Due to legislation by Congress, financial institutions outside the US will report the identity and specifics of American account holders to the IRS. Following the IRS enforcement campaign in Switzerland, tax experts expect Israel to be the next target.

An American citizen, even residing outside the US, must continue filing his annual tax returns with the IRS (the Internal Revenue Service). The filing requirements are determined by criteria depending on, among other things, gross income level, age and marital status. The fact that a US citizen living abroad, for example in Israel, reports on income and pays taxes to the tax authorities of the foreign country where he lives and works does not exempt him from his obligations to the IRS. The United States has an almost unique approach of taxing nonresident citizens on worldwide income. In addition, the IRS embraces a broad definition of who constitutes a US taxable individual. Therefore, an individual born in the United States to foreign nationals who left the country while an infant must file tax returns with IRS. Even if he grew up and lives in another country and even if he never held a US passport or other US documents.

It should be noted that the filing requirements apply even if the US citizen has no tax liability to the IRS due to regulation preventing double taxation. Therefore, Israelis with dual American citizenship must file tax returns with the IRS even if they were born in Israel and never visited the US. According to recent estimates, some 200,000 US citizens reside in Israel and 80,000 of them are required to file tax returns with the IRS.

Moreover, an American citizen, whether residing in the US or abroad, holding an offshore account or investment portfolio must file a Report of Foreign Bank and Financial Accounts (FBAR) if the account or investment portfolio amounted to $10,000 during the lapsed year. The reporting requirement applies also when no beneficial ownership is involved with signature rights only or a joint account with another.

If taxes are due, failure to file tax returns and satisfying taxes leads to penalties which, depending on the circumstances, may reach 25 percent. If no taxes are due, no fines are imposed for failure to file the tax return.

However, failure to file the FBAR reporting offshore financial assets can be much more expensive. For willful failure to file an FBAR, the law authorizes a penalty of up to the greater of $100,000 or 50% of the balance of the undisclosed account for each of the six last years. If the IRS cannot demonstrate willful failure for filing the FBAR, said omission is subject to a $10,000 fine for each of the past six years. The IRS may waive said penalties if taxpayer demonstrates reasonable cause for failing to file the FBAR. For this purpose, the IRS examines the background and circumstances of the particular taxpayer. It is firmly recommended to hire experienced legal counsel for resolving these issues with the IRS. Please note that information furnished to legal counsel is subject to attorney-client privilege, while no such privilege exists between a certified accountant and his client.

Come to the IRS before the IRS comes to you.

Come to the IRS before the IRS comes to you. (taxes image via Shutterstock)

In past years, IRS enforcement was limited as to foreign financial accounts held by US citizens outside the US. But times have changed, due to the enactment of the Foreign Account Tax Compliance Act (the “FACTA”) by Congress in 2010. The purpose of the FACTA is raising taxes from Americans with financial activity outside the United States. The FACTA is effective from January 2013, and from January 2014 financial institutions outside the US will be required to provide US authorities with the names of American account holders, their home addresses, account numbers and account balances. A 30% withholding tax will be imposed on certain US source payments made to foreign financial institutions refusing to furnish annual information of their US account holders. The provisions of FACTA apply to all financial institutions, including banks, investment banks and insurance companies. Recently the Israeli Ministry of Finance established a team for the implementation of the FACTA.

The IRS launched voluntary disclosure programs for those taxpayers who failed to comply with their filing requirements regarding offshore accounts or assets. The program requires filing tax returns and FBARs for up to eight years and reduced fines. Under the voluntary disclosure program, a penalty of 27.5% is due of the highest aggregate balance during the past eight years prior to disclosure for failing to file the FBAR. A 12.5% penalty applies to accounts whose highest value did not exceed $75,000. (A 5% penalty applies to limited circumstances of taxpayer inheriting an offshore account and withdraw only small amounts.) In addition, there is 20% penalty for taxes due.

For taxpayers intentionally avoiding filing requirements, the offshore voluntary disclosure program offers benefits and discounts. However, those who were genuinely unaware of their filing requirements may benefit by opting out of the program for an audit if they are subject to unreasonably high penalties under the program. The voluntary disclosure program is criticized for not really distinguishing between different categories of taxpayers and whether their failure to file tax returns was willful or not.

Recently, in order to help US citizens residing abroad to catch up with their filing obligations, the IRS announced a new procedure which will go into effect on September 1, 2012. Under the new procedure, taxpayers with low tax liability, owing $1,500 or less, are required to submit delinquent tax returns for the past three years only and to file delinquent FBARs for the past six years without facing additional enforcement action.

The FACTA is heavily criticized as a tremendous disruption of the global financial system, with high implementation costs imposed on US financial institutions and job loss as result. Critics claim the legislation is flawed, prevents investment in the US, and will have devastating consequences on the US economy and on Americans residing overseas. Recently, four US Senators implied in a letter to the Secretary of the Treasury Geithner that the Department of Treasury acted beyond its authority in regards to the legislation. Legislators are continuing to make efforts at repealing the FACTA. But for the meanwhile, it is the law of the land.

Following IRS enforcement against U.S. accounts in Switzerland, tax experts expect the next target is US accounts in Israel, as the activities of Israeli financial advisors is already investigated. The rule in this context: Come to the IRS before the IRS comes to you.

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This article describes the basic principles of the offshore voluntary disclosure merely, and it has been prepared and published for informational purposes only. It is not offered, or should be construed, as legal advice. For resolving a specific case contact legal counsel.

For forwarding questions contact: aaron@farkasesq.com.

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