Since the time the IRS announced the revised Offshore Voluntary Disclosure Program, there has been a consistent restlessness among American expats. At the forefront of this change is the inclusion of the Streamlined Compliance Procedure Program, which is available to U.S. individual taxpayers residing in the United States as well as those who live abroad.

The Streamlined Foreign procedures cater to those U.S. citizens or lawful permanent residents – i.e., expats – who satisfy the non-residency requirement. The non-residency requirement has two strands. First, the taxpayer must not have a U.S. abode. And second, the taxpayer must have lived outside of the U.S. for at least 330 full days in at least one (or more) of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed. Which year the taxpayer lived outside of the U.S. for the threshold number of days is meaningless so long as it occurred during one of the three years in the look-back period. Satisfying the latter requirement is easier said than done, especially for Canadian “snow birds” who migrate south of the border to Florida in the winter months to avoid the blistering Canadian winter. As an aside, with the arctic blast that Mother Nature unleashed on the east coast this winter, where the mercury fell below zero degrees Fahrenheit for the better part of the season, winter 2015 in Canada had nothing on winter here in the states.

Since its implementation, the IRS’s Offshore Tax Compliance has seen sharp criticism from different corners of the world, more from countries with a sizeable American population. It is evident that a large chunk of the American population regularly pays their taxes. However, what about those who live abroad? Should they be paying equal taxes despite the fact they do not live on American soil? Do they enjoy the same perks and laurels as those who live in the country?

You may also ask whether the IRS is justified in asking expats to pay the same tax ratio. The answer to all of these questions is a simple “no,” but not without explanation. First, let’s look at what the expat tax is all about and why the IRS doesn’t exclude expats from their tax database. Additionally, we will unveil the IRS’s opinion in this regard and what their “company line” is when it comes to these new tax reforms.

IRS and the Disclosure of Expat Accounts

The internal Revenue Service (IRS) is the sole entity responsible for tax and deductible collection throughout the United States. The agency works autonomously without carrying any external financial influences. Although the agency prepares tax collections and related documents to facilitate necessary deductions from all taxable incomes, the legal provisions give the IRS final authority to accumulate the taxable amount if a taxpayer refuses to do so.

Voluntary programs launched by the IRS are nothing new and have been going on since time and memorial (i.e., 1960s). The IRS established the Voluntary Compliance Initiative for taxpayers who had unreported accounts. Many of these accounts were found to have irregular or unreported tax liabilities and were using offshore payment cards for conducting financial transactions. To stop such activities, the IRS took necessary initiatives under regulation Proc. 2003-11, which plugged many foreign tax related loopholes.

The Consequences of the Program

The new IRS program was a mess from the beginning. Initially, many expat taxpayers were not sent notices, which was a grave mistake by the IRS. If that wasn’t enough, there were approximately 2,000 taxpayers who never had a chance to reinstate their accounts in the tax net. Luckily, for such expats, the IRS reformed the program and extended the deadline. This time around, they made sure all expats received notices well within the deadline. For this purpose, the IRS initiated the Offshore Voluntary Compliance Program (OVCP) under regulation Proc. 2003-11.

For those unfamiliar with regulation Proc. 2003-11, it pertains to the irregular, incomplete, deliberately hiding of the due tax liability by American expats. The regulation was meant to bring expat taxpayers who deliberately underreported their U.S. tax liabilities.

However, so far the IRS has only included those expats who were required to pay their due taxes on their income within the desired deadline, after which, the IRS would hold no responsibility nor provide any tax amnesty to such defaulters. Fulfilling on their promise, the IRS took action against 29,000 tax defaulting expats in 2014. By 2015, the IRS plans to include 30,000 more expats into the tax collection database, which is the largest number of taxpaying expats since the inception of this regulation.

Who are Affected?

The IRS tax compliance targets all expats who own an account at any foreign bank which reaches a high watermark balance of at least $10,000 (USD) at any given point during the year. These users must complete the IRS form sent to them via e-mail and postal codes.

The form is marked as “IRS 1040 Schedule B,” and has relevant information on why and how to register for the Offshore Voluntary Compliant Initiative and how to become eligible for the benefits that accompany the program by registering within due time. Not to be overlooked is the additional requirement that expats complete an “FBAR” (Foreign Bank Account Report) once a year; these are due on or before June 30 of the year following the year that the taxpayer had the foreign account.

If you deliberately avoid signing the form that the IRS has sent to you “sealed with a kiss,” you qualify as a tax defaulter under IRS code sec. 1041 (1041 pertains to the Report for Foreign Banks and Financial Accounts, or “FBAR” for short). If this happens, you can faith the wrath of the IRS, which has been known to bring many a taxpayer to the brink of insanity. The parade of horribles consist of any one of the following: onerous penalties that could leave you with nothing more than the shirt on your back to the possibility of a criminal referral to the Department of Justice, or both. Indeed, the stakes are high. The only ironclad way of avoiding this calamity is to be fully transparent by disclosing all of your foreign bank accounts on your FBAR and reporting any interest income generated by them – no matter how negligible – on your 1040.

Some taxpayers operate under the false belief that if the interest income generated by their foreign accounts is negligible or if they have already paid taxes on the interest generated by their foreign accounts to the foreign government in which they live (such that the foreign tax credit virtually eliminates any and all U.S. tax liability due and owing to Uncle Sam), that there is no point in filing an FBAR. In other words, these taxpayers take the position that filing an FBAR is a mere formality. Such taxpayers are flirting with disaster. To say that they are “living life on the edge” would be a complete understatement. As the IRS has said time and time again, no amount of interest income is too small to trigger an FBAR-reporting violation.

Tax Deduction Ratio for Expats

The biggest concern before the new reforms were incorporated in the program was the ratio of tax collection from foreign expats, among other things. Another question mark was that since expats were living abroad and were not benefitting from any of the federal perks, utilities and advantages, then what moral ground did the IRS have to tax their incomes?

There were hot and contentious debates on this issue a few months before the new regulation was implemented. Although these were valid concerns expressed by the expat community, the IRS came up with different answers for both.

The answer to the first question was the possible tax amnesty for expats who had been paying their taxes and showing proper incomes. Another incentive was provided to appease expats who challenged the status quo by questioning the need for a tax deduction from their foreign earned salaries when no US government facilities were ever used.

Revised Terms of OVDP

No discussion of tax compliance vis-a-vis U.S. expats would be complete without a discussion of the IRS’s Offshore Voluntary Disclosure Program. The revised terms of the OVDP program call for an automatic offshore penalty of 27.5% of the highest year’s aggregate maximum balance over an eight-year look-back period. The highest year’s aggregate balance is determined by comparing the maximum aggregate balances for each year during the eight-year disclosure period and selecting the highest aggregate balance among those years.

That balance, in turn, becomes the base to which the 27.5% penalty applies. Many a taxpayer has asked the question, “Is the offshore penalty negotiable?” Unfortunately, the answer is “no.” If a taxpayer has already submitted his OVDP letter and attachments and then wakes up the next morning feeling “buyer’s remorse,” the only way out from under the offshore penalty is to “opt out” of the program.

As if things couldn’t get any worse, to the extent that the taxpayer has an account at any of the banks listed below, the offshore penalty automatically increases from 27.5% to 50%. Ouch!

Following is the list of banks:

1. UBS AG

2. Credit Suisse AG, Credit Suisse Fides, and Clariden Leu Ltd.

3. Wegelin & Co.

4. Liechtensteinische Landesbank AG

5. Zurcher Kantonalbank

6. Swisspartners

7. CIBC First Caribbean International Bank Limited, its predecessors, subsidiaries, and affiliates

8. Stanford International Bank, Ltd., Stanford Group Company, and Stanford Trust Company, Ltd.

9. HSBC India

10. The Bank of N.T. Butterfield & Son Limited (also known as Butterfield Bank and Bank of Butterfield).

11. Sovereign Management & Legal, Ltd., its predecessors, subsidiaries, and affiliates (effective 12/19/14)

12. Bank Leumi le-Israel B.M., The Bank Leumi le-Israel Trust Company Ltd, Bank Leumi (Luxembourg) S.A., Leumi Private Bank S.A., and Bank Leumi USA (effective 12/22/14)

13. BSI SA (effective 3/30/15)

14. Vadian Bank AG (effective 5/8/15)

15. Finter Bank Zurich AG (in effect since 5/15/15)

The IRS is further looking at formulating more incentives for taxpayers and expats who scrupulously follow their responsibilities and pay their taxes on time.

Additionally, the IRS is also looking to draw more incentives for such tax payers such as interest and tax reduction schemes, reduced penalties and other forms of financial incentives. Under the new regulation, if approved by the government, even tax default expats would be able to pay their taxes with minimum fuss.

Original Post By:  Michael DeBlis