Late on December 7, 2011 the IRS issued Fact Sheet 2011-13 (“Information for U.S. Citizens or Dual Citizens Residing Outside the U.S.”), which provides important guidance on two matters for taxpayers residing outside of the U.S.: first it gives insight into the type of facts that would support a “reasonable cause” argument for the abatement of penalties; second, it clarifies the procedure to bring current unfiled returns, thereby confirming the IRS’s disdain for “quiet disclosures”. The guidance provided by the Fact Sheet makes clear the importance of engaging a professional who is experienced in these matters.
Facts likely to support a “reasonable cause” argument for the abatement of penalties
Many of the penalties faced by individuals who haven’t filed their U.S. returns may be reduced to zero provided the taxpayer can prove reasonable cause for not filing. Reasonable cause is a legal doctrine, the application of which is determined by all of the facts and circumstances surrounding the taxpayer’s failure to file. Particular facts that support its application are found in case law, administrative interpretations, the statutes, and the treasury regulations.1
The taxpayer was unaware of his U.S. filing obligations
Depending on the particular facts, one of the theories that may support a finding of reasonable cause is that the taxpayer was unaware of his filing obligations. The Fact Sheet lists several facts that the IRS will, apparently, weigh more heavily than others in determining whether being unaware is sufficient to support the “reasonable cause” argument, including:
- The taxpayer’s education;
- Whether the taxpayer has previously been subject to the tax for which the return has not been filed;
- Whether the taxpayer has been penalized before;
- Whether there were recent changes in the tax forms or law the taxpayer could not reasonably be expected to know; and
- The level of complexity of a tax or compliance issue.
The Fact Sheet then gives several examples, the facts of which support a finding of reasonable cause, the most telling of which is Example 4. Under Example 4 the IRS concludes that reasonable cause is shown based on the following facts:
- The taxpayer complied with tax filing and payment obligations in his country of residence;
- He was previously unaware of his U.S. filing obligations;
- After discovering his U.S. filing obligations he filed his previously unfiled returns;
- He attached a statement to his returns setting forth his reasonable cause argument;
- He had a legitimate reason for maintaining non-U.S. accounts;
- There was no indication that he had taken efforts to intentionally conceal the reporting of income or assets; and
- There was no additional U.S. tax due.
In making the reasonable cause argument, it is critically important to analyze the facts, support the facts with affidavits or other evidence, and to make sure that the facts are supported by existing law. A U.S. lawyer who is experienced with the foregoing is an essential component to prevailing on reasonable cause argument.
Procedure to bring current unfiled returns: DO NOT ATTEMPT “QUIET DISCLOSURE”
The Fact Sheet states that if a taxpayer has not filed returns or foreign bank account reports (FBARs) he should immediately file the delinquent returns (6 years for the FBAR) and attach a statement with the filings that sets forth the reasonable cause argument. This guidance makes clear the IRS’s distain for “quiet disclosures.”
In the past many taxpayers have attempted to bring current their unfiled returns by simply filing the returns without notifying the IRS, this is what is referred to as a “quiet disclosure.” The IRS has publicly stated that it will not tolerate quiet disclosures and that those who attempt to bring their filing obligations current via quiet disclosure risk criminal prosecution. For example, in FAQ 15 of the Offshore Voluntary Disclosure Initiative (OVDI)2 the IRS stated:
“Those taxpayers making ‘quiet’ disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.”
The Fact Sheet makes clear that unfiled returns must be brought current and the IRS must be informed of the taxpayer’s actions, including his reasonable cause argument. By following these rules, the taxpayer will maximize the possibility of proving reasonable cause and thereby reducing his penalties to zero.
Other penalties may apply
The Fact Sheet addresses only the penalties that apply for failure to file FBARs and U.S. income tax returns. However, section 3 makes clear that other failure-to-file penalties may apply for other forms that have not been filed. These other forms include:
- Forms 3520 and 3520A, which are required for certain interests in non-U.S. trusts or estates and gifts or inheritances from non-U.S. persons;
- Forms 5471 and 8865, which are required for certain interests in non-U.S. corporations and partnerships;
- Forms 926 and 8865, which are required for certain transfers to non-U.S. corporations and partnerships; and
- Form 8938, which is a new form that is required to be filed beginning in 2012. The form must be filed by certain individuals who own non-U.S. accounts (much like the FBAR). There is a $10,000 penalty for failure to file this form.
The publication of the Fact Sheet is great news for individuals living outside the U.S. who are not current on their U.S. tax filing obligations because it gives some degree of certainty as to the facts that will support a reasonable cause argument for the abatement of penalties, and it also gives guidance as to the procedure to bring delinquent filings current.
1. e.g., United States v. Boyle, 469 U.S. 241, 250-251 (1985); Internal Revenue Code Section 6664(c); IRM 20.1.1; IRM 4.26.16; Treasury Regulation 1.6664-4.
2. See also, 2009 Offshore Voluntary Disclosure Program FAQ 10.