The Title 26 Miscellaneous Offshore Penalty (“Miscellaneous Offshore Penalty”) is one of the most critical aspects of the Streamlined Domestic Offshore Procedures (“SDOP”). In this article, I want to conduct a general overview of how the Miscellaneous Offshore Penalty is calculated.
As a side note, it is important to keep in mind that this is an educational article which aims to provide a general overview of the calculation of the Miscellaneous Offshore Penalty in common situations. In providing this general overview of the SDOP Miscellaneous Offshore Penalty, the article necessarily glosses over some complex issues that may change the determination of Miscellaneous Offshore Penalty in a particular case. In order to calculate your Miscellaneous Offshore Penalty properly, the readers should contact an experienced international tax attorney for a legal advice based on their specific facts and circumstances.
What is Miscellaneous Offshore Penalty?
A taxpayer who enters SDOP is required to pay a 5% Miscellaneous Offshore Penalty as part of the SDOP requirements. The Miscellaneous Offshore Penalty is paid in lieu of the penalties associated with the delinquent filings of FBARs, Forms 8938 and other information returns.
The calculation of SDOP Miscellaneous Offshore Penalty is very different from 2014 OVDP calculation in terms of the relevant time period and the penalty base. (Note: OVDP is now closed). Let’s explore each of these factors.
Miscellaneous Offshore Penalty: Time Period
Miscellaneous Offshore Penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. Generally, this means that the Miscellaneous Offshore Penalty is imposed on the past six years covered by the FBAR statute of limitations.
However, there is an exception where the three-year tax covered tax return period does not completely overlap with the six-year covered FBAR period. For example, the SDOP disclosure for tax returns covers years 2012 and 2014 because the due date for the 2014 tax return is passed, but the FBAR period is 2008-2013 because the due date for the 2014 FBAR has not passed. In such cases, the Miscellaneous Offshore Penalty is imposed on the highest aggregate value of the foreign financial assets for the past seven years.
In most cases, six years will be the standard time period for the calculation of the Miscellaneous Offshore Penalty, which is a lot better than the 2014 OVDP eight-year disclosure period.
Miscellaneous Offshore Penalty: Penalty Base
In general, the Miscellaneous Offshore Penalty is imposed on any foreign financial asset in a given year within the covered SDOP time period if one of the following is true:
1. The asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year;
2. The asset should have been, but was not, reported on a Form 8938 for that year; or
3. If the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.
Two important features of this calculation of the penalty base under SDOP must be emphasized. First, the Miscellaneous Offshore Penalty should be calculated not only on the foreign bank and financial accounts listed on the FBAR, but also on “other specified assets” required to be listed on Form 8938. This means that many more assets outside of a foreign financial account can now be subject to the Miscellaneous Offshore Penalty . Examples of such assets include but not limited to: foreign stocks not held in a financial account, a capital or profits interest in a foreign partnership, certain forms of indebtedness issued by a foreign person (such as a note, bond, debenture, an interest in a foreign trust, foreign swaps, foreign options, foreign derivatives and other assets. It should be remembered, though, that this is a generalization and, in certain circumstances, an international tax attorney may except certain such assets from Miscellaneous Offshore Penalty base.
The second critical difference between SDOP Miscellaneous Offshore Penalty and 2014 OVDP Offshore Penalty is the inclusion in the calculation of the penalty base the assets for which no additional income needs to be reported. There are a lot of nuances with respect to the exclusion and inclusion of assets under the 2014 OVDP which are beyond the scope of this article. For the purposes of the present discussion, I will ignore them and concentrate on the general rule only (again, this is an area that should be explored with an international tax attorney based on the specific facts of a client’s case) that if an asset should have been reported on Forms 8938 and FinCEN Form 114 and it was not, then, it should be included in the penalty base.
Miscellaneous Offshore Penalty: Calculation of Highest Aggregate Value of Assets
As it was mentioned above, the Miscellaneous Offshore Penalty is calculated based on the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period. The issue is how this “highest aggregate balance/value of assets” is calculated.
For the purposes of SDOP Miscellaneous Offshore Penalty, the highest aggregate balance/value is determined by a two-step process. First, you need to aggregate the year-end account balances and year-end asset values of all the foreign financial assets subject to the miscellaneous offshore penalty for each of the years in the covered tax return period and the covered FBAR period. Then, you select the highest aggregate balance/value from among those years and calculate the 5% value of this balance.
It is the first step that is radically different from the 2014 OVDP Offshore Penalty determination process, and it can produce very interesting results especially in the case of bank accounts. The most surprising result is that an account that was closed in one of the covered years is likely to produce a zero end-of-year balance irrespective of how much money was on it prior to December 31.
This factor can be a very important consideration when one decides to participate in SDOP. For this reason, I highly encourage the readers to consult an experienced international tax lawyer in these matters.
Contact Sherayzen Law Office for Professional Help with Your Undisclosed Foreign Assets
If you have undisclosed foreign accounts and any other assets, contact Sherayzen Law Office for professional legal and tax help. Our team of experienced tax professionals will thoroughly analyze your case, estimate your current penalty exposure, identify the offshore voluntary disclosure options available to you, prepare all legal documents and tax forms (including amended tax returns) needed in your case, rigorously defend your interests in front of the IRS, and guide you through the entire voluntary disclosure process.