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.