As the world grows smaller, U.S. taxpayers continue to expand their reach into foreign jurisdictions. In addition, more foreign residents are choosing to make the U.S. their home, bringing with them ownership in foreign entities or interests in foreign bank accounts. Often, these taxpayers learn of various U.S. information return obligations—e.g., IRS Forms 8938, 5471, 8865, and FBARs—after applicable filing deadlines have passed, resulting in costly late-filing penalties.
For more than a decade, however, the IRS has offered a compliance initiative known as the Streamlined Filing Compliance Procedures (SFCP). Under its current iteration, eligible taxpayers can avoid late-filing information return penalties (and other penalties) via one of two available SFCP programs: the Streamlined Foreign Offshore Procedures (SFOP) and the Streamlined Domestic Offshore Procedures (SDOP).
What Is The Difference Between the SFOP and the SDOP?
The key distinction between the SFOP and the SDOP relates to the taxpayer’s residency in the U.S. during a three-year lookback period. For these purposes, the three-year period consists of the most recent three tax years ending with the tax year in which a U.S. tax return deadline has passed, taking into account proper extensions of time to file.
U.S. citizens and green-card holders qualify for the SFOP if they: (i) are physically outside the U.S. for at least 330 days in any one tax year in the three-year lookback period; and (ii) do not have a U.S. abode at any time in the three-year window. Individuals who are not U.S. citizens or green-card holders also meet the residency requirements of the SFOP if they do not meet the substantial-presence test under section 7701(b) in the same three-year period.
Taxpayers who do not meet the SFOP residency tests can only participate in the SDOP, assuming they also meet the other SDOP requirements. As discussed below, the SFOP has reduced offshore penalties and less stringent prior-year filing requirements than the SDOP.
Are There Other Requirements Under the SFOP And the SDOP?
The SFOP and the SDOP both have general requirements. First, the taxpayer must be an individual or an estate of an individual. Entities do not qualify.
Second, the taxpayer must certify under penalties of perjury that the failure to report foreign income and the failure to file foreign information returns was due to non-willful conduct. Taxpayers should be careful here regarding the meaning of non-willful. According to the IRS, non-willful conduct means negligence, inadvertence, or mistake or conduct that resulted from a good-faith misunderstanding of the requirements of law. Conversely, federal courts and the IRS have defined willfulness to include not only intentional violations but also objectively reckless ones. There is an extremely fine line between non-willful conduct and objective recklessness.
Third, the taxpayer must submit the streamlined submission prior to the IRS initiating a civil or criminal investigation of the taxpayer. Taxpayers who receive an audit notice prior to making a streamlined submission are generally prohibited from entering the program, even if the audit notice does not relate to the undisclosed foreign assets.
Fourth, the taxpayer must have a valid Taxpayer Identification Number (TIN).
Fifth, the taxpayer must have failed to report gross income from a foreign financial asset.
In addition to the five general requirements above, there is an additional requirement that applies to the SDOP. Specifically, taxpayers who wish to enter into the SDOP must have filed U.S. income tax returns for each year in the three-year lookback period unless they did not have a filing obligation. The SFOP has no similar eligibility requirement—i.e., these taxpayers may file original returns.
What Information Is Included With A SFCP Submission?
Under the SFCP (either the SFOP or the SDOP), taxpayers must submit the following to the IRS: (1) three years of original or amended income tax returns (as applicable), which must include the delinquent international information returns; (2) six years of FBARs; and (3) an IRS Form 14653, Certification by U.S. Person Residing Outside of the U.S., for SFOP filings and an IRS Form 14654, Certification by U.S. Person Residing in the U.S., for SDOP filings. The Forms 14653 and 14654 require a narrative, signed under penalties of perjury, for disclosure of relevant facts to support the asserted non-willful conduct.
Moreover, these taxpayers must pay all U.S. income tax and interest owed for the three-year lookback period.
What Are The Benefits of the SFCP?
There are numerous benefits to making a submission under the SFCP. Under both the SFOP and the SDOP, taxpayers are not required to pay civil penalties associated with any late-filed information returns (e.g., FBARs) or any accuracy-related, late-filing, or late-payment penalties. In fact, taxpayers who qualify under the SFOP do not have to pay any civil penalties at all.
However, taxpayers who make an SDOP submission must pay a 5% miscellaneous offshore penalty, which is computed based on the value of the undisclosed foreign assets. Generally, this 5% penalty is computed based on: (i) the value of any foreign assets that should have been, but were not, reported on an FBAR or an IRS Form 8938, and (ii) the value of any disclosed assets in which the taxpayer failed to properly report gross income. For these purposes, the penalty can cover a six-year lookback period but applies only to the highest aggregate end-of-year balance during that period (i.e., only to one tax year).
Although the SDOP requires payment of a 5% miscellaneous offshore penalty, this penalty is usually much less than other potential civil penalties that could apply outside the program. For example, a non-willful FBAR penalty alone can be $10,000 per year (indexed for inflation), up to six years.
Because the SFCP offers reduced civil penalties, taxpayers are wise to at least consider this program as a means to regain compliance with their federal tax reporting obligations.
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