Monday, March 3, 2014

The Scariest Tax Form? Scary Is in the Eye of the Beholder (3/3/14)

Robert Wood has a timely reminder that certain forms, if not filed or filed properly, can create major statute of limitations problems for U.S. taxpayers.  Robert W. Wood, Scariest Tax Form? Skip It, And IRS Can Audit Forever (Forbes 3/l3/14), here. The particular form he focuses on is the Form 5471.  The Form 5471 is here.  The instructions for the form are here (in pdf format) and here (in html format).  Here is the key excerpt:
The IRS normally gets three years to audit. Sometimes, say if you mess up with offshore account reporting, the IRS gets six. Having a foreign bank account and unreported income is tough to resolve. The safest approach is going into the IRS Offshore Voluntary Disclosure Program, although some clients opt for more aggressive approaches. 
What many people find surprising is that having a company that holds a foreign account is even more sensitive. Yes, we’re talking about controlled foreign corporations, also called CFCs. When a U.S. shareholderdholds more than 50 percent of the vote or value of a foreign corporation, the company is a controlled foreign corporation or CFC. A U.S. shareholder is a U.S. person who owns 10 percent or more of the foreign corporation’s total voting power. 
That triggers reporting, including filing an annual IRS Form 5471. It is an understatement to say this is an important form. Failing to file it means penalties, generally $10,000 per form. A separate penalty can apply to each Form 5471 filed late, and to each Form 5471 that is incomplete or inaccurate. 
What’s more, this penalty can apply even if no tax is due on the return. That seems harsh, but the next rule—about the statute of limitations—is even more surprising. If you have a CFC but fail to file a required Form 5471, your tax return remains open for audit indefinitely. Normally, the statute expires after three or six years, depending on the issue and its magnitude. 
This statutory override of the normal statute of limitations is sweeping. The IRS not only has an indefinite period to examine and assess taxes on items relating to the missing Form 5471. In fact, the IRS can make any adjustments to the entire tax return with no expiration until the required Form 5471 is filed. You might think of a Form 5471 like the signature on your return. Without it, it really isn’t a return.
This is scary.  But there are many returns and return filing obligations that are scary.  Picky and choosing is a matter of personal preference.  Mr. Woods is concerned about an unlimited civil statute of limitations -- or at least a civil statute suspension until the information is provided.  The criminal statute of limitations is not suspended.

Now, focusing on the return filing requirement generally, most of these forms are scary for purposes of criminal exposure.  Failure to file them can be criminally prosecuted for failure to file.  Filing them incorrectly can be criminally prosecuted for evasion, tax perjury, false statements, just to pick the most obvious.  They are all scary.

Now, going back to Mr. Wood's issue, the more egregious offshore tax evasion used offshore entities -- often foreign corporations sometimes with or without foreign trusts (which have their own reporting requirements).  Those offshore entities usually required the filing of Forms 5471, which were not filed because, well, the U.S. taxpayers did not want to disclose anything related to the offshore evasion.  I say egregious because the criminal prosecutions to date have overwhelmingly involved offshore entities, often corporations.

In many ways, the limitations on Government and on life generally do not keep issues open forever.  That is not a legal limitation.  That is a practical limitation.  Even if the Government can go back to 1975 or 1985, which is the likelihood that it will go back that far.  Still, that threat, however remote, can hang like the sword of Damocles in taxpayers' imaginations.  And if, in the extremely rare possibility that the IRS chooses to go back that far, the cost could be staggering because of the power of compound interest which the IRS can charge on the tax and the income tax penalties.

Thanks to Mr. Woods for focusing our attention on this issue.

10 comments:

  1. Form Crime. No wonder we refer to U.S. Citizenship now, as the "Tax, Form, Penalty and Survelliance Club, which comes to you as a side benefit of the lottery of birth. :) With Citizenship based Taxation, an anomaly that only America could create, and FATCA perpetuate, it is no wonder that many long term Americans are giving it up. Why live with that Damocles Sword over your head?

    It is why I warn all Kiwis and Australians I meet, to think very long and hard about signing up for membership. If you aren't born into, and still have a choice, why would you want to do it, if there were better options elsewhere?

    BTW, Jack, if you have not read Allison Christians blog on the Canadian Charter Challenge to FATCA IGA, I recommend it to you...

    http://bit.ly/1hrA21q

    In it, she says this...

    "FATCA's enforcement of legal-status based taxation renders it normatively unjustifiable. It violates the residence principle, which Reuven Avi-Yonah has gone so far as to call an international customary law. It is also of course completely unworkable on a global scale: imagine if other countries decided to learn from the US example and started smoking out their own disapora to enforce their own FATCA regimes. It is unimaginable that if the OECD countries got together and seriously debated status-based taxation, they would agree on a global standard to enforce it for all countries. The common reporting standard GATCA they have devised, which is so obviously based fundamentally on the residence principle, shows that the OECD recognizes that enforcing status-based taxation is not and should not be a goal of any project to counter tax evasion.

    Yet no conversation is being had about the outlier, whose demands will make enforcement of GATCA more extensive and more expensive for every other country.

    Residence based taxation is not perfect by any means but it is the least worst alternative if governments want to continue to use personal income taxes in a world in which individuals are to be allowed the freedom to move. FATCA deserves to fail to the extent it ignores this reality. A [Canadian] constitutional challenge will at minimum open a desperately needed political conversation about why this is so."

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  2. Thanks Jack for your comment...


    Yes, it is a policy argument, and a good one, imho. Is Citizenship Taxation the optimal best system? Well I have a hard time understanding how you could say "I don't Know". In fairness, coming from your background and homeland position, maybe you haven't given it the due consideration it deserves.

    I do understand differences of opinion, however, with how the Obama administration has conducted its offshore jihad since 2009, the impacts of this policy plus FATCA is clearly being shown for what what it is, VERY inappropriate for a global economy with a mobile citizenry. It puts Americans at an economic and competition disadvantage, to say nothing of all the penalty risk for benign failures of compliance with the MOST COMPLICATED TAX SYTEM on the GLOBE. As you know, even Nina Olson recognizes the problems...

    http://1.usa.gov/ZWXMF2

    It is incompatible with a democratic system supposed built upon individual freedoms and quaint constitutional ideas of 'due process'. How coercive or repressive is America willing to be to maintain its NON international norm of citizenship based taxation, and will the rest of the world help with the U.S. Citizen (Person) round up? Now, that is a question I can answer with, "I don't know." However, the trend lines under this administration are NOT encouraging. Good intentions to GET homeland TAX offshore Cheats has gone awry, imho

    Heaven help us if the rest of the world decided to copy it, but obviously they are NOT, as GATCA is built upon Residency based taxation and not an unsustainable Citizenship model

    I would recommend to you, this proposal for U.S. tax policy change that was submitted to the Senate Finance on January 17th. It has, as one of its authors, Willard Yates, the father of the FATCA form 8938.

    http://bit.ly/1bV0ISQ

    It might give you some thoughts to reflect on. You are good with the law, and I appreciate the knowledge and help you have contributed with this excellent blog, but you might look a little harder at this misguided policy. With due respect, if Yates, from inside the Treasury, comes from this (" I realized we didn’t know anything about anything when it came to U.S. citizens working overseas, accidental or otherwise"). to now open opposition to Citizenship taxation, I have hope for you. :)

    http://bit.ly/1lt7R10

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  3. I don't think that Nina Olsen thinks the construct of citizenship taxation with yielding to foreign residence and other foreign sourcing via tax credits. Her complaint is with the implementation of the OVDI/P and whether it achieves the best result consistent with the construct that has been the U.S. paradigm for many years.


    I could be wrong and, indeed, am often wrong.


    Jack

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  4. Yes, and I could be wrong too, but in this case, I don't think so.

    After watching and feeling the impacts of the past 4 years of offshore jihad, and thinking a lot about a subject which I have never given consideration to in the past, I have come down on the side that says, "Citizenship Taxation is Wrong for America, and wrong for its Citizens." It does more harm than any marginal revenue it might generate.

    America needs to adopt those residency based "international norms" that it is quick to lecture the world about, when it suits its needs. Maybe there is a GOOD reason why NO OECD country practices what the U.S. practices? Citizenship taxation is a paradigm for sure, a throw back to Byzantine times and needs to be abolished!

    Yes, Nina has complained about the application of OVDP on 'benign actors', and rightfully so. Maybe the new IRS commissioner will listen to her, as the old guy Shulman did NOT.

    However, in addition, she has also graphically pointed out how difficult it is for Americans abroad (accidental or otherwise) in being compliant with U.S. international tax laws. What she hasn't advocated for, is a policy change to CBT (wished she would), but maybe she thinks that is NOT her role. Her role is to point out the current difficulties and let Congress decide how to rectify.

    Again, this MSP from her previous reports to Congress...

    "International Provisions are among the Most complicated in the internal revenue code."

    "The complexity and administrative detail of the international reporting requirements are overwhelming."

    "Even inadvertent noncompliance may result in steep civil and criminal Penalties."

    Here is the link again as provided above.
    http://www.taxpayeradvocate.irs.gov/userfiles/file/2011_ARC_MSP%207-12.pdf

    Much of this would go away, if the U.S. followed 'international norms' of a residency based taxation, and that is the policy change I do advocate. Without that change, the U.S. has decided that Americans living abroad, have no value other than tax chattel and penalty extraction opportunities. With the FATCA round up, it is little wonder that so many are deciding it is time to hand in their membership in such a club.

    You don't need a CI prode to understand impacts and consequences. When the CBT regime becomes too onerous, people make human rights decisions to severe the relationship, even at the cost of form 8854 compliance, exit taxes and risk that ideologues like Schumer / Reed will get their way to ban them forever from visiting Disneyland or Las Vegas again.

    One really has to ask yourself, how far down a repressive road are you willing to go to enforce citizenship taxation? What cost are you willing to bear to maintain an out of date paradigm? That is 'you', only in the rhetorical sense. I don't hold you personally responsible for CBT, I just want you to think long and hard about it like you do in interpreting tax law. :)

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  5. GlobalCapitalismMarch 6, 2014 at 1:29 AM

    Yes Jack is trying to interpret tax law but fails to realize that his "passive-agressiveness" is doing more harm than good.
    No wonder so many refer to U.S. Citizenship now, as the "Tax, Form, Penalty and Survelliance Club, which comes to you as a side benefit of the lottery of birth. The law as it stands forces US citizens to make a modern day’s ‘Sophie’s choice’ between their love for their country by not renouncing citizenship and their love for their families by continuing to provide for them without banking services.”

    http://www.c-span.org/video/?318121-1/hearing-irs-targeting-conservative-groups

    They’re all crazy!!!!!

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  6. Jack I am sure you will be happy to read that Ukraine's banks have taken a cue from Carl Levin's strategy of sneaking FATCA itself through as a midnight amendment to a bill that was too long for anyone to read — what better time than when the rest of the public is busy paying
    attention to some minor political kerfluffle like the fate of their
    country?

    A stop to the violence and hatred? A stable coalition government? A
    resolution to the crisis in Crimea? Nah, none of that stuff really
    matters compared to the business of privatising the profits and
    socialising the costs. And with Ukraine's U.S. "allies" pushing FATCA
    down their throats, the banks have some big costs they need to foist on
    the Ukrainian taxpayer, to make sure the banks don't have to pay all of
    it themselves.

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  7. Hi Jack--great article.

    As usual with the foreign compliance regimes, there's an odd twist here for US expats--a US expat who has never (or not recently) filed a single piece of paper with the IRS is actually in a better position than a US expat who has filed returns reporting all income but failed to file a 5471. (And note that the 5471 is often for a non-US corp through which the US expat operates a business, not a vehicle for hiding assets etc.) The reason for this is that the US expat who has never filed anything can often take advantage of the non-resident non-filer program and be back in the IRS's good graces by filing only 3 years of past returns (and 6 years of FBARs), whereas the US expat in the second situation is only clear of possible penalties if they go back and file every 5471 that they missed. This is often a daunting task where the US expat is a Category 4 filer and therefore must include beginning-and-ending balance sheets and an income statement with the 5471.

    By the way, I took your Tax Procedure class about a dozen years ago--I still have the binder in my office. I now live in Belize (where my wife is from) and focus on tax planning and compliance for US expats and US citizens investing offshore (my website is www.ustax.bz).

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  8. Stewart,

    Great to hear from you.


    You are right the the nonfiler nonresident does get a better break for the reason you mention.


    I wish you the best in your practice. As to the book, you can download a copy of the updated book (PDF) from SSRN. The footnoted version is here.


    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2310960



    I should have the updated version filed by mid-August.


    Best,


    Jack Townsend

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  9. Does a US citizen spouse married under community property regime need to file form 5471 when foreign spouse is the sole owner per the corporate statutes?

    Under foreign law where they live, the corp is considered CP regardless of the fact that one spouse's name is not listed as owner.

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  10. wow, that is quite a question and one well worth taking advice on. Strangely enough, a friend with whom I correspond about all the weird tax traps that befall Americans Abroad sent me something on this a few months ago: a recent case, in which the US tax court analysed the issue of community property regimes and US tax. Not sure if it is on point for your situation but may help: http://www.ustaxcourt.gov/InOpHistoric/charania.TC.WPD.pdf

    ReplyDelete

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