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Do you have banking accounts, mutual funds, and other financial assets outside the US? Are you worried about whether you need to report them to the IRS? The answer is - you might! And the penalties are stiff if you are required to and don’t.
Here’s the short version: if you have foreign accounts that exceed certain thresholds, you are required to report them. In addition, as a US person - which includes resident aliens, you have to pay income tax on your worldwide (US and foreign) income, which may include investment income. It is essential that you report your assets and income from abroad if you are required to.
Who is a US person?
You are subject to foreign asset reporting requirements if you are a US person, which includes US citizens and resident aliens.
US citizens and resident aliens have to disclose offshore accounts exceeding the aforementioned thresholds.
According to the IRS, you are a United States person if you are any of the following:
- A citizen or resident of the United States
- A domestic partnership or domestic corporation
- An estate other than a foreign estate
- A trust that
- A person that is not a foreign person
You are considered a foreign person if you are:
- A nonresident alien
- A foreign corporation, foreign partnership, foreign trust or foreign estate
- Not a US person
You are a resident alien if you pass either of these two tests:
Who Must File FBAR (Foreign Bank Account Reporting)?
A US person, as mentioned above, must file FBAR when they have a financial interest or authority over a financial account located outside the United States. However, they will only need to file if the foreign accounts exceed $10,000 at any time during the calendar year they are filing taxes for.
Whether or not your foreign financial account has produced taxable income, you’ll still need to report it on FBAR. Living abroad and filing a joint income tax return will affect whether or not you need to report these assets.
According to the IRS, if you are a US person living in the US, you must file Form 8938 if you must file an income tax return and:
Filing Single - The total value of your foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year
Married Filing Jointly - The total value of your foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year
Married Filing Separately - The total value of your foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.
According to the IRS, If you are a US person living abroad, you must file Form 8938 if you must file an income tax return and:
Single or Married Filing Separately - The total of your foreign financial assets is more than $200,000 at the end of the year.
Married Filing Jointly - The total of your foreign financial assets is more than $400,000 on the last day of the tax year or more than $600,000 at any time during the year. This rule applies even if only one spouse is living abroad.
Jointly but Unmarried - The total of your foreign financial assets is more than $200,000 on the last day of the tax year or more than $300,000 at any time during the year.
Please note, you are a person living abroad if you are a US citizen who pays taxes in a foreign country, and have been living outside the US for at least 330 days out of a consecutive 12-month period.
You file FBAR online through the BSA E-Filing System rather than filing it with your federal tax return. It’s due on or before April 15. However, if you need an extension, you are granted one automatically until October 15 without request.
FBAR is an informational return and is not filed with your tax return. However, if you fail to submit your FBAR when you have foreign assets to disclose, the IRS may penalize you.
Don’t File FBAR
A US person will not need to file if they use a consolidated FBAR to report their financial accounts. Additionally, they will not need to file if the accounts are jointly owned with a spouse and they completed FinCen Form 114a. This authorizes their spouse to file FBAR on their behalf.
You don’t need to report your foreign financial accounts if they fall under one of these categories as well, according to the IRS:
- They are correspondent/Nostro accounts
- They are owned by a governmental entity or by an international financial institution
- They are maintained on a US military banking facility
- They are held in an individual retirement account (IRA) you own or are beneficiary of
- They are held in a retirement plan that you’re a participant or beneficiary of
- They are part of a trust that you’re a beneficiary of - if another US person files the FBAR
Foreign banks are required to tell the IRS about you.
FATCA requires foreign financial institutions and entities to report information on accounts held by a U.S. taxpayer.
In compliance with this law, foreign institutions send information including your name, address, account numbers, balances, and identification numbers to the IRS.
In most cases, foreign banks will ask you to fill out Form W-8 or Form W-9 if you are a US citizen or if you ever lived in the US. Even if you ignore this request for information, a bank may still forward your bank account details or interest on foreign holdings to the IRS if they have reason to believe that you are a US person.
Your foreign accounts may be subject to double taxation.
When you maintain a financial account in another country, you may be subject to taxes in the US and that foreign country. If you are subject to US income tax on your accounts, you may be eligible for a credit or itemized deduction for the foreign taxes you accrued. You may also take advantage of exemptions or preferential tax rates under a tax treaty.
If the foreign taxes are imposed on you by a foreign country or US possession, you can claim a credit. However, the IRS states that only income, war profits and excess profits taxes quality for the credit. You will file Form 1116, Foreign Tax Credit to claim the foreign tax credit to reduce your tax liability.
If you take an itemized deduction for these taxes instead, you will file them on Schedule A (Form 1040), Itemized Deductions to reduce your US taxable income.
There are serious consequences if you don’t report your foreign accounts.
If you don’t disclose your offshore accounts, you may be caught through an IRS audit and your foreign accounts may be frozen. The IRS may also impose penalties for failure to comply with offshore account disclosures.
Taxpayers who did not file an FBAR but were required to may be subject to civil and criminal penalties unless there is a reasonable cause.
For a non-willful violation, the IRS levies a $10K fine per violation. Your violation is not willful if you failed to report your offshore accounts because of “negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”
On the other hand, willful conduct refers to the intentional violation of the law. For willful conduct, the civil penalty is the greater value between 50% of the balance in your offshore account at the time of your violation or $100K. In certain cases, the IRS may also reduce the penalty.
Form 8938 Penalties
If you did not file Form 8938 or if you understated taxes related to your foreign assets, you may be subject to a $10K penalty. Failure to file within 90 days after you receive a notice from the IRS may add penalties up to $50K.
For underpaid taxes due to undisclosed foreign assets, you may have to pay a penalty equal to 40% of the underpaid amount. If the underpayment is due to fraud, the penalty increases to 75% of the underpaid accounts.
Like FBAR, you may also be subject to criminal penalties.
Related Article | 4 Ways To Reduce Your Taxes On Your Foreign Income
What are your options if you have undisclosed offshore accounts?
For taxpayers who have undisclosed offshore accounts, there are three options.
Option #1. Submit Delinquent FBARs
If you were not able to submit your FBARs but you have paid taxes on your foreign accounts, you may be exempt from penalties if you submit your delinquent forms. You may be eligible for this program if:
- You did not receive any reminder from the IRS about your delinquent FBARs
- You are not under criminal investigation or a civil examination by the IRS
You can submit the delinquent forms electronically at the FinCEN website. You should also include a statement explaining the reason for late filing.
If you paid all taxes related to your foreign accounts properly, the IRS will not impose any penalty.
Option #2. Engage in Compliance Procedures
If you believe that your failure to file your FBAR is not willful and you are not subject to any civil examination by the IRS, you may file your delinquent forms under the Streamlined Offshore Procedures.
Under the streamlined compliance procedure, you have to:
- amend or file your tax return for the last 3 years
- file FBAR for the last 6 years
- submit a non-willful certification
Streamlined procedures have two forms:
Streamlined Domestic Offshore Procedure (SDOP): You may apply for this program if you who live in the US. You can file SDOP if you filed your tax returns on time. Under this program, the penalty is reduced to 5% of your highest account balance at the end of the year.
Streamlined Foreign Offshore Procedure (SFOP): You may apply for SFOP if you lived in a foreign country for 330 days during the 12-month period. If you lived in a foreign country for 330 days or you did not meet the Substantial Presence Test in any one of the last three years, you may be eligible for a waiver of all FBAR and FATCA penalties.
Option #3. Offshore Voluntary Disclosure Program
If your failure to disclose your offshore accounts is willful or fraudulent and you want to avoid criminal prosecution, you may be eligible for the Offshore Voluntary Disclosure Program. If your offshore accounts have large deposits or account balances, this program may be suitable for you.
Under OVDP, you need to file amended returns for a six-year period. The total penalty on your undisclosed accounts is $100K or 50% of the highest account balance whichever is greater. The IRS examiner may increase or decrease the penalty but it should not exceed 100% of the highest aggregate balance in your foreign account.
Like the programs above, you can only apply for OVDP if you are not under examination by the IRS.
Expert Advice Recommended
If you have foreign accounts to disclose or pay taxes on or if you did not disclose offshore accounts that you should have, it is recommended to get professional help. A tax expert like MYRA can help you understand your reporting obligations.