Monday, October 1, 2012

Tax Justice For Americans Abroad? Some May Pay 5% Penalty Instead Of The Monster 27.5% Penalty

There is an often over-looked and perhaps little-known IRS rule in the twenty two pages of fine print of the IRS Frequently Asked OVDI Questions which may fit the facts of many thousands of Americans living abroad. If you live abroad and have $10,000 or less in U.S. Source Income each year and can show that you are in full compliance with the tax laws of your adopted country, you may get back in the good graces of the IRS with the payment of back taxes from 2003, and a mere 5% penalty and not even have to include your business interests in the penalty base.

Consider the Adams family described in my August 6, 2012, article in Tax Notes International. [1]The Adams family lives in Vancouver, British Columbia, where Mr. Adams is the president of a small but successful manufacturing company. Mr. Adam’s great-grandfather, a U.S. citizen, settled in Canada in the latter part of the 19th century after moving there to take a job building the transcontinental railroad. Subsequent generations of the Adams family are all citizens of the United States, although they have no economic connection to it. They cannot recall when a family member last filed U.S. tax returns. The current generation has never filed U.S. income tax returns.

You may qualify if you have less than $10,000 in U.S. Source income: Although it was not clear in my article, the Adams family was in trouble with the IRS simply because they had more than $10,000 in dividends from a U.S. based mutual fund. If that single fact were different and they could show the IRS that they never got more than $10,000 from a U.S. source, they could qualify under FAQ 52 category number 3, [2] provided they have been fully compliant with all the requirements of the Canada Revenue Agency during the years in issue.
What makes this provision particularly appealing is the statement in the rule which says,

 For these taxpayers only, the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence.

This means that for the Adams family in my article, they can sign up for the IRS’s OVDI program and file the requisite number of back tax returns and delinquent FBAR's, and exclude from the 5% penalty base, any valuation of his manufacturing company in British Columbia, his business bank accounts, his vacation home on Vancouver Island which he rents out, and Grandma’s trust provided it does not earn more than $10,000 from U.S. sources in any given year.

Even more appealing is despite the accounting fees and legal fees the family will need to pay to prove all this to the IRS, the foreign earned income credit and the foreign tax credit is likely to wipe out most or all of any U.S. taxes which might become due from their delinquently filed U.S. forms 1040.

Obviously, FAQ 52 will only apply to a select group of Americans living abroad.  The FAQ makes it clear that examiners have no discretion to negotiate a lesser penalty amount under this FAQ which is the same rule under the entire OVDI program. Query whether some taxpayers who meet all the requirements but for the $10,000 rule, will have any luck under the opt out procedures negotiating a zero or lesser penalty?
Our office is currently presenting to the IRS under OVDI, a large American family which has lived, worked, and prospered  in a Central American country for three generations. Stay tuned to find out how we make out with the IRS.

[1] The same article was published in Tax Notes on July 9, 2012.
[2] FAQ 52:  Under what circumstances would a taxpayer making a voluntary disclosure under this initiative qualify for a reduced 5 percent offshore penalty?
Taxpayers who are foreign residents and who meet all three of the following conditions for all of the years of their voluntary disclosure: (a) taxpayer resides in a foreign country; (b) taxpayer has made a good faith showing that he or she has timely complied with all tax reporting and payment requirements in the country of residency; and (c) taxpayer has $10,000 or less of U.S. source income each year. For these taxpayers only, the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable income that was not reported on the U.S. tax return.


  1. What about FAQ 52.2: "Taxpayers who are foreign residents and who were unaware they were U.S. citizens [are] entitled to the reduced 5% offshore penalty"?

    Why would confiscation of 5% of such a person's worldwide assets for such a "crime" be appropriate? What does this policy say about the nation that instigated it?

    1. My thoughts exactly. I suppose i fit the rules. I have no US source income, and I am fully compliant with the CRA. So why would I give the IRS 5% of anything. Nice of them to exclude my house and my business, but 5% of my savings is 5% too much

      Where does the idea that people like this should be penalized with 5% of their life savings come from? They are obviously not "tax evaders" It boggles the mind.

  2. A broken man on a Halifax pierOctober 2, 2012 at 1:30 AM

    The house is only *not* included in the penalty base *if* it hasn't been bought or sold in the last eight years, a fairly major qualification for a lot of people.

    If it has been, all of the money used for the transaction will have flowed through bank accounts, making it pretty much automatically the high point of the "foreign accounts" for the last eight years. The 5% penalty will be based on that, and even for middle-income people could easily get into five figures.

  3. There is nothing "mere" or "appealing" about reducing a specious penalty from 27.5% of everything someone owns to 5%.

    What we see in this post is cognitive bias. The 27.5% rate is an anchor that makes 5% look "good" only by comparison. A 5% fine of everything a person owns for a paperwork foot-fault is an abomination. Truly awful. The US should hang its head in shame over this.

  4. When can we expect the same for immigrants who did not know about FBARs?

  5. Why is nobody considering using the new streamlined IRS procedures?

    My brother spoke to this guy the other day I really don't think the cost will be that excessive.

    My brother and I spoke to this guy the other day and we should be able to catch up our US tax returns under the new streamlined procedures.

    And he seems to think we can just file 3 years of returns with 6 FBARs

    1. Re: Why is nobody considering using the new streamlined IRS procedures?

      The answer is because nobody qualifies for them. And those who may, don't want to risk the IRS making a capricious decision that they are "heightened compliance risk".

      Don't even consider this option without getting competent legal advice.

  6. Tax justice for Canadian-americans abroad?
    Steven, you and others in the US tax field might be interested in this article that just appeared here in Canada, and which is being widely shared:
    'U.S. Tax Laws: The Long Arm of Uncle Sam'
    by Don Whiteley
    | October 5, 2012
    "New U.S. laws targeting overseas tax cheats have not only left a million Canadians facing the potential of financial ruin, but have put local credit unions in an impossible bind."

    ...."In many cases, perhaps even most, the people affected by this have minimal if any ties to the U.S. They include people who have lived in Canada for decades, as Canadian citizens, and thought they’d put their U.S. roots behind them; people born in Canada to parents who are or were U.S. citizens — so-called accidental Americans — whose only connection to the U.S. is their parents’ heritage; people born in the U.S. to Canadian parents, and returned to Canada as children where they have now lived their entire adult lives; people who were in the U.S. as landed immigrants (greencard holders) and returned to their homeland or moved somewhere else — all are ensnared by this tax jihad.".....


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