Dual Citizens - Filing obligations of United States Citizens Residing Outside of U.S. and Dual Citizens
By Steven A. Braun and Reena Prabhakar, Drucker & Scaccetti, P.C.
Recent publicity regarding the efforts of the United States tax authorities to crack down on U.S. persons with undisclosed foreign bank accounts has caused great concern for U.S. citizens who reside outside the U.S. or are dual citizens of both U.S. and another country. They should now be aware of the fact that they are required to file tax returns and disclose certain information that could be subject to substantial penalties, in many cases.
The Internal Revenue Service ("IRS") issued a Fact Sheet (FS-2011-13, December 2011) to provide information to taxpayers who are dual citizens of United States and a foreign country. The Fact Sheet offers guidance on the U.S. federal income tax return and the FBAR filing requirements and the penalties for noncompliance.
United States law imposes a filing obligation on U.S. citizens living abroad and Americans who hold dual citizenship, meaning that they are citizens of United States and another country at the same time. A U.S citizen, whether residing in the U.S or in a foreign country, is required to file a United States federal income tax return and disclose their foreign financial accounts.
In 2009 and 2011, the IRS offered individuals with undisclosed foreign financial accounts an opportunity to become compliant with their U.S. tax filing and disclosure obligations through participation in a voluntary disclosure program. The 2011 Offshore Voluntary Disclosure Initiative (OVDI) and its predecessor, the 2009 Offshore Voluntary Disclosure Program (OVDP), permitted eligible taxpayers with undisclosed foreign accounts and unreported income from those accounts to get current with their filing obligations. The OVDI and OVDP eliminated the risk of criminal prosecution and provided for reduced civil penalties for taxpayers accepted into the program. In general, participants were required to file tax returns and pay all the back taxes, interest, and penalties for the past eight years. The penalty structure of the 2011 OVDI also required individuals to pay a penalty of up 25 percent of the highest aggregate balance in foreign accounts.
Income Tax Return Filing
The Fact Sheet indicates a United States citizen must file a federal income tax return for any tax year in which their gross income is equal or greater than the applicable exemption amount and standard deduction. Generally, U.S. citizens are required to report all of their worldwide income on their federal tax return, regardless of which country is the source of the income or where they reside. The Fact Sheet states that in order to become compliant, you only need to file U.S. tax returns going back six years.
If a taxpayer is required to file a federal income tax return and fails to do so, the taxpayer may be subject to the (a) failure to file penalty and/or (b) failure to pay penalty. The failure to file penalty is 5 percent of the amount of tax shown on the return. If the noncompliance continues for more than one month, an additional 5 percent may be imposed for each month thereafter, not to exceed 25 percent. However, if there is no tax due, there is no penalty. The failure to pay penalty begins running on the due date of the return and is 0.5 percent of the amount of the tax due. If the failure to pay continues for more than one month, an additional 0.5 percent penalty may be imposed for each month thereafter, not to exceed 25 percent. Again, there is no penalty if no tax is due.
The IRS will not impose the penalties if the taxpayer can show the failure to file or failure to pay was due to reasonable cause and not willful neglect. The IRS will consider the facts and circumstances, in regards to the taxpayer, when determining if the failure to file or pay was due to reasonable cause. Where a taxpayer demonstrates ordinary business care and prudence in meeting his tax obligations, IRS will generally grant taxpayer reasonable cause relief.
FBAR filing requirement
A U.S. citizen with financial interest or signature authority over any foreign financial account, including bank, brokerage, securities, or other types of financial accounts located outside of the United States, may also be required to report that information each year on Form TD F 90-22, Report of Foreign Bank and Financial Accounts (FBAR). Probably all U.S. citizens residing in a foreign country have a foreign bank account for their ordinary banking activities, which could be subject to the reporting requirement . If a person is required to file FBARs for prior years, they only have to file them for the last six years. The statue of limitations for assessing FBAR penalties is six years from the due date of the FBAR.
A failure to file the FBAR may subject the taxpayer to a willful or a non-willful civil penalty, in absence of reasonable cause. The civil penalty for willfully failing to file an FBAR can be up to greater of (a) $100,000 or (b) 50 percent of the total account balance at the time of the violation. Non-willful violations are subject to a penalty of up to $10,000 per violation. However, if the failure to file was due to reasonable cause, as determined by the IRS, there is no penalty.
The IRS will consider factors such as taxpayer's reliance on a professional tax advisor, no indication of intent to conceal income or assets, and other additional facts that weigh in favor of a determination that the violation was due to reasonable cause. The IRS will consider the facts and circumstances of the taxpayer's situation before imposing a penalty, and, may, instead issue a warning letter.
The IRS reopened the Offshore Voluntary Disclosure Program (2012 OVDP) with News Release IR-2012-5 on January 9, 2012. The 2012 OVDP, unlike the 2009 and 2011 programs, will be open for an indefinite period of time, with no set deadline for taxpayers to apply. The overall penalty structure for the 2012 OVDP is the same as for 2011 OVDI, except for taxpayers in the highest penalty category. For the 2012 OVDP, the penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign accounts/entities or value of foreign assets during the eight tax years prior to disclosure. Like the 2011 OVDI, some participants, in limited circumstances, will be eligible for a lower penalty of 12.5% or 5%. The IRS anticipates it will be providing additional specifics on the new program within the next month.
The IRS also stated in IR 2012-5 its developing procedures by which dual citizens may come into compliance with U.S. tax law.
New reporting requirement
Under legislation enacted in 2010, U.S. taxpayers holding financial assets outside the United States must report information about those assets on a new Form 8938, Statement of Specified Foreign Financial Assets. This form must be attached to your individual income tax return. Generally, reporting on this form applies for assets held in taxable years beginning January 1, 2011, therefore, Form 8938 will be due in 2012.
Many dual citizens who have not filed U.S. tax returns or have not disclosed foreign accounts have been unsure of what they should do. The Fact Sheet makes it clear that the IRS has a long standing practice of allowing voluntary disclosures. The IRS practice is to allow voluntary disclosures and to consider such disclosures with other factors in determining whether criminal prosecution should be recommended. This practice extends to a disclosure of any tax issue as well as offshore accounts. In general, criminal prosecution is not generally recommended if a full and truthful disclosure is made.
Taxpayers must consider their specific situation before making a decision about how best to become compliant with the U.S tax laws. With the announcement of the 2012 OVDP, they and their advisors need to determine whether they should follow the guidance provided in the Fact Sheet, file returns for the past six years and hopefully be granted reasonable cause relief, or, alternatively, participate in the 2012 OVDP, file and pay taxes for the past eight years to obtain amnesty from criminal prosecution.
Drucker & Scaccetti, P.C. (D&S) provides specialized tax, business and financial consulting to individuals, entrepreneurs, corporate executives, professional service firms and family-owned businesses. The shareholders of D&S are hands-on professionals who bring a refreshing level of personal integrity to the financial services that they offer.
Steven A. Braun, Shareholder
Reena Prabhakar, Managing Associate