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.