Any U.S. person having a financial interest in or authority over a foreign financial account during a calendar year is required to file an information report with the U.S. Department of the Treasury by June 30 of the following year. The information is reported through filing Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts or FBAR). The FBAR reporting requirements apply to any foreign accounts where the aggregate balance exceeds $10,000 at any time during the year. In an effort to encourage voluntary compliance by non-filers, the Internal Revenue Service (IRS) announced a program to centralize the civil processing of offshore voluntary disclosures and to offer a uniform penalty structure to taxpayers using undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax. As part of this initiative the IRS indicated that it would permit certain taxpayers, who had reported and paid tax on all their taxable income for prior years but had not complied with their FBAR reporting obligations, an opportunity to file their delinquent Forms TD F 90-22.1 (including any filings due on June 30, 2009), without penalty as late as September 23, 2009. On August 7, 2009, the IRS issued Notice 2009-62, 2009-35 IRB 1, further extending the deadline to June 30, 2010, in the two limited cases of:
Persons with no financial interest in, but with signature authority over, a foreign financial account
Persons having a financial interest or signature authority over a foreign financial account in which assets are held in a commingled fund
There has been considerable discussion within the tax community regarding the persons required to file FBARs and the scope of the items required to be reported. The IRS has provided guidance in the form of frequently asked questions and answers (FAQs), that can be found at http://www.irs.gov/newsroom/article/0,,id=210027,00.html (initially posted May 6, 2009, (Q & A 1-30) and subsequently modified and supplemented on June 24, 2009, (modifying A26 and adding Q&A 31-51)).
A less publicized feature of this guidance is its coverage of information returns other than Form TD F 90-22.1. In its supplementary list of FAQs (see FAQ 42), the IRS has indicated that it would waive failure to file penalties, not only with respect to FBARs, but also with respect to “tax information returns, such as Form 5471 [Information Return of U.S. Persons With Respect to Certain Foreign Corporations] for controlled foreign corporations (CFCs) or Form 3520 [Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts] for foreign trusts” in situations where foreign income has been reported and taxes paid, provided such filings are made by September 23, 2009. (Notice 2009-62 does not have any bearing on the foregoing.) FAQ 42 does not specifically reference any forms other than Form 5471 and Form 3520, but it is probably reasonable to extrapolate that this concession should extend to other information returns relating to a U.S. person’s foreign investments such as Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) and Form 8858 (Information Return of U.S. Persons With Respect to Foreign Disregarded Entities). This On the Subject focuses on the relief available with respect to delinquent or incomplete Forms 5471, and also outlines the implications of non-filing of, or filing of incomplete, Forms 8865 and 8858, as well. (Ideally, the IRS will issue guidance clarifying that information returns such as Form 8865 and Form 8858 fall within the concessions set out in FAQ 42.)
The expansion of the waivers relating to FBARs to include other U.S. federal income tax information returns relating to foreign investments may provide certain taxpayers who have been delinquent in filing these returns (or have filed less than complete returns) a chance to get into compliance without incurring any penalties.
Information Return Filing Requirements and Associated Penalties
In general, a U.S. person must file certain information returns with the IRS if such U.S. person:
Becomes or ceases to be a 10 percent owner in a foreign corporation or foreign partnership;
Becomes an officer or director of a foreign corporation in which a U.S. person owns an interest of 10 percent or more;
Owns more than 50 percent of a foreign corporation (controlled foreign corporation or CFC) or foreign partnership (controlled foreign partnership or CFP);
Is the owner for income tax purposes of a foreign disregarded entity (i.e., an entity not created or organized in the United States that is disregarded as an entity separate from its owner for U.S. income tax purposes); or
Has a reporting obligation with respect to a CFC or CFP which is the tax owner of a foreign disregarded entity.
(Ownership is generally determined on the basis of both direct and indirect holdings, and in certain instances applying constructive ownership and attribution rules, and in the case of a foreign corporation the requisite ownership thresholds can be satisfied through either voting power or the value of the stock held.) These information returns are generally due and filed with the U.S. person’s federal income tax return. The required forms with respect to investments in foreign corporations and foreign partnerships are Form 5471 and Form 8865, respectively; the required form with respect to investments in foreign disregarded entities is Form 8858.
Direct Monetary Penalty
The penalty for failure to file Form 5471 or Form 8865 (or for filing an incomplete Form 5471 or Form 8865) is $10,000 for each failure, unless the failure was due to reasonable cause. If the failure to file continues for more than 90 days after the day on which the IRS mails notice of such failure to the person required to file, there is an additional penalty of $10,000 for each 30-day period (or fraction thereof) during which such failure continues after the expiration of the IRS's 90-day notice, not to exceed $50,000 for each such failure.
Reduction in Foreign Tax Credits Claimable
In the case of a failure to file Form 5471 or Form 8865, as the case may be, with respect to a CFC or CFP, in addition to the direct monetary penalty described above, the U.S. person may lose the benefit of certain foreign tax credits, and this can have serious consequences in relation to foreign operations of a U.S. person that are profitable and subject to tax in foreign jurisdictions. The amount of the reduction is 10 percent of the amount otherwise to be taken into account in computing the foreign taxes that can be credited pursuant to Section 901 (credits for “directly-paid” foreign taxes) or when applying Section 902 (credits for indirect or “deemed paid” foreign taxes available to certain corporate stockholders of foreign corporations) and Section 960 (“indirect credits for foreign taxes paid” in respect of certain income of CFCs that is included in the income of a U.S. shareholder of the CFC even prior to distribution (i.e., Subpart F income)) of the Internal Revenue Code of 1986, as amended. The amount of foreign tax credit reduction for each failure to furnish information with respect to a foreign corporation cannot exceed the greater of $10,000 or the income of the foreign corporation for the period in question, and is reduced, dollar for dollar, by the amount of any direct monetary penalty paid. The 10 percent reduction is not limited to the taxes paid by the foreign corporation with respect to which there is a failure to file, but may apply to the taxes paid or deemed paid by all foreign corporations controlled by the U.S. person. However, the reduction does not apply to any foreign tax credits that are carried over or back to the taxable year. If the failure to furnish information continues for 90 days or more after the IRS notifies the person of the failure to submit information, an additional 5 percent reduction will be imposed for each additional three-month period (or part thereof) of non-compliance.
The penalties described above for CFCs and CFPs can apply to the non-filing of, or filing of an incomplete, Form 8858, as well.
Other Consequences of Delinquency
The failure to file a properly completed Form 5471, Form 8865 or Form 8858 extends the period of limitations on assessments with respect to any event or period that would have been reflected on the form if filed as required.
In addition to the civil penalties discussed above, criminal penalties may also apply for failure to submit information or for filing false or fraudulent information.
Reasonable Cause Exception
A failure to file may be excused for reasonable cause. In general, if a U.S. person has reasonable cause for failing to provide information, the period for providing information without any penalty continues as long as reasonable cause exists. This “grace” period applies for both the regular due date for filing of the information returns described above and the 90-day period that starts when the IRS gives notice of a failure to supply information. However, what constitutes reasonable cause is less than clear. It generally requires the proven exercise of "ordinary business care and prudence" in endeavoring to obtain requisite information. Recent administrative rulings indicate that the IRS is taking a much narrower view of what constitutes reasonable cause for the failure to file, or the failure to file complete, information returns such as Forms 5471, 8865 and 8858.
Compliance for Purposes of the Waiver
A taxpayer seeking to avail itself of the penalty waiver with respect to information returns filed by September 23, 2009, should file an amended federal income tax return by that date showing no change to its income or tax liability. In the case of a corporate taxpayer with delinquent Forms 5471 filings, this generally will require the filing of a Form 1120-X (Amended U.S. Corporation Income Tax Return) for each affected taxable year, incorporating the information reported on the Form 1120 (U.S. Corporation Tax Return) filed by the corporation but with the delinquent Forms 5471 attached. The filings must be made with the appropriate IRS service center along with a statement explaining why the information returns are being filed late. The taxpayer is also required to send copies of the delinquent information returns together with copies of tax returns for all relevant years, no later than September 23, 2009, to the IRS’s Philadelphia Offshore Identification Unit at the following address:
Internal Revenue Service
11501 Roosevelt Blvd.
South Bldg., Room 2002
Philadelphia, PA 19154
Attn: Charlie Judge, Offshore Unit, DP S-611
Anecdotal evidence suggests that the IRS has begun focusing on more vigorous enforcement of the timely filing of the information returns discussed above and the rules governing the content of these returns, adding importance to the dispensation from penalties afforded by FAQ 42 for affected taxpayers that avail themselves of it.