cause decision, including the following:
- Reasons given for not meeting tax obligations;
- Compliance history;
- Length of time between the failure to file and the subsequent compliance;
- Circumstances beyond the taxpayers control;
- Level of education;
- Whether the taxpayer had previously been subject to tax;
- Whether there were prior penalties;
- Whether there were recent changes in tax forms or law; and
- The level of complexity of a tax compliance issue.
In the case of FBAR delinquent filings, the IRS confirmed that a taxpayer does not need to file an FBAR that was due more than six years after the due date of the FBAR since there is a six-year statute of limitation on assessment of penalties. If an FBAR is required to be filed and a taxpayer fails to file an FBAR, in the absence of reasonable cause, the IRS might assess a non-willful or willful civil penalty for failure to file an FBAR. Non-willful violations are subject to a penalty of up to $10,000 per violation. The civil penalty for willful failure to file an FBAR can be up to the greater of $100,000 or 50% of the total balance of the foreign account at the time of the violation.
The IRS can abate FBAR penalties if the taxpayer files a delinquent return and provides a written statement explaining why the failure to file was due to reasonable cause. Factors that indicate reasonable cause include the following:
- Reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account;
- The unreported account was established for a legitimate purpose;
- There were no indications of efforts taken to intentionally conceal the reporting of income or assets;
- Filing of tax returns and payment of tax liability in the country of residence; and
- There was no tax deficiency (or there was a tax deficiency but the amount was de minimis) related to the unreported foreign account.
Factors that might weigh against a determination that an FBAR violation was due to reasonable cause include the following:
- The taxpayer’s background and education indicate that he/she should have known of the FBAR reporting requirements;
- There was a tax deficiency related to the unreported foreign account; and
- Whether the taxpayer failed to disclose the existence of the account to the person preparing his/her tax return.
The IRS also notes that in determining the facts and circumstances of a particular case, an IRS examiner may issue a warning letter instead of a penalty. IRS examiners are instructed to consider whether compliance objectives would be achieved by issuance of a warning letter instead of a penalty.
We suggest that you speak with your tax advisor concerning the income tax and the FBAR compliance requirements if you are a U.S. citizen or a dual citizen residing abroad.