With the ending in September of an Internal Revenue Service program that allowed individuals with unreported offshore assets to report the holdings in return for reduced penalties, pressure is mounting on taxpayers with undisclosed foreign accounts.
For those who can prove they were not willfully noncompliant in not reporting, the IRS still offers options with mitigated or no penalties, depending on the circumstances.
While a taxpayer whom the IRS views as “willful non-compliant” ‒ someone who knew about the filing requirements but ignored them ‒ now faces stricter penalties. Not only could such taxpayers face criminal penalties, but the IRS is getting more sophisticated about tracking such accounts, and intergovernmental agreements are making that task easier for the agency.
The Foreign Account Tax Compliance Act, or FATCA, requires foreign financial institutions, governments and non-financial foreign entities to report information to the IRS about U.S. citizens who have those accounts.
Cryptocurrency investors need to pay careful attention to offshore reporting requirements as well, because many virtual-currency exchanges are outside the U.S.
The consequences of not filing
The owner of, or someone with signature authority over, foreign bank and securities accounts must file a Foreign Bank Account Report, or FBAR, which is FinCEN Form 114, to report interest on such accounts if the aggregate balance in the accounts exceeds $10,000 at any point during a tax year.
U.S. taxpayers also are required under FATCA to file IRS Form 8938 if their holdings in foreign bank accounts, securities accounts and generally most any other asset exceeded $50,000 ($100,000 if married and filing jointly with a spouse) at any point during a tax year.
The penalty for ignoring these reporting and filing regulations is quite severe.
Under U.S. Code Title 31, Section 5321, individuals can face civil and criminal penalties, depending on the nature of the taxpayer behavior.
Civil penalties range from $1,078 for a negligent violation to as much as 50 percent of the highest account balance per tax year for a willful failure to file. Thus, if a taxpayer had $1 million in a foreign bank account and willfully failed to report the income and file FBARs for six years, he or she could owe as much as $3 million in penalties ‒ $500,000 per year – plus the tax and interest.
Additionally, criminal penalties for willful failure to file FBARs can be up to $250,000 and 5 years in prison.
Know your crypto exchanges
Virtual currency, or cryptocurrency, flows in and out of virtual-currency exchanges. Since many of those exchanges are offshore, the currency triggers FBAR reporting requirements.
The IRS considers “convertible” virtual currency – the type that can be digitally traded and purchased or exchanged into U.S. dollars or other real or virtual currencies – to be subject to taxation, as is property.
As for triggering FBAR reporting requirements, a 2014 ruling in U.S. v. John C. Hom set the general precedent that a cryptocurrency account is a foreign financial account if the exchange on which the digital currency trades is organized outside the U.S.
The IRS has two voluntary programs to aid those who own foreign bank and securities accounts that rose above $10,000 and who show no evidence of willful non-compliance. These streamlined disclosure procedures options allow taxpayers to receive a reduced penalty rate of no more than 5 percent of the highest balance.
Additionally, for those who failed to file FBARs but were not willfully non-compliant and who do not owe taxes, the IRS has a delinquent FBAR submission procedure. Individuals who qualify can submit FBAR forms going back six years without penalties for failing to file.
It's important to keep in mind that the above remedies require individuals to certify – under penalty of perjury – that the non-compliance was not willful. The IRS describes non-willful conduct as “conduct that is due to negligence, inadvertence or mistake, or conduct that is the result of a good-faith misunderstanding of the requirements of the law.”
For willful violators, the best advice is voluntary disclosure. These individuals will want to consult with a tax professional as well as an attorney. While there are no guarantees, by coming forward instead of waiting to be caught, an individual might avoid criminal charges and negotiate an agreement on the civil penalties.
If you have offshore accounts or are unsure about your cryptocurrency investments, consult with a financial adviser equipped with the skills and capabilities to help with the FBAR requirements.
As noted, the penalties for noncompliance are harsh and can include criminal prosecution. Doing nothing is not a viable option and likely will make the situation worse.
Edward R. Jenkins is a Professor of Practice in Accounting at Penn State and a consultant with Boyer & Ritter LLC Certified Public Accountants and Consultants. He can be reached at 814-234-6919 or firstname.lastname@example.org