Despite its appearances, the calculation of the Streamlined Domestic Offshore Procedures Title 26 Miscellaneous Offshore Penalty (“Streamlined Five Percent Offshore Penalty) may actually be a complex process. Moreover, the correct calculation of the Streamlined Five Percent Offshore Penalty may lead to some paradoxical conclusions, including a preference for the OVDP Penalty (now closed). Due to the complexity of the calculation of the Streamlined Five Percent Offshore Penalty, this process should be handled by an experienced international tax lawyer. Nevertheless, in this article, I will outline some of the general contours of this process for educational purposes only.
General Calculation of the Streamlined Five Percent Offshore Penalty
The calculation of the Streamlined Five Percent Offshore Penalty is a three-step process. First, you need to identify the Penalty Base. Second, you need to determine the December 31 value of each asset included in the Penalty Base and enter these values into Form 14654. Finally, you need to determine the aggregate value of these assets per year and apply the Streamlined Five Percent Offshore Penalty to the highest aggregate value.
Penalty Base of the Streamlined Five Percent Offshore Penalty
The first and most important step in the calculation is determining the Penalty Base. I strongly advise retaining an international tax lawyer to do this calculation for you; neither the accountants nor the clients themselves should be trusted with this task, because it requires a legal determination of what assets need to be included in the Penalty Base for the Streamlined Five Percent Offshore Penalty.
In general, however, the Penalty Base consists of all foreign assets that are subject to the Streamlined Five Percent Offshore Penalty – i.e. a legal determination needs to be made with respect to which assets need to be included in the calculation of this penalty and which assets do not need to be included.
This determination needs be made with respect to assets that the taxpayer had in each of the last six years – this is called the voluntary disclosure period. For example, in general, the voluntary disclosure period for taxpayers who are filing their voluntary disclosure under the Streamlined Domestic Offshore Procedures in March of 2016 will be calendar years 2009-2014.
After a few changes in its position, the IRS finally established its position on the calculation of the Penalty Base and it is frightfully broad. In general, the Penalty Base for the Streamlined Five Percent Offshore Penalty consists of three types of assets. First, it includes, for each of the six years in the voluntary disclosure period, all foreign financial accounts (as determined by the FBAR rules) in which the taxpayer has a personal financial interest and which should have been, but were not reported, on an FBAR.
The second class of assets, consists of all foreign financial assets (as defined in the instructions for Form 8938) in which the taxpayer has a personal financial interest and that should have been, but were not, reported on Form 8938. Note here the difference in the number of years applicable to this asset class – only in each of the three years in the covered tax return period (i.e. in our example above, in general, it would be years 2012-2014; however, if the 2015 tax return was filed, then, the covered tax return period could shift to 2013-2015). This is very different from the first class of assets reportable on the FBARs. The difference is due to the fact that the Streamlined Domestic Offshore Procedures only require the tax returns to be filed for the past three years, while the FBAR covers the past six years.
This second class of assets is the most problematic, because Form 8938 is very broad and covers a wide range of assets, including interests in foreign businesses and foreign trusts. Moreover, the Streamlined Five Percent Offshore Penalty is even applicable to the assets that are reportable on Forms 3520, 5471, 8621 and other forms which are linked to Form 8938 – i.e. foreign financial assets that would be reportable on Form 8938 had it not been for the provision in Form 8938 instructions designed to eliminate the burden of the duplicate reporting. Other complications may arise with respect to the spectrum of assets that should be included in this second category of the Penalty Base.
The third class of assets includes all foreign financial accounts and other foreign financial assets that were reported on the FBAR and Form 8938, but the gross income for these accounts and assets was not reported in that year. This is called income tax non-compliance.
Valuation of Assets for Streamlined Five Percent Offshore Penalty
After your international tax lawyer determines the assets that need to be included in the Penalty Base, the next step is to value these assets in order to enter them into Form 14654 (here, if you have numerous assets, I recommend that your lawyer creates an attachment that includes all required information). There are two important issues that one must remember with respect to asset valuation for the purpose of calculating the Streamlined Five Percent Offshore Penalty.
First, your lawyer should value the assets as of December 31 value of the applicable year; the IRS is not looking for the highest value of an asset, just the December 31 value. This is easy to do with respect to foreign financial accounts, but the problems arise with respect to other assets included in the Penalty Base, which leads us to the second issue.
Second, special rules apply to valuation of ownership of foreign disregarded entities, corporations and trusts. A reasonable valuation method should be used in making these determinations. Oftentimes, the balance sheet of Form 5471 can be used; however, sometimes an event (for example, a sale of corporate stock) may occur which provides a reasonable value for the stock. Remember, however, the valuation should be done as of December 31. This means that, if the stock is sold on December 30, the value of the stock (for the purpose of the year in which the stock is sold) would be zero.
Application of the Streamlined Five Percent Offshore Penalty to the Highest Aggregate Balance
The last step in the Streamlined Offshore Five Percent Penalty calculation is the easiest. Once the asset values included in the Penalty Base are properly valued and entered into Form 14654, the international tax lawyer needs to add-up the totals for each year and determine the highest aggregate amount among the years. Then, the lawyer should apply the Streamlined Five Percent Offshore Penalty to the highest aggregate balance – this is the amount due to the IRS.
Contact Sherayzen Law Office for Help With Your Voluntary Disclosure Under the Streamlined Domestic Offshore Procedures
The determination of the Streamlined Five Percent Offshore Penalty may be a difficult and tricky process and you need an international tax lawyer to do it. Moreover, the actual choice of the type of voluntary disclosure that a taxpayer should pursue needs be analyzed by an experienced attorney.
Sherayzen Law Office is a leading offshore voluntary disclosure law firm in the world with clients in virtually every continent. We have helped hundreds of US taxpayers to bring their US tax affairs into full compliance with US tax laws and we can help You!