Whether a U.S. taxpayer with noncompliant offshore holdings should pursue the formal OVDP or should file remedial returns under the IRS voluntary disclosure practice is an issue that requires considerable professional judgment by the tax practitioner, particularly on the issue of ‘‘willfulness.’’ This judgment must take into account all facts and circumstances, including all items of evidence, whether in the form of banking or tax-related documentation, third-party statements, or the taxpayer’s own statements. Where “willfulness” is not reflected in a particular taxpayers case, it may be more advisable to pursue compliance through the IRS offshore voluntary disclosure practice IRM section 22.214.171.124.6 (July 1, 2008) referred to as a “Noisy Disclosure”.
As stated above, the December 2011 Fact Sheet (FS 2011-13 (12/9/11) provides an example of a taxpayer living outside the United States who failed to file U.S. income tax and information returns despite being compliant with the revenue laws of the country in which the taxpayer resided. The facts as postulated indicate no U.S. income taxes were due on the late-filed returns because of application of foreign tax credits paid to the country of residence. This is not true in your case because expect that your US income tax returns will have a net tax of greater than $1500 per year.
In analyzing whether reasonable cause existed for the failure to file a return or pay a tax due, the analysis of the example asserts the IRS will consider “all available information,” including:
- the reasons given by the taxpayer for not meeting the taxpayer's compliance obligations;
- the taxpayer's compliance history;
- the time span between the failure by the taxpayer to meet the compliance obligation and subsequent compliance; and
- any circumstances beyond the control of the taxpayer.
FBAR - Reasonable Cause. Factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause include:
- Reliance on Tax Advisor. Reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account,
- Other Legitimate Purpose. That the unreported account was established for a legitimate purpose and there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and
- No Tax Deficiency. That there was no tax deficiency (or there was a tax deficiency but the amount was de minimis) related to the unreported foreign account.
- Other Factors. There may be factors in addition to those listed that weigh in favor of a determination that a violation was due to reasonable cause. No single factor is determinative.
FBAR – No Reasonable Cause. Factors that might weigh against a determination that an FBAR violation was due to reasonable cause include:
- Background. whether the taxpayer’s background and education indicate that he should have known of the FBAR reporting requirements,
- Tax Owed. whether there was a tax deficiency related to the unreported foreign account, and whether the taxpayer failed to disclose the existence of the account to the person preparing his tax return.
- Other Factors. As with factors that might weigh in favor of a determination that an FBAR violation was due to reasonable cause, there may be other factors that weigh against a determination that a violation was due to reasonable cause. No single factor is determinative.
Current IRS procedures state that an examiner may determine that the facts and circumstances of a particular case do not justify asserting a penalty and that instead an examiner should issue a warning letter. See IRM 4.26.16, Report of Foreign Bank and Financial Accounts (FBAR). The IRS has established penalty mitigation guidelines, but examiners may determine that a penalty is not appropriate or that a lesser (or greater) penalty amount than the guidelines would otherwise provide is appropriate. Examiners are instructed to consider whether compliance objectives would be achieved by issuance of a warning letter; whether the person who committed the violation had been previously issued a warning letter or has been assessed the FBAR penalty; the nature of the violation and the amounts involved; and the cooperation of the taxpayer during the examination.
We contend that Noisy disclosures should also be available for nonresidents who do not owe any additional income tax on late filed form 1040 returns as a result of the expatriate exclusion for foreign service earned income ($92,200 for 2013) or because their foreign source unearned income did not exceed the personal exemption and the standard deduction (roughly $10,000 for a single person filing separately for 2013).
A noisy disclosure involves filing your amended returns and late filed FBAR returns, complying with the IRS offshore voluntary disclosure practice contained in IRM section 126.96.36.199.6 (July 1, 2008) and providing a reasonable basis disclosure for why you don't believe you should be subject to any penalties. Here again, If the taxpayer's assessment of reasonable cause is mistaken, the civil penalty exposure may be much worse.