Various options are available to correct the problem of missing information returns for U.S. taxpayers having an interest in any offshore/foreign assets and holdings such as Form 8938, Form 5471, Form 3520, and Form 3520-A. Failure to file these forms does not result in underpayment of any income or other tax liabilities, they are simply “informational” returns that provide heaps of data to the IRS. Penalties for failures are stiff and can range from a minimum of $10,000 to several million dollars.
The Delinquent Information Submission Procedure, or DISP, provides a possible penalty-free opportunity to US taxpayers who do not need to use the Offshore Voluntary Disclosure Program or the Streamlined Filing Compliance Procedures to file delinquent international information returns if they had “reasonable cause” for the tax noncompliance. Taxpayers wishing to use the DISP cannot be under a civil examination or a criminal investigation by the IRS and cannot have already been contacted by the IRS about the delinquency. Taxpayers using the DISP are to attach a “reasonable cause statement” explaining the facts to each delinquent information return filed.
In using the DISP, there is no guarantee the reasonable cause statement will be reviewed, processed, or even considered. Despite using the DISP, these reporting penalties are often assessed systemically or semi-systemically. Essentially, that means that the penalties are automatically imposed. This puts the taxpayer in the position of having to present the reasonable cause position to the IRS with no assurance it will be timely heard, especially given current IRS backlogs. Meanwhile, the IRS may still collect the penalty.
Undue Taxpayer Stress
The number of these kinds of cases has been increasing. The Taxpayer Advocate specifically addressed these reporting penalties and categorized this issue as “Most Serious Problem #8: International” in her 2020 National Taxpayer Advocate Report to Congress. In that Annual Report to Congress, it was noted that 9,889 penalties were assessed in 2018 totaling $253,087,500; yet 5,468 abatements totaling $179,532,000 were ultimately granted. The abatement percentage by number was 55%, while the abatement percentage by dollar was 71%. The abatement percentages in 2016 were 67% and 88%, respectively.
In other words, simply from the agency perspective, the IRS is wasting precious time and resources by adhering to the “automatic” penalty assessment. Hapless taxpayers must seek abatement through Appeals or Taxpayer Advocate Office assistance. The time it takes to reach a final determination typically exceeds one year and, in most cases requires the taxpayer to engage professional tax advice to pursue penalty relief. This is a huge burden on the taxpayer.
The icing on the cake? The IRS summary assessment procedure for such penalties probably exceeds statutory authority. In the view of the National Taxpayer Advocate, among others, these information return penalties are not of the type that the tax law permits to be systemically imposed. Rather, it is believed they are of the type subject to the safeguards of deficiency procedures, meaning that the taxpayer will receive a notice of deficiency and explanation as to the possible options to address the matter.
IRS Wakeup Call
The IRS is now taking notice. In the Internal Revenue Service Advisory Council Public Report, November 21 2021, the IRS Advisory Council, or IRSAC, may finally cause IRS to see the light and become more “reasonable” on this issue with a possible change in IRS procedure on the horizon. Let’s hope so. Here’s a snapshot of what IRSAC had to say.
U.S. Taxpayers Abroad
The IRSAC Report noted several important points faced by many Americans abroad who have been assessed penalties for failures in reporting foreign holdings. Reasons include foreign tax deadlines not coinciding with U.S. filing deadlines and final accounting information being unavailable until after the U.S. deadline has passed. Some countries require that information be reported on a fiscal year beginning with the date an entity was created rather than on a calendar or natural business year basis. Numerous foreign companies will maintain their accounting records in accordance with the reporting period required by the country of residence. In those circumstances, information also may not be available in time for the U.S. filing deadline.
In another common circumstance that causes problems, IRSAC noted U.S. individuals may be the recipient of gifts or inheritance from foreign individuals yet lack any indication from bank information that the distribution was from a foreign trust or that they have been named a beneficiary requiring additional information reporting. In many jurisdictions, foreign bank transactions and trusts are subject to secrecy laws limiting permissible disclosure of information that is critical to accurate information reporting by U.S. individuals.
The IRSAC Report also highlighted the reality of poor tax advice, which I have seen is particularly the case with respect to U.S. international tax issues. The taxpayer may have sought professional tax advice, which was erroneous, but even this is not enough to abate penalties. One common example is misunderstanding that gifted or inherited amounts generally may not be taxable, yet still may be reportable if received from a foreign person.
According to the IRSAC Report, "[C]urrently, the IRS does not consider the inability to obtain information because of foreign secrecy laws or incorrect tax advice to constitute reasonable cause for failure to file or incomplete foreign information returns.” It recognized that these factors are essentially beyond the control of the taxpayer despite best efforts.
The IRSAC made some concrete suggestions:
- IRS should consider the reasonable cause statement submitted by the taxpayer before penalties are automatically assessed and, provide taxpayers a ninety-day grace period with a temporary hold on collection activity to remedy information reporting deficiencies after initial filing.
- The IRS should consider developing a uniform reasonable cause statement and information template that provides taxpayers and their advisors with valuable guidance on how best to submit information useful for IRS review and consideration and avoid follow-up requests that delay resolution.
Yea for IRSAC! Let’s hope this—and much more—will happen to help the American abroad who is all too often faced with near impossible tax compliance hurdles.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
With over 35 years of U.S. tax and international experience, Virginia La Torre Jeker has been a member of the NYS Bar since 1984. Virginia has been practicing U.S. tax overseas since 1986. After spending 15 years in Hong Kong, she has been in Dubai since 2001. She provides expert insight into the latest changes in American tax laws and outlines the U.S. tax obligations of American expats and foreign individuals with U.S. connections.
We’d love to hear your smart, original take: Write for Us
To contact the reporter on this story: