IRS STREAMLINED FILING COMPLIANCE PROCEDURES AND THE NON-RESIDENCY REQUIREMENT

March 10, 2022

The Internal Revenue Service (“IRS”) has increased civil enforcement of international reporting requirements in recent years. These international reporting requirements require taxpayers to file a number of different information returns with the IRS and to file Foreign Bank Account Reports (“FBAR”) with the U.S. Financial Crimes Enforcement Network (“FinCEN”)[i]. Some common information returns include:

• Form 3520, used to report a gift from a foreign person, estate, or entity, or to report a relationship with a foreign trust;
• Form 5471, used to report certain ownership interests in, control of, or to report the taxpayer holding an officer/director position in a foreign corporation;
• Form 8858, used to report a foreign disregarded entity or foreign branch directly or to report a connection with either of these through another entity connected to the taxpayer;
• Form 8865, used to report an interest in a foreign corporation; and
• Form 8938, used to report assets that are owned and located outside of the U.S. if they exceed a specified threshold value; and

Another such information return is Form 3520-A. This form is filed by a foreign trust that has at least one U.S. owner. The Form 3520-A is filed by the Trustee of the foreign Trust. However, it is the U.S. owner who is ultimately penalized if a Form 3520-A is not timely filed.

Taxpayers are also required to file an annual FBAR if they have signatory authority over, or a beneficial interest in, a foreign bank account(s) which, at any point in the year, have an aggregate balance which exceeds $10,000.

Unfortunately for non-compliant taxpayers, enforcement of the rules by the IRS can result in the assessment of very steep penalties. Penalties for a failure to timely file many of these Forms will be at least $10,000 per Form per year where a taxpayer is non-willful in their non-compliance. Failure to timely file Forms 3520 and 3520-A can result in even larger penalties. And additional penalties can be assessed per form per year where the IRS issues a taxpayer a continuation letter demanding the taxpayer file delinquent Forms[ii]. Taxpayers are exposed to these penalties even when their non-compliance was the result of bad advice from their return preparers.

The IRS currently offers some programs for taxpayers to correct their past non-compliance as an alternative to merely filing delinquent Forms (known as a “quiet disclosure”). One such program is the Streamlined Filing Compliance Procedures. This program is available only to individual taxpayers and only for taxpayers who certify under penalty of perjury that their non-compliance was “non-willful”. Other requirements include that the taxpayer cannot be under criminal investigation or civil audit and that the taxpayer failed to report gross income from the non-compliant foreign asset(s).

Through the Streamlined Procedures, a taxpayer will file amended tax returns with the delinquent information returns included for the prior three years for which the filing deadline has passed. The taxpayer will also file amended or original FBARs for the past six years for which the filing deadline has passed. Additional income tax and interest owed for each of the three years for which amended income tax returns are filed will also be due with the submission.

There are two types of submissions within the Streamlined Procedures, one for taxpayers residing in the U.S. and one for taxpayers residing outside the U.S. If a taxpayer resides in the U.S. for purposes of the procedures, they will be required to pay a miscellaneous offshore penalty equal to five percent of the value of the unreported foreign assets. If a taxpayer resides outside the U.S., they will not be required to pay any penalty. Residency for purposes of the Streamlined Procedures is determined under two tests, one for citizens and lawful permanent residents, and the other for non-citizens and non-permanent residents.

For citizens and lawful permanent residents, the taxpayer meets the non-residency requirement if “in any 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, the individual did not have a U.S. abode and the individual was physically outside the United States for at least 330 full days.” So, taxpayers need only satisfy this test for one of the three years included in their submission through the Streamlined Procedures. Where there are joint taxpayers, both spouses must satisfy this non-residency requirement.

The non-residency requirement for non-citizens and non-permanent residents is different. Such taxpayers satisfy the non-residency requirement if “in any one or more of the last three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the individual did not meet the substantial presence test of IRC section 7701(b)(3).” Again, taxpayers need only satisfy this test for one of the three years included in their Streamlined Procedures submission, and for joint taxpayers both spouses must satisfy this non-residency requirement. Additionally, the example provided by the IRS demonstrates clearly that taxpayers can satisfy this non-residency requirement even when they have been physically in the U.S. for less than the three years includible in the Streamlined Procedures submission.

Non-residency must be established as part of the Streamlined Procedures submission. This includes the taxpayer certifying that they did not have a U.S. abode and were outside the U.S. for at least 330 days in one or more of the years at issue, or that they did not meet the substantial presence test in one or more of the years at issue (whatever the case may be). Satisfying the non-residency requirement can save taxpayers money by allowing them to avoid paying the five percent miscellaneous offshore penalty. So, taxpayers considering correcting their past non-compliance through the Streamlined Procedures should review whether they satisfy the non-residency requirement.

Taxpayers with international non-compliance issues who meet the above requirements should consider the Streamlined Procedures. While the program is not guaranteed to prevent an audit by the IRS, it is as close as non-willful taxpayers can get to avoiding an audit while bringing themselves into compliance. The program is also a way for taxpayers to substantially reduce the penalties they will owe (or even avoid penalties entirely)[iii]. It is uncertain how long the IRS will continue the Streamlined Procedures as a program for bringing taxpayers into compliance, so taxpayers with international reporting issues should consider pursuing the program as soon as possible.

If you are a taxpayer with international reporting non-compliance issues, please contact one of the experienced Orange County tax attorneys with the Law Offices of A. Lavar Taylor.

Author: Daniel W. Soto, Attorney