I.R.S. Penalties For Late Filing and Late Paying On Offshore Income

Ron Cohen, CPA, MST By Ron Cohen, CPA, MST
Greenstein, Rogoff, Olsen & Co., LLP

Doing business outside of the U.S.?  Have an Offshore bank account or Brokerage Account? Own more than 10% of a foreign country legal entity? (and some rules apply to even lower levels of ownership).

The I.R.S. maze of rules and arsenal of penalties is overwhelming; even for CPAs and tax lawyers who work on international taxes.

Make no mistake, the I.R.S. expects “transparency.”  There is a form to file or a regulation to follow where taxpayers have to disclose all offshore economic activities and commercial relationships.

The list below is a summary by the I.R.S. of the many of the penalties that can apply to Offshore Income.

Additional penalties apply related to “transfer pricing” for multinational businesses, that are not listed here.

Please call me at (510) 797-8661 x237 is you believe any of the below may apply to your tax situation and we can discuss what corrective actions you should take.

From the I.R.S.:

The following summary of potential reporting requirements and civil penalties is not necessarily all encompassing, and it is unlikely that any one taxpayer would be subject to all of the reporting obligations or penalties listed below:

(1) Penalties for failure to comply with the Bank Security Act requirement that United States persons report their financial interest in, or authority over, financial accounts located in a foreign country.

U.S. citizens, residents, and certain other persons, must annually report their financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account (such as a bank or investment account) that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. This reporting requirement is met by filing Form TD F 90-22.1 (Report of foreign Bank and Financial Accounts, commonly known as an “FBAR”). FBARs are filed with a Department of the Treasury facility located in Detroit and are not to be filed with tax returns; the filing date for FBARs is June 30th. The requirement to file FBARs is in the regulations under 31 U.S.C. § 5314 (which is a provision of the Bank Secrecy Act). Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account. Criminal penalties may also apply. Refer to IRM for additional FBAR penalty considerations.

(2) Fraud Penalties (Sections 6651(f) and 6663):

When an underpayment of tax, or failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.

(3) Failure to File Tax Return (Section 6651):

When a taxpayer is required to file a tax return and does not do so on or before the due date of the return, Section 6651(a)(1) imposes a penalty of 5 percent of the net tax amount required to be shown on the tax return for each month (or fraction of a month) that the amount is late. The maximum penalty is 25 percent. This penalty is increased to 15%, with a maximum of 75%, if the taxpayer’s failure to file is fraudulent.

(4) Failure to Pay tax Penalties (Sections 6651(a) (2) and 6651(a)(3)):

When a taxpayer fails to timely pay the amount of tax shown on the return, Section 6651(a)(2) imposes a late payment penalty equal to .5 percent of the late payment for each month (or part of a month) that the payment is late. The maximum penalty is 25 percent.

When a taxpayer fails to pay a tax that is required to be (but was not) shown on a return within 21 days after the date of the Service’s notice and demand for that tax, Section 6651(a)(3) imposes a penalty of .5 percent for each month (or part thereof) that the assessment remains unpaid. The maximum penalty is 25 percent.

(5) Accuracy- Related Penalty (Section 6662):

The accuracy-related penalty for underpayments in imposed at the rate of 20 percent on the portion of any underpayment of tax required to be shown on a return attributable to negligence, a substantial understatement of tax, a substantial overstatement of pension liabilities or a substantial estate or gift tax valuation understatement. The accuracy-related penalty with respect to a substantial valuation misstatement can be as high as 40 percent.

(6) Penalties for failure to file certain information returns (Sections 6035, 6038, 6038A, 6038B, 6038C, 6039F, 6046, 6046A, and 6048):

Form 5471. Information Return of U.S. Persons With Respect To Certain Foreign Corporations, U.S. persons who are officers, directors, or shareholders in certain foreign corporations (including, for example, an International Business Corporation used in an offshore scheme) report information required by Sections 6035, 6038, and 6046, and compute income from controlled foreign corporations under Sections 951-964. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

Form 5472. Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Reports transactions between a 25% foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by Sections 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, in $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

Form 926. Return by a U.S. Transferor of Property to a Foreign Corporation. Reports transfers of property to a foreign corporation and to report information under Section 6038B. The penalty for failing to file each of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.

Form 3520. Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts. Reports various transactions involving foreign trusts, including creation of a foreign trust by a U.S. person, transfers of property from a U.S. person to a foreign trust, and receipt of distributions from foreign trusts under Section 6048. This return also reports the receipt of gifts from foreign trusts under Section 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.

Form 3520-A. Annual Information Return of Foreign trust with a U.S. Owner. Reports ownership interests in foreign trusts, by U.S. persons with various interests in and powers over such trusts under Sections 6048(b). The penalty for failing to file each one of these information returns, or for filing an incomplete return, is five percent of the gross value of trust assets determined to be owned by the U.S. person.

Form 8865. Return of U.S. persons With Respect to Certain Foreign Partnerships. U.S. persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions, and changes in foreign partnership interests under Sections 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.

Update: 8/7/10

There’s a new disclosure rule as a result of the 2010 Hiring Incentives to Restore Employment Act (P.L. 111-147) signed into law March 18, 2010:

New Disclosure Rules
For tax years beginning after March 18, 2010, new Sec. 6038D requires individuals with an interest in a “specified foreign financial asset” during the tax year to attach a disclosure statement to their income tax return for any year in which the aggregate value of all such assets is greater than $50,000. Although the nature of the information required is similar to the information disclosed on an FBAR, it is not identical.

For example, a foreign trust beneficiary, not within the scope of the FBAR requirements because his trust interest is less than 50 percent, may be required to disclose this interest if its value, together with the value of other specified foreign financial assets, exceeds the aggregate value threshold.

These new rules are not a substitute for FBAR compliance, which are unchanged.

Specified Foreign Financial Assets
These assets are depository or custodial accounts at foreign financial institutions and, to the extent not held in such accounts, are:

  1. Stocks or securities issued by foreign persons;
  2. Any financial instrument or contract held for investment that has a foreign issuer or counterparty; and
  3. Any interest in a foreign entity.

The information to be included on the statement includes identifying information for each asset and its maximum value during the tax year.

More on this as the IRS lets us know what new form to use….


For tax years beginning after March 18, 2010, a new accuracy-related penalty is added to Sec. 6662. This new provision, which is subject to the same defenses otherwise available under Sec. 6662, imposes a 40 percent penalty on any understatement attributable to an undisclosed foreign financial asset.

The term “undisclosed foreign financial asset” includes all assets subject to certain information reporting requirements for which the required information was not provided by the taxpayer as required under the applicable reporting provisions. These requirements include:

  • Information reporting with respect to certain foreign corporations and partnerships under Sec. 6038; (From Ron: Form 5471 and 8865)
  • Information with respect to certain foreign-owned corporations under Sec. 6038A; (From Ron: Form 5472)
  • Information with respect to foreign financial assets under new Sec. 6038D; (From Ron: They should have a new form coming out)
  • Returns as to interests in foreign partnerships under Sec. 6046A; and (From Ron: Form 8865)
  • Information with respect to certain foreign trusts under Sec. 6048. (From Ron: Form 3520)

An understatement is attributable to an undisclosed foreign financial asset if it is attributable to any transaction involving such asset. Thus, a U.S. person who fails to comply with the various self-reporting requirements for a foreign financial asset and engages in a transaction regarding that asset incurs a penalty on any resulting underpayment that is double the otherwise applicable penalty for substantial understatements or negligence.

For example, if a taxpayer fails to disclose amounts held in a foreign financial account, any underpayment of tax related to the transaction that gave rise to the income would be subject to this penalty, as would any underpayment related to interest, dividends or other returns accrued on these undisclosed amounts.

Extended Statute of Limitations
The new law authorizes a six-year limitation period for assessment of tax on understatements of income attributable to foreign financial assets. The six-year period for omitting an amount exceeding 25 percent of the gross income reported on the return is unchanged.

This change applies to returns filed after March 18, 2010, as well as for other returns for which the Sec. 6501 assessment period has not expired as of March 18, 2010.

Note: The tax community is in shock over the statue of limitations issue. It appears, that if a simple, small Form 5471 for a small foreign corporation is left out of a tax return by mistake, or is incomplete, the statute of limitations remains open, not just for the Form 5471 information, but for the entire tax return, FOREVER, until the years after the unfiled Form 5471 is filed. For those of you in large corporations, this is a major FAS 109, FIN 48 exposure.