The IRS’ Amnesty Program for Foreign Account Holders: What You Need to Know

The IRS is coming after high-net-worth individuals and companies with offshore interests; you can protect yourself with a new amnesty program, but it expires August 31

Last Updated: August 8, 2011 @ 6:28 PM

In case you have missed the recent press coverage on unreported foreign bank and other financial accounts, the IRS announced a second amnesty initiative earlier this year.  

The good news, if you have not already disclosed your foreign financial accounts, is that under the amnesty you can avoid criminal prosecution and get back into the system at a relatively low cost. 

The cost of the amnesty is filing amended tax returns for the 2003-2009 tax years, paying tax, interest and penalties on the unreported income, and paying a 25 percent penalty on the highest balance in the accounts during that same time period. 

Based upon our experience, this will leave taxpayers with about 60 percent of the balance of their account. 

The bad news is that you have to complete a three-step process by August 31, so time is running out. If you have an unreported foreign bank account, and you do not participate in this 2011 amnesty program, you can expect to face serious civil and financial penalties, and possible criminal penalties, and fines that exceed the balance of the unreported account.

Most states have published notices to their taxpayers reminding them that if they file amended federal tax returns, they also need to file amended state tax returns as well.

California has announced its own amnesty program for taxpayers with unreported foreign accounts, which began August 1.

Reporting Payments to Foreigner Recipients

Hollywood makes tens of thousands of payments each year to foreign actors, musicians, directors, writers, producers, and others for personal services, residuals, royalties, etc.

Many of these payments are subject to U.S. withholding tax, at a rate of 30 percent unless the rate is reduced by the terms of an applicable income tax treaty.

In addition, the payments must be reported on Form 1042, the foreign counterpart to the domestic Form 1099.

Historically, most companies have done a bad job of identifying which payments are made for foreigners, collecting the appropriate Form W-8 prior to the payments to support withholding at a reduced rate, and then reporting those payments on Form 1042. 

The IRS has finally realized how poorly companies have been complying with their reporting and withholding obligations, and have announced that auditing this area of compliance is now a priority focus for the IRS's Large Business & International Group.

There are significant penalties for failure to file Form 1042, and there is a separate penalty for each form which is not filed. As a result, those penalties, if fully assessed, could easily exceed $100,000.

The IRS recently established a new group within the Large Business & International Group – the Global High-Wealth Industry Group, whose function is to audit the tax returns of high-wealth individuals and their affiliated companies, LLCs, S  corporations, partnerships, private foundations, and trusts on a coordinated basis. 

A significant focus of any audit by that group will be on the offshore activities of the taxpayers, including unreported foreign accounts, second homes, and offshore trusts and corporations. 

It is expected that this group will coordinate with similar groups in Australia, Canada, Germany and the UK.  

Recent experience with an audit by that group suggests that the audits will be very focused, detailed, intrusive and extremely document-intensive. We have seen Information Document Requests that are eight-10 pages long. We expect the group to be very active in auditing California-based taxpayers.

Many foreigners who come to the U.S. do not fully understand the U.S. tax system and the different ways in which they can become a U.S. tax resident. 

A green card holder is automatically classified as a U.S. tax resident. 

A foreigner who is in the U.S. for more than 183 days in a single year, or more than 121 days per year over a three-year period, may be classified as a U.S. tax resident under what is known as the "substantial presence" test. 

If the foreigner comes from a country with which the U.S. has an income tax treaty, they may be able to take advantage of the residency provisions of the treaty, to avoid becoming a U.S. tax resident. 

Once a U.S. tax resident, they become subject to U.S. federal and possibly state income tax on their worldwide income, not just their U.S. source income.  

They also become subject to the full range of information reporting, including the reporting of all foreign financial accounts, as well as interests in foreign corporations, partnership and trusts. 

There are significant penalties, in many cases $10,000 per unfiled form, for failure to file the correct information reporting forms on a timely basis. 

Income from foreign trusts may now become subject to U.S. tax. In addition, certain foreign trusts set up within five years of the date the foreigner becomes a U.S. resident become subject to additional reporting under Section 679. 

Lastly, if a green card is given up at some later date, or the holder takes the position that he or she is not a U.S. tax resident under the income tax treaty tests, that can constitute "expatriation" subjecting him or her to U.S. tax on the gain from the deemed sale of all of his or her assets at fair market value on the expatriation date.