Civil International Tax Penalties
When it comes to IRS international reporting of foreign accounts, assets, investments, and income, one of the key factors motivating taxpayers to get into (or remain) in tax compliance is the sheer magnitude of the offshore penalties involved when a person files late — or does not file at all. For example, when a person receives a gift from a foreign person — even a family member such as a parent or other relative — and they do not properly report the gift, they could become subject to a 25% penalty on the value of the gift. Likewise, US persons who have foreign accounts that they did not properly report on the annual FBAR, may become subject to extreme fines and penalties, depending on whether the violation is considered willful or non-willful — and which circuit the taxpayer resides in. Let’s take a brief look at five (5) important facts about civil international penalties.
Penalties are Not Based on Income
One very common misconception about international IRS penalties is that taxpayers are only penalized on the tax implications of missed reporting for foreign assets or gifts, but that is incorrect. In fact, most civil international penalties are issued for missed reporting of assets that have nothing to do with taxes — such as gifts, trusts, and foreign accounts that do not generate much of any income.
Most international-related penalties are categorized as ‘assessable penalties’. This means that more often than not, the first notice that a taxpayer receives about a foreign penalty is when they receive a CP15 Notice. In other words, taxpayers will usually not have the opportunity to dispute the penalty before it is issued — but instead their first bite of the apple will be on the defensive when submitting a protest to the CP15 Notice.
The Initial Protest is a Big Hurdle to Overcome
When a Taxpayer receives a CP15 notice for an international penalty, they typically have 30 days to respond. Unfortunately, oftentimes the IRS Agent that receives the initial protest letter may not have the authority (or simply not want) to abate a six or seven-figure penalty. Still, Taxpayers should submit a well-crafted, persuasive protest letter in order to fight the good fight for later submissions.
CDP or Appeal (or Both)
If the protest letter is rejected, Taxpayers generally have the opportunity to appeal the matter to the IRS Office of Appeals before they have a chance to pursue a CDP (Collection Due Process Hearing). In general, the CDP is preferred to the appeal – and while the CDP has its own set of complexities (such as the IRS issuance of a Notice of Federal Tax Lien), it paves an easier path for the Taxpayer to continue onto Tax Court if necessary. While there is no hard and fast rule that says a taxpayer who pursues an appeal is automatically prevented from submitting a CDP later down the road on the same issue, the IRS will often take the position that the initial appeal was the hearing – and that Taxpayers are not entitled to a second bite at the apple with a CDP Hearing.
Is Tax Court Available?
Tax Court may be available in some situations, but not in others. Generally, FBAR disputes are handled in Federal Court. While circuits are split on how penalties for FBAR should be handled, there is currently a case at the Supreme Court (Bittner) on the issue of civil non-willful FBAR violations.
Current Year vs Prior Year Non-Compliance
Once a taxpayer misses the reporting requirements for prior years, they will want to be careful before submitting their current year’s international reporting forms. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely FBARs, taxpayers should consider speaking with a Board-Certified Tax Law Specialist that specializes exclusively in these types of offshore disclosure matters.