Time to Comply – Offshore Planning


For many years, US taxpayers have been able to avoid paying taxes by placing or receiving assets into offshore accounts. Rules regarding reporting and disclosure were ambiguous and enforcement by the IRS was weak. As a result, offshore planning became synonymous with tax-free planning. Unfortunately, most advisors have been conditioned to equate offshore with tax avoidance as well, which results in bad advice being given to US taxpayers. Better advice is as follows:

  • Offshore planning is taxable under the Internal Revenue Code;
  • Offshore structures and assets must be fully disclosed to the IRS;
  • Enforcement by the government is at an all-time high;
  • Penalties for failing to comply are significant – large civil penalties as well as criminal prosecution; and,
  • The time has come for all US taxpayers with foreign structures to become tax compliant!

While the Code is complex and the terminology can be befuddling, the rules pertaining to offshore planning can be simplified and are actually quite clear. The most important things for you to know are:

1)     Yes, You Really are Taxed on Worldwide Income. To be clear, US taxpayers are taxed on their worldwide income, from whatever source derived! This applies to all individuals carrying a US passport, regardless of where in the world they reside, and all residents of the US, regardless of where in the world they hold a passport.  While certain structures may afford better tax treatment than others, they are all still subject to the tax rules under the Internal Revenue Code. Do not be fooled by foreign advisors who declare that the foreign account is not subject to taxation because it is located in a tax-free jurisdiction. While this may be accurate as it pertains to the tax-free jurisdiction, it is not true with respect to the US. Unless and until you relinquish your US passport, you will always be taxed on worldwide income.

2)     You Must Disclose Your Offshore Assets. There is no shortage of IRS Forms for US taxpayers with foreign components in their structure. The most commonly discussed forms are the “FBAR” (Form TDF 90-22.1) and the “Shadow FBAR” (Form 8938). The FBAR is required when you have a financial interest in or signature authority over a foreign account in excess of $10,000 – in aggregate at any time during the year. This form must be received by the Department of Treasury by June 30 each year. The Shadow FBAR is required when you have “foreign financial assets” in excess of a stated threshold amount, regardless of your signature authority over them. The threshold amounts vary based on the nature of the taxpayer, but for individuals it is an amount in excess of $50,000 on the last day of the tax year, or more than $75,000 at any time during the year. The Form 8938 gets attached to your annual return. In addition to these, you must also ensure that you “check the box” on your annual 1040 where it asks if you have any offshore accounts. Other potential forms for international structures include: 3520, 3520A, 8858, 8865, 5471, and 5472 to name a few…

3)     If You Don’t Disclose, Your Foreign Institution Will Likely Disclose For You. Under the new Foreign Account Tax Compliance Act (“FATCA”), the US made a dramatic statement by broadening its reach and imposing reporting obligations on those foreign financial institutions that have accounts for US taxpayers. While met with initial resistance for many reasons, the foreign financial community has for the most part resigned itself to the fact that it must comply with the demands of the US and report US account owners. To be sure, the US is a formidable adversary, and if given the choice between keeping a taxpayer’s account secret or avoiding the wrath of the US government, most institutions are quickly buckling to the threats of the US government. In addition, a multitude of countries are rapidly entering into Tax Information Exchange Agreements (“TIEAs”), which require the participating countries to share information on their respective taxpayers if they have assets or income the other country. This is not just a US issue, countries are adopting a cooperative effort around the globe to stop tax evasion and to increase their collection revenues. Therefore, with these other parties making disclosures about you to the US, it is ill-advised for you not to.

4)     If You Don’t Disclose, the Penalties are Severe. Once upon a time, the IRS seemed complacent just collecting the taxes that were owed on foreign accounts, with a reasonable amount of interest that oftentimes could be negotiated. Not anymore. Noncompliant taxpayers can expect penalties, and severe ones at that. For example, the maximum penalties for failing to file the FBAR can be up to 50% of the account value for civil penalties, and criminal penalties of up to $500,000 and 10 years in prison. In addition, with respect to FATCA, the understatement penalties under IRC 6662 increase from 20% to 40% and the statute of limitations can run up to 12 years. Each form and corresponding failure to file has its own set of penalties. They are draconian, and they can be stacked on one another. The longer one waits to come clean, the more the penalties will hurt the taxpayer and wipe out most of the account.

5)     There is an Amnesty Program to Help You Become Compliant Without Going to Jail. Due to the success of the offshore amnesty programs of 2010 and 2011, the IRS launched its third amnesty program in 2012, and it is still available in 2013. Provided that the taxpayer is not under investigation or audit already, the taxpayer may come forward and report all years from 2003 on and avoid criminal prosecution. However, in addition to paying the tax that should have originally been paid, the taxpayer must pay the following: a) interest, b) a penalty of 27.5% of the highest aggregate balance during the unreported years, and c) a penalty of 20% of the income tax owed. While the penalties do add up, liberty does have a value.

In sum, if you have offshore assets, entities, trusts, accounts, or income in your structure, it is a new day for tax compliance. You must report and pay any applicable taxes, or you may suffer severe consequences. Given all the opportunities the IRS has provided for US taxpayers to come forward, it is becoming less tolerant and forgiving of those who don’t. Based on experience, becoming compliant is a much easier and affordable proposition for those taxpayers who hire counsel and get to the IRS first. If the IRS gets to you first, you are in for far greater pain.

So, as tax time approaches, let this serve as your reminder that the offshore stuff you’ve ignored to date should be ignored no longer. It’s time to comply and get out of your hole, before it’s too deep…

Jim Duggan, JD