Delinquent Tax Filing Procedures
What Happens If You Forgot to File Your Forms?
There are options for filing delinquent tax forms that could be easier and less financially painful than you think. Congress has given the IRS large weapons, with a wide array of huge delinquency penalties. However, they would rather coax taxpayers into compliance by using the carrot approach.
We will briefly explain the three programs the IRS currently offers to help taxpayers get caught up:
- Streamlined Filing Procedure
- Delinquent FBAR Submission Procedures
- Delinquent International Information Return Submission Procedures
For additional information, see Options Available for U.S. Taxpayers.
Streamlined Filing Compliance Procedures
The IRS created the original streamlined procedure in 2012. At first, the program applied only to taxpayers living outside the United States who qualified for the foreign-earned income exclusion. The IRS then restricted it further to taxpayers with unreported income of $1,500 or less.
In June 2014, the IRS relaxed and expanded the streamlined procedure to cover all non-willfully delinquent taxpayers. The new streamlined programs let taxpayers—whether living in the U.S. or abroad—who failed to disclose their foreign accounts and report their foreign income, become fully compliant at a much lower cost than entering the now-closed Offshore Voluntary Disclosure Program (OVDP).
Today, two streamlined procedures exist. Taxpayers who qualify for the foreign offshore procedures face no penalties. Taxpayers who qualify for the domestic offshore procedures and live in the United States face a penalty equal to 5% of the highest account balance.
The IRS also removed the old $1,500 unreported tax threshold, so participants no longer need to worry about rejection if they have substantial foreign income to report. The IRS eliminated the prior applicant risk assessment process as well.
For an overview, see Your Unfiled FBARs, Coming Clean Could Be Much Easier Than You Think.
General Requirements
The modified streamlined filing compliance procedures are designed only for individual taxpayers and estates of individual taxpayers. The program for taxpayers living in the United States is called the Streamlined Domestic Offshore Procedures, and the program for expats is called the Streamlined Foreign Offshore Procedures.
Under both programs, taxpayers are required to certify that the failure to report all income, pay all taxes, and submit all required information returns, including FBARs (FinCEN Form 114) was due to "non-willful" conduct.
The IRS defines this conduct as conduct "due to negligence, inadvertence, or mistake, or conduct that is the result of a good faith misunderstanding of the requirements of the law" (IR-2014-73).
Willful vs. Non-Willful
The IRS definition of non-willful covers a lot of ground. Negligence, for example, means "any failure to make a reasonable attempt to comply with the provisions of the Code" (IRC Sec. 6662(c)) or "to exercise ordinary and reasonable care in the preparation of a tax return" (Reg. Sec. 1.6662-3(b)(1)).
The courts add that "negligence is a lack of due care in failing to do what a reasonable and ordinarily prudent person would have done under the particular circumstances" (Kelly, Paul J., (1970) TC Memo 1970-250). The court also stated that a person may act negligently without acting in bad faith.
So, if you ignored FBAR filing requirements for many years and failed to report your foreign income, you may have acted negligently, but you probably did not act willfully. That likely qualifies you for one of the new streamlined procedures. On the other hand, if you stuffed cash into a suitcase and hauled it to Switzerland to hide it from the IRS, that’s willful conduct—and you don’t qualify.
If you think your behavior might count as willful under these guidelines, consult an attorney before submitting returns through one of the streamlined procedures. We work with attorneys who specialize in this field, and we can provide a referral free of charge or obligation.
Civil Examination
If the IRS has already started auditing your tax returns for any year, you cannot use the streamlined procedures—even if the audit has nothing to do with undisclosed foreign assets. If you are under examination, talk to your IRS agent. You also remain ineligible if you face a criminal investigation.
Previously Filed Delinquent Tax Returns
If you qualify for the streamlined procedures but previously filed delinquent or amended returns in a "quiet disclosure" attempt to fix foreign reporting obligations, you can still use the streamlined procedures. However, the IRS will not abate any penalties it has already assessed on those filings.
Valid Taxpayer Identification Number Required
All returns you submit under the streamlined procedures must include valid Taxpayer Identification Numbers. That means a valid Social Security number, or if you are not eligible, an Individual Taxpayer Identification Number (ITIN) issued by the IRS. If you don’t have a Social Security number or ITIN, you can apply for an ITIN with your streamlined submission.
General Treatment Under Both Offshore and Domestic Procedures
Tax returns submitted under either procedure will be processed like any other returns. You will not be sent an acknowledgment of receipt and will not be asked to sign a closing agreement, as these procedures are not an amnesty program. So, while your returns will not be subject to IRS audit automatically, they may be selected for audit under the normal audit selection process. The accuracy and completeness of submissions might be checked against information received from foreign banks, financial advisors, and other sources. Therefore, it is possible that your returns might be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate.
Qualifying For the Foreign Offshore Procedures
The foreign offshore procedures allow you to become compliant penalty-free, so this is the preferred process over the domestic offshore procedures. If you fail to qualify for this process and you have unreported income, the domestic offshore procedures might be your next option. In addition to meeting the general eligibility requirements, to use the Streamlined Foreign Offshore Procedures you must also satisfy the following requirements:
- You must meet the non-residency requirement described below. If filing jointly, both spouses must meet the non-residency requirement for at least one of the most recent three calendar years for which the due date has passed
- You must have failed to report the income from a foreign financial asset and pay the required tax, and may (not must) have failed to file an FBAR (FinCEN Form 114) and/or one or more international information returns (Forms 3520, 3520-A, 5471, 5472, 8938, 926, 8621, etc). In other words, an international information return that was required to be filed may be filed as part of this streamlined submission, but a delinquent international information form is not a requirement to qualify. If all international information returns have been filed, but gross income from foreign accounts has been omitted, this streamlined program is available
- These failures must have resulted from non-willful conduct, as defined above, and you must complete and sign a statement attached to Form 14653 certifying that
Nonresidency Requirements for US Citizens and Green Card Holders
This requirement is met if you are a US citizen or permanent resident, (or the estate thereof), in any one or more of the most recent three years for which the US tax return due date (or properly extended due date) has passed, did not have a US abode, and was physically outside the United States for at least 330 full days.
This means that even if you were living in the United States for two of these years, you still qualify if you meet the 330-day test in the third year. These criteria mean that you will meet the tests for the foreign earned income exclusion in the year or years of absence from the United States.
Nonresidency Requirement for Foreign National Visa Holders
If you are a foreign national who is not a permanent resident, you must meet the substantial presence test to be considered a resident of the United States for tax purposes. If you are not considered a resident, you are generally not subject to the FBAR filing requirements. A foreign national who does not meet the substantial presence test for one or more of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed meets the non-residency requirement.
For more information on the substantial presence test, see Determining Your Residency Status in U.S. Tax Guide for Foreign Nationals.
If you are eligible to use the Streamlined Foreign Offshore Procedures and comply with the filing instructions, you will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties.
However, your returns could still be selected for audit under the normal audit selection process. If the IRS determines an additional tax deficiency for a return submitted under these procedures, the IRS may assert applicable additions to tax and penalties relating to that additional deficiency.
What You Must Do
The procedures are to:
- File delinquent or amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 8938, and 8621) for each of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed
- For each of the most recent six years for which the FBAR due date has passed, file any delinquent FBAR
- Complete and sign a statement on Form 14653 certifying that you are eligible for the Streamlined Foreign Offshore Procedures, that all required FBARs have now been filed, and that your failure to fully comply with US tax laws resulted from non-willful conduct. The full amount of the tax and interest due in connection with these filings must be remitted with the streamlined submission
Qualifying for the Domestic Offshore Procedures
In addition to meeting the general eligibility requirements, you must satisfy extra conditions to use the Streamlined Domestic Offshore Procedures if you don’t qualify for the foreign offshore procedures because you fail the non-residency test (for joint filers, one or both spouses must fail to meet the test). To qualify, you must:
- Have filed a U.S. tax return (if required) for each of the most recent three years whose due date (or extended due date) has passed. (This requirement does not apply to the foreign offshore procedures.)
- Have failed to report gross income from a foreign financial asset and pay tax on it. If you omitted no gross income, you don’t qualify for these procedures, but you may benefit from the delinquent FBAR submission procedures or the delinquent international information return submission procedures described below
- (Optional) Have failed to file an FBAR and/or one or more international information returns, such as Forms 3520, 3520-A, 5471, 8938, 926, or 8621. In other words, you may include delinquent information returns in your streamlined submission, but you don’t need them to qualify. Even if you filed all international information returns but failed to report foreign income, you can still use this program
- Show that your failures resulted from non-willful conduct (as defined earlier) and complete and sign a statement on Form 14654 certifying that fact
Note
If you qualify for the domestic procedures and follow the filing instructions, the IRS will not impose failure-to-file, failure-to-pay, accuracy-related, information return, or FBAR penalties. However, you will owe a Title 26 miscellaneous offshore penalty (explained below).
What You Must Do
The main procedures are to:
- Submit complete and accurate amended tax returns with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, 8621) for each of the most recent three years whose due date (or extended due date) has passed
- File any delinquent FBARs for the most recent six years whose FBAR due date has passed
- Complete and sign a Form 14654 statement certifying that you qualify for the Streamlined Domestic Offshore Procedures, that you filed all required FBARs, that your computation of the miscellaneous offshore penalty (shown on Form 14654) is accurate, and that your failure to comply with U.S. tax laws was non-willful
- Remit the full amount of tax, interest, and the miscellaneous offshore penalty with your streamlined submission.
The Miscellaneous Offshore Penalty
This is a rather arbitrary penalty, imposed on only those taxpayers who fail to meet the non-residency requirements. The IRS rationale is that taxpayers residing in the United States should have been aware of their filing requirements and are therefore deserving of a penalty. However, the penalty is only a small fraction of the penalties the IRS is statutorily authorized to impose (and that were imposed through the OVDP programs).
The Title 26 miscellaneous offshore penalty is equal to 5% of the highest aggregate balance/value of your foreign financial assets that should have been, but were not, reported on an FBAR or Form 8938. Alternatively, they were properly reported, but gross income concerning the assets was not reported on a return submitted under the streamlined procedures.
The penalty is computed by taking the highest aggregate balance/value determined by aggregating the year-end account balances and year-end asset values of all the financial assets subject to the penalty for each of the years in the covered period and selecting the highest aggregate balance/value from among those years.
Delinquent FBAR Submission Procedures
If you do not need to use the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but you:
- Have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114),
- Are not under a civil examination or criminal investigation by the IRS, and
- Have not already been contacted by the IRS about the delinquent FBARs,
Then you should file the delinquent FBARs following the FBAR instructions. Include a statement explaining why you are filing the FBARs late, and select a reason for filing late on the cover page of the electronic form.
The IRS will not impose a penalty for filing delinquent FBARs if you properly reported and paid all tax on the income from the foreign financial accounts reported on those FBARs. Filing the FBARs does not automatically trigger an audit, though they may be selected for review through the normal audit process.
Delinquent International Information Return Submission Procedures
What is Reasonable Cause?
The IRS does not specify exactly what constitutes reasonable cause in its determinations. It decides each case based purely on the facts and circumstances. However, the IRS provides some guidance. For example, Treas. Reg. Section 1.6038A-4(b)(2) states:
The IRS determines whether a taxpayer acted with reasonable cause and in good faith on a case-by-case basis, considering all relevant facts and circumstances. Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of the taxpayer’s experience and knowledge. Isolated computational or transcriptional errors generally do not conflict with reasonable cause and good faith. Reliance on an information return or the advice of a professional (such as an attorney or accountant) does not automatically demonstrate reasonable cause and good faith. Likewise, reasonable cause and good faith do not automatically exist if the taxpayer relied on facts that were incorrect without their knowledge. However, reliance on an information return, professional advice, or other facts constitutes reasonable cause and good faith if the reliance was reasonable under all circumstances.
The courts have also weighed in on reasonable cause in numerous decisions, and taxpayers generally have not fared well. However, rare victories exist.
Example
In one Tax Court case, penalties were overturned based on reasonable cause for a pro se taxpayer (without an attorney) who provided a credible reason for excluding settlement proceeds, had well-documented support for claimed medical expenses, and lacked knowledge in tax law (Nancy Huff v. Commissioner, TC Memo 1995-200).
If you think you have a reasonable cause argument, consult a tax advisor (like us) to evaluate your options. For more information on resolving delinquent accounts, see our post titled Your Unfiled FBARS.
Reasonable Cause Procedure
The IRS allows taxpayers who do not need to use the Streamlined Filing Compliance Procedures to report and pay additional tax, but who:
- Have not filed one or more required international information returns,
- Have reasonable cause for not filing the returns on time,
- Are not under a civil examination or criminal investigation by the IRS, and
- Have not already been contacted by the IRS about the delinquent returns,
To file the delinquent information returns with a statement of all facts supporting reasonable cause. Taxpayers must also certify that any entity for which they file delinquent information returns did not engage in tax evasion.
The IRS does not explain the conditions under which taxpayers would not “need” to use the Streamlined Procedures. Taxpayers who qualify only under the Domestic Offshore Procedures might feel they do not need to incur the 5% penalty. The IRS clarifies that taxpayers with unreported income or unpaid tax can still file delinquent international information returns under this procedure (see Delinquent International Information Return Submission Procedures Frequently Asked Questions and Answers).
The IRS encourages anyone who believes they have reasonable cause for failing to file delinquent international information returns to use this procedure. However, the IRS warns that it may impose penalties if it rejects the reasonable cause explanation.