Philip Wrigley had a problem. As the notoriously parsimonious owner of the Chicago Cubs in the 1970s, Mr. Wrigley did not want to spend big money to attract top players. But as the savvy owner of a successful confectionary business he also knew that no one would buy tickets to see a perennially second-division ball club. So he came up with the idea of the “loveable losers” a slightly-above average team that could win 80 or 85 games in a season.
The point of this story is that Mr. Wrigley did not want to be penny wise and pound foolish as the old saying goes. He knew that while fielding a 60- or 70- win team would trim payroll, such a club could not sell tickets and he would wind up losing more money than he saved.
We all make purchasing decisions like this every day albeit on a somewhat more limited scale. In a previous post we looked at this dilemma as it pertains to those with unpaid U.S. taxes on overseas assets. Many such people are attracted to the new Streamlined Filing Compliance Procedures (SFCP) due to the siren’s song of low financial penalties and conducting business on the down-low but these things come with strings attached.
One risk of the SFCP is (if you wish to deal with the matter quietly) the IRS might assume that you have something to hide. This supposition is backed up by a General Accounting Office Report from 2013 which records that the IRS audited more than 10,000 quite disclosure returns between 2003 and 2008(a proportion that is much higher than the one found in ordinary returns).
It gets even worse. Once the IRS agents get to work on theses audits they sometimes take a slash-and-burn approach to disallowing deductions. This is because the auditors see SFCP returns as amended returns and they largely smell blood.
The heightened audit risk may not apply in the Offshore Voluntary Disclosure Program (OVDP). In fact, most OVDP matters are concluded without audits because of the cooperation agreement. Whereas the IRS may think you have something to hide if you do not want to be forthcoming, the agency may assume the opposite in those cases where the taxpayers are willing to bare their souls.
Lost Tax Credits
As a general rule, late-filed returns may not claim the Foreign Earned Income Exclusion (FEIE). The treasury regulations set forth very specific limitations when claiming the FEIE and agents enforce these provisions without mercy. This loss can be financially debilitating in many cases and certainly gives reason for pause before filing streamlined returns.
The same thing applies regarding the Foreign Tax Credit (FTC) for Resident Aliens and U.S. Citizens because a late-filed return means a late foreign corporation and partnership report with Forms 5471 or 8865. This raises the possibility of eye-popping penalties of up to $10,000 per incident along with a 10 percent reduction in the credit for foreign tax paid. If you think dual citizenship gives you immunity, think again. Although the Model Tax Treaty extends eligibility to these individuals, eligibility is still subject to provisions in the Tax Code.
A 1996 tax court case highlights some of these issues. Espinosa v. Commissioner involved a nonresident alien with rental property in Texas and New Mexico that produced a net loss. Mr. Espinosa had a number of years of unfiled returns and tried to claim the loss as a credit. Although there are no time deadlines in this section of the Tax Code, the court applied the above-referenced tax credit regulations and disallowed the $10,000 per year credit.
This is the big one… so you will want to pay attention! Participants in the OVDP get immunity from tax evasion and fraud charges (which could carry significant prison time and fines of up to $100,000) and SFCP filers get ZERO. As a matter of fact… they get less than ZERO! First, by filing a streamlined disclosure, the IRS is on your trail as discussed. Second, offshore tax disclosure is kind of like The Force in that once you start down the dark path it will forever dominate your destiny. Once you file a Streamlined Filing Compliance Procedures (SFCP), you lose eligibility for the OVDP; and you simply have to suffer through it when the heat can get very intense. The bottom line is never be penny wise and pound foolish with your foreign asset tax returns. Get the best team possible advisor on your side and you increase your chances for success.
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