Friday, August 29, 2014

New IRS Internal Guidance on Processing Streamlined Submissions (8/29/14; 7/2/16)

A commenter called attention to an IRS internal procedure guidance with IRM changes dated 8/13/14.  That guidance is numbered WI-21-0814-1244 and titled  Streamline Filing Compliance Procedures for Accounts Management International IMF.  The guidance is here. [JAT Note on 7/2/16:  The IRS has taken down the link.  At least some of the guidance, with some redactions (see below), now appears in IRM 21.8.1.27.2.1  (05-01-2015), Adjusting Streamlined Filing Compliance Domestic Accounts - (Streamlined Domestic Offshore - SDO), here.  I have provided a subsequent blog entry on this issue.  See IRM Guidance on Processing SDOP - On Flagging Returns for Scrutiny and IRM Redactions (Federal Tax Crimes Blog 7/2/16), here.]

I have just looked through the guidance.  I have not studied it closely.  The key point that caught my eye on this review is that there are procedures established for some preliminary vetting of the documents that are filed under the SFOP and SDOP procedures.  I quote some of them and then offer comments.
IRM 21.8.1.27.2.1 Adjusting Streamlined Filing Compliance Domestic Accounts
- (Streamlined Domestic Offshore - SDO) 
3. LB&I will review the submissions for statute considerations. LB&I will complete the "AM Streamline Coversheet" and attach it to the package notating their statute recommendations regarding open statutes and statute extensions.
The IRS must determine if the certification is complete -- a table checklist is provided in paragraph 7.

One thing they check for is an open examination. (See par. 8, table).  [JAT Note on 7/2/16:  This discussion from the guidance as originally published appears to have been redacted in the regulations  21.8.1.27.2.1  (05-01-2015), Adjusting Streamlined Filing Compliance Domestic Accounts - (Streamlined Domestic Offshore - SDO), here, see particularly paragraph 9.F. which apparently is the following paragraph but it is redacted (so I don't know if the guidance has been changed)  I have written a subsequent blog entry on this.  See IRM Guidance on Processing SDOP - On Flagging Returns for Scrutiny and IRM Redactions (Federal Tax Crimes Blog 7/2/16), here.]
9. To complete adjustments on Form 1040X filed under the SDO:  
6. After making the assessment, refer any case with 5 or more foreign information returns (Forms 3520, 3520-A, 5471, 5472, 8938, 926, or 8621) by e-mailing the CIS ID number to "*LB&I OVDP Compliance" with an explanation that the case is being forwarded due to 5 or more foreign information returns. Enter CIS notes indicating the case was referred to *LB&I OVDP Compliance "5 or more foreign income statements"  
NOTE: The total of 5 forms is a combination of all years filed. For example submissions containing 3 Forms 5471 for 2011 and 3 Forms 5471 for 2012 would be referred since the total is 6. Submissions with a combination totaling less than 5 would not be referred.
JAT Comment: The latter requirement for forwarding returns with 5 or more information returns is obviously a critical one in terms of trying to anticipate what the IRS might do.  I don't think that less than 5 will mean the taxpayer certifying nonwillfulness has no risk.  The returns could be picked up under the regular IRS procedures which, inter alia, score returns for factors unrelated to offshore accounts.  Then, once an audit starts, the assumption would be that some level of audit of the certification will take place.  But, given the uncertainty in all this process, I personally believe it would be a mistake to make an aggressive certification of nonwillfulness even if the taxpayer can imagine that he understands his audit risk factors.  I don't understand audit risk factors, at least not well enough to take any important action based on the understanding.  The proper way to analyze this is that you should not certify if you are making a false certification or, if you can't calibrate nowillfulness exactly, a certification of nonwillfulness when the facts put you toward the willful end of the spectrum.  That is not legal advice to anyone, for I do not provide legal advice on this blog without specific engagement of my services.  This is just a cautionary concern that I think readers should consider.

Addendum 8/30/14 2:30pm

A commenter on another blog another blog entry here has pointed out that this new IRS posting says something that may or not be consistent with the original instructions as to the years covered for SDOP or SFOP.  Those original procedures (still in effect as of today, see the SDOP instructions, here) said that the years for which amended or delinquent returns must be filed are:
each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) 
Some taxpayers have been concerned about which 3 years when the taxpayer is on extension for 2013 and has filed prior to the end of the extension period.  Say they filed original 1040 and FBAR on June 30, 2014.  Does that taxpayer submit returns for 2010, 2011 and 2012 or for 2011, 2012, and 2013 (2013, of course, is compliant because of the recent filing).  If the instructions quoted above are read literally, the required years are 2010, 2011 and 2012 because the extended due date has not yet passed.  But still it could be a matter of interpretation because, once the return is actually filed, the extended due date is meaningful only to the date of filing.  Still, that is not the plain reading of the requirement.

This new IRS publication for changes to the IRM suggests even a further nuance.  It says that the returns required are:
each of the most recent 3 years for which the U.S. tax return due date (or properly applied for extended due date) is past and the statute of limitations is still open.
 I have highlighted the language that does not appear in the SDOP and SFOP instructions.

Consider this example.  Suppose the taxpayer filed his 2010 return on 4/15/11.  Taxpayer will join SDOP on 9/1/14.  Which years must be amended?  His 2010 year is closed (assuming the normal 3 year statute applies); 2010's statute closed on 4/15/14.  So, then presumably, the open years are 2012, 2013 and 2014.  So those are the only years that should be amended and submitted (and, if as in the example above, the taxpayer filed a compliant originals for 2013, so the only amended return years are 2011 and 2013).

This is an interesting question.  I don't know whether taxpayers should follow the guidance in the SDOP and SFOP general instructions or can rely on the internal guidance in the IRM revisions.  The general legal rule is that IRM provisions are for the IRS's internal guidance and confer no rights on the taxpayer.

Of course, a taxpayer can avoid the problem altogether by waiting until 10/16/14 to submit the streamlined submissions.

37 comments:

  1. It would appear that metric applies to SDOP but not SFOP. Would agree or am I misreading?

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  2. I don't understand audit risk factors, at least not well enough to take any important action based on the understanding."

    In light of the latest revelations about the thousands of Lehner's lost emails, now including blackberry emails, that seem like a zombie that just Holder just can't seem to kill, it is clear that the only people who understand current audit risk factors are Obama's treasury Kommissars.

    Peter Dunn was warned by Steven Mopsick that the IRS was watching him, would his SDOP perhaps encounter extra scruitiny? The US is clearly on an expat rape and plunder jihad. To add icing to the cake < href="http://isaacbrocksociety.ca/2014/08/27/state-department-to-hike-renunciation-fees-to-us2350-says-no-public-benefit-in-respecting-human-right-to-change-nationality/">the DoS is increasing the renunciation fine from $450 to $2350

    Jack, a while back you poo-pooed the compliance costs to both expats and foreign financial institutions and said you would do a follow up post on these minimal costs. In honor of the 500% increase in DoS penalties imposed on those so audacious as to think that they have the right to escape the tax compliance chains imposed by a foreign country, I would suggest it is high time you wrote this follow up post.

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  3. Since you have to file form 8621 / tax lot / dividend it would seem that any non-trivial amount of PFIC's would tip you over the limit. With reinvested dividends over 12 years I had to file well over 400 of these forms.

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  4. The "information forms" seven of them being listed, are those all of it? I thought fbar itself was an information form. (well nevermind, I suppose fbar isn't sent with the 1040)

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  5. Keep in mind that exceeding the magic number only means that someone is going to look at the information to see whether something is required. Over what number of years did you have to file the 400+ forms. If it is over 3 years, then you had a lot of PFICs for which you did not file. That may not be bad enough, but it certainly means that you had many components of income that were not reported, and the IRS may just want to ask a few more questions about your situation.

    Jack Townsend

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  6. These 400+ forms covered 8 years as required by OVDP. You don't need a lot of PFICs. My wife had a income fund that paid out 4 times a year. The dividend was reinvested created a new small tax lot. Dividends where small. Investment was small. We we talking at most a couple of hundred dollars from dividends a year.
    Our PFIC taxation on the dividends was way less than normal income tax on the dividends would be. This is because breaking the small dividends down to tax lots caused a huge number (maybe 90%) of the forms to generate sub 50c values that round to zero. Of course many of the fields int he form aren't zero.
    The IRS rejected the aggregate numbers to make their life easier. They demanded the forms but they didn't know I had already produced them with a computer program to take our spreadsheets and fill in the PDFs automatically. So we just dumped the lot on them. They accepted them after we corrected their misunderstanding of the PFIC tax laws (pre PFIC years for the years you aren't a US person).
    Since the number of forms grows each year we would likely have had over 200 forms just for the last three years. First dividend of the year generates n forms, second n+1, third n+2 and last n+3. That's per fund. This the tax lots and the tax lots dividend generated after 10 years.
    You may think this taxation makes sense but clearly ordinary people can't comply without massive compliance costs and time consumed. This is why FATCA makes no sense. The tax laws are crazy and the tax treaties totally inadequate.

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  7. Also, for the 5 information returns limit, does this apply to straight SDOP (3 years returns) or does it apply to participants in OVDP requesting transition to SDOP?

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  8. That is just stunning. Boy, am I glad I missed that trap! Talk about formication! The tax code is just nuts. No wonder so many living abroad are shedding their citizenship. Wonder if the new fee hike making the CLN more costly than the passport will slow down the trend...

    http://onforb.es/1B4VSjK

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  9. RajNIL, after reading your comment I have done some looking and concluded that FBARs are not information returns. The IRS website describes them as returns where some form of income/gain or another is to her reported. That is not the case with FBARs. Also under the new procedures we are talking about look at paragraph 1 IRM 21.8.1.27.2 (taxpayers residing in the US) are eligible if "……they have failed to report…..and may have failed to file an FBAR and/or one or more international information returns. (I found the and/or above significant?
    JACK….AGREEMENT? NOT/ COMMENTS? THANKS.

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  10. RON,

    I am not sure exactly what you are asking. However, if there is not some other illegal activity, the only substantive noncompliance would be tax noncompliance as a basis for asserting any FBAR penalty. Hence, from an administration perspective, reviewing the income tax returns filed in SDOP and SFOP and focusing on the forms related to tax noncompliance would be most useful. Hence, if I was doing the triage (where some FBAR failure to file or filing incorrectly is the sine qua non), I would either ignore the FBARs for the 3-year period in scoring or move the scoring from 5 to 8.

    Jack Townsend

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  11. The discussion had to do with whether FBARS count or not as information returns (for 5 max count on the 8/13/14 procedural update). I was making the point I think they do not count. I was asking your opinion as to whether they do or do not count.

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  12. HMRC estimates that 45% of UK residents have an ISA. This tax advantaged savings account is clearly then a pretty normal savings vehicle in the UK. Since it can be used to save for a house for example and isn't primarily used for retirement it isn't protected by the UK-US tax treaty. Contributions to the account are limited annually. Any 'US Person' living in the UK (you must be resident to have an ISA) will get financial advise to open these.
    Of course if it was just taxable in the US as a normal capital asset things would at least be manageable. Instead a special sec 1291 tax applies specifically meant to punish the holders of foreign mutual funds.
    I challenge tax professionals who think this is OK to assume that the S&P 500 is being tracked by a foreign mutual fund. The dividends have been reinvested over a ten year period. You will have something like 41 tax lots.
    Do the taxes for this year. You will have 4 dividends this year. That will be something like 170 (41 + 42 + 43 + 44) form 8621 this year. Each one a beast to calculate since you have to work out the excess distribution and divided it over the holding period for the tax lot.
    Want to sell the holding? Well that's another 45 (41 + 4) form 8621's right? Similar excess distribution calcs for the sales except all is excess.
    I advise you to build the interest rates tables first to project the sec 1291 tax to the present day to pay the interest. Takes some time to get all the treasury numbers for this.

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  13. I thought I was saying that they do not count in my opinion.

    Jack Townsend

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  14. That is my understanding. But keep in mind that having 5 or more such returns does not mean anything except that they will get another level of review. I suspect that many, maybe even most, returns subject to that additional level of review will not be disturbed.

    Jack Townsend

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  15. PFICS were for many years an abstract area, pretty much only understood by corporate tax lawyers. It is only recently that they have been applied to everyday investments such as mutual funds, and I doubt too many people in the IRS understand them fully (with the exception of the specialist counsel). Form 8621 is a mess, only because the required calculations for excess distributions and appropriate penalties is incredibly complex.
    Two more points: ISA's not only raise PFIC issues but also foreign trust issues, since many of them are structured as trusts, so not only are Form 8621's going to be delinquent, but Form 3520/A's as we'll.
    Finally, a lot of current focus is on expats and current immigrants, but what about future immigrants. How many high income people are going to want to work in the US if their move is accompanied by the knowledge of a tax compliance nightmare and their domestic banks close their accounts once they show signs of US indicia (such as a US address). I know of two cases (purely anecdotal, admittedly), where this came up. In one, he recent immigrant to the US found that his Iprivate bank (with whom he had been for generations) had to close his accounts and another who decided not to take a posting after that same bank told him they would have to close his account if he went.

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  16. IgnorantFBARvictimAugust 30, 2014 at 5:08 PM

    I own multiple mutual funds (PFICs) in small denomination. The total value of my 50+ funds exceed $350K. I mostly had losses every year due to currency devaluation but I believe I will have to file fifty 8621 forms per year to report the dividend of roughly $5000 per year. Since my dividend was reinvested in the mutual fund, and in my country there is no tax on reinvested dividends, I got caught off-guard on US tax reporting obligation on global income (dividend). I did not also know that mutual funds counted as a foreign account for FBAR, thinking only Bank account were supposed to be reported. My tax preparer didn't know about the rules either until I recently called him about my 2010, 2011 and 2012 returns. So here I am, very stressed out, sleepless, trying to fix the mistake ASAP. I talked to two different OVDP hotline persons in regards to SDOP's 5 or more foreign return limit for additional review. Their answer is consistent to what Jack mentioned. IRS person also said that the goal of SDOP was to encourage people to come forward before IRS finds them. I believe rather than worrying about the additional review for 5 or more returns, it is important to act quickly and file the SDOP packet because if IRS opens an audit before you file then it is too late.

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  17. Jack, I thought so, I just wanted to clarify. thanks!

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  18. "Peter Dunn was warned by Steven Mopsick that the IRS was watching him"..... is this really true ?! Mopsick has said many things over the years ,most of them were only his personal opinion and were not true.

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  19. I have a question that might sound stupid, but it may have merit. I joined the OVDP in 2012 and submitted amended returns for 2004 through 2010. 2011,2012,2013 have been totally compliant. I tried to transition, but was denied. I am left with opt out or withdrawal. What is if withdrew or opted out and then applied to the streamlined. Given I am totally compliant in all my taxes and reporting and therefore non willful in any way I should be approved immediately. If so does that make the other years ago away? Or would the IRS still seek to process any penalties they could on open years 2008,2009 and 2010? Just a thought.


    Also can anyone comment if the IRS has given them refunds for the taxes, interest and penalties that they paid when they opted out for closed years.? Jack you called this filing a protective order. Has any protective order worked for anyone?

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  20. I havent analyzed the whole IRS document but it seems that the review triggered by 5+ information returns is focused on correct tax reporting. (Why this review would happen for someone with 5 information returns showing minimal income and not to someone with fewer returns showing large income is beyond me.) But it seems that the review of wilfulness is a different issue than the review of information returns.

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  21. 1. I don't think that opting out of OVDI/P and trying to go streamlined will work. By opting out, you are immediately in the audit posture. You cannot do streamlined if you are under audit. Moreover, and in any event, permitting one to achieve indirectly (via streamlined after opt out) that which was denied on the direct attempt (transition streamlined) would not make any sense. I doubt that the IRS will agree.

    As to the second point, on opt out you will get a refund for closed years (i.e., the years that were already closed when you signed the first Form 872 consent). But there is a nuance here that a six-year statute could apply because of 25% omission or because of omitted income from the type of accounts reportable on Form 8938 (even for years before the Form 8938 was required). So there might be a 6-year statute of limitations, that then would get extended by the Form 872 extension.

    The key to getting the refund is to make sure the refund statute of limitations is still open. The rule is this as to the payments made in OVDI/P for the possibly closed years: The IRS can only make refunds of taxes paid if the claim for refund is filed within 2 years of the date of payment or a valid Form 872 for the year extends the date for assessment and refund. The better part of wisdom would be to file an amended return making the claim (might even be an informal claim by letter, but that is not advised) within two years of the date of payment.

    Best regards,

    Jack Townsend

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  22. Likewise I wonder if any of the 5% SDOP penalty is refunded in case of a post-SDOP audit? If one is getting an audit after paying the 5%, then the 5% should be refunded, right?

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  23. Jack,

    Thank you for your post.


    From your post in this discussion thread, could you explain the 25% omission? Is the 25% the tax loss for IRS?

    Also, I understood from your post that the the 6 year statute of limitations might be extended to further include all years agreed to per 872. That is it may cover all years of OVDP 2004 thru 2010 even during opt-out?


    Finally, how will FBAR penalties be applied during opt-out given the extended statute of limitations?

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  24. 1. 25% of the gross income omission.

    2. The Form 872 will cover all years that were open when the IRS counter-signed the Form 872. The IRS will expect seriatim extensions during the process to assure that those years stay open for assessment (which means that they are also open for refund, but refunds for those open years are not likely since the taxpayer self-reported the tax on the amended returns for those years).

    3. I don't think anyone can predict with any degree of precision how the FBAR penalties will be asserted on opt out. Generally, with good facts, a favorable nonwillful penalty will be asserted (favorable in reference to the offshore penalty without opting out). I do think that is the general rule with good facts. I have seen one major aberration, so opting out is not a risk-free exercise.

    Jack Townsend

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  25. I am getting mixed answers so thought I post this question regarding PFIC calculations. Say I have 50 PFICs. In a tax year, if I had some activity (dividends, sale) on 20 PFICs but the other 30 had no activity. Do I need to file the 8621s for all 50 PFICs or do I just file 8621 for the PFIC which had excess distribution (dividends, sale)?

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  26. For what it's worth, the PFIC rules were designed specifically with mutual funds in mind. Of course, the rules are not well known, are not well advertised, and were not designed with the understanding that there are millions of US citizens living abroad and other US taxpayers who own non-us mutual funds, as a matter of course, from having lived outside the US.

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  27. Jack, regarding the case you refer to as an aberration (200% penalty.) Is there a possibility that this could be made into a test case? If the client opted out, the facts must be good. I don't know how a 200% penalty would compare to the taxpayer's total net worth. And of course legal fees are a consideration. I'm just asking because there have been "bad actor" FBAR cases, and I would love to see a "good actor" case.

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  28. Don't know yet whether the IRS will persist. But, if it does, the client will then make the judgement call whether to litigate. I think, however, that if the client chooses to litigate, I will force the issue into a local district court with a jury via a refund suit and press for an early trial.

    There are some issues that I want to have a shot at in influencing the law before too many results come down in bad cases -- for example, the burden of proof (I think it should be clear and convincing, a very high and hard to meet standard), the role of willful blindness, review of the amount of the penalty, etc. I am not sure that they have gotten properly fleshed out to date.

    Jack Townsend

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  29. Jack and Anonymous, I am trying to understand what it is you are referring to about the 200% penalty being an aberration. Is that an OVDP penalty calculation you are talking about? What do you think of my OVDP penalty calculation, it is1800%!!! Total Tax defienciency over the 8 years is $9K and penalty calculation is $174K!!!! I had a rental condo.

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  30. RON,

    The 200% penalty is just the FBAR willful penalty. I was not comparing it to the income tax deficiencies. The 200% relates to the amount in the account.

    I have seen one OVDP offshore penalty get over 1200% of the income tax deficiency. The client opted out and got a very favorable result.

    If you opt out, the rental condo will not draw an FBAR penalty. And, since tThe returns are qualified amended returns, you will only pay tax and interest for the open income tax years.

    Of course, you would not opt out if there are factors indicating willfulness.

    Jack Townsend

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  31. From my own investigation you have to file form 8621 for each PFIC you own (each mutual fund) unless they are in a foreign pension protected by a tax treaty, US qualified pension or the balance amount of the PFIC is small enough.
    See the flowchart here:
    http://www.tax-charts.com/charts/1.1298-1T.pdf

    Note that not all dividends are excess distributions. Sale gains are always excess distributions (called dispositions in PFIC land).
    It doesn't seem well known, but if you are subject to AMT you can dispose of your PFICs slowly to eat up your AMT such that you don't pay the Sec 1291 tax due to a bug in form 8621. Sec 1291 tax doesn't generate income and so doesn't increase AMT but does increase federal taxes.
    This is likely why they have the language about AMT in the OVDP FAQ for modified mark to market. They don't want you to escape that.

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  32. Thanks Jack. In an opt out, since the condo does not count, would it count though in the detemination of willfulness-nonwillfulness scale? The condo situation is an inadvertent case given the fact that family members managed it. (As for accounts there is totally no problem) I have read somewhere that others managing your assets may not be a reasonable cause argument. So, question I guess is: in an opt out where there is no problem with accounts at all, would the condo inadvertence as a result of family managing count towards the determination of will/nonwillfullmess? I ask this since in an opt out the condo would not be included.

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  33. RON,

    It is hard to assess how the noncompliant real estate will factor in. If it generate large amounts of income or net income, it would be a negative factor, even though in a technical sense it is not relevant to the FBAR penalties. If it is a modest amount of income and/or tax, then I doubt that it would have any influence.

    Jack Townsend

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  34. Thanks for the chart. I will check out the AMT info. I am applying for SDOP, and I confirmed with OVDP hotline that Mark2Market is only allowed for OVDP. For SDOP, I have to use the sec 1291 (default) calculation. However, my question still remains, as to whether I need to report my PFIC which had neither dividend nor sale. Many of my PFICs were inactive, and hence I am confused whether I need to file the 8621 for PFIC with no activity. I am above the threshold value since the aggregate value of all my PFICs(mutual funds) is higher than 300K.

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  35. It's about $15K income yearly for 6 years, a tax deficiency of about $1K per year.

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  36. Ron


    Could you point us to WHERE you read that others managing your assets ( I'm assuming co-owned assets- for example a Bank account with a parent as a co -owner ) is not a reasonable cause argument

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  37. Hello Jack,
    could you shed some light (details) on how the post--assessment appeals judicial approach works after a civil audit took place. In theory appeals seeks to
    resolve the controversies without litigation on a fair and impartial
    basis to both the government and the taxpayer.

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