Over the past twenty years, the U.S. has significantly increased the penalties associated with failing to report certain foreign-related transactions, and it has created new filing requirements that have their own associated penalties. The increase in penalties has occurred for tax return filing requirements as well for the FBAR (FinCEN Form 114, formerly TD F 90-22.1).
The chart above (PDF) shows the penalties that an individual could be subject to in selected years if the taxpayer fails to file certain tax forms and the FBAR.
We have created a simple scenario that illustrates the escalation of penalties:
- A non-U.S. citizen individual became a U.S. tax resident in July during the year.
- In September of the year prior to becoming a U.S. resident, the individual formed a foreign grantor trust and contributed $25,000 to the foreign trust. The foreign trust holds the $25,000 in one bank account.
- The individual owned 100% of a foreign corporation.
- The individual owned 51% of a foreign partnership.
In the individual’s first year of U.S. tax residency, the individual fails to file certain forms (such as the FBAR, Forms 3520, 3520-A, 5471, 8865, 8938), but does not have reasonable cause for failing to file the forms. The taxpayer did not willfully fail to file the FBAR.
In 1995, the individual was only required to file two forms (the FBAR and Form 5471) and would be subject to penalties totaling $2,000. In 2011, the same individual was required to file six forms (the FBAR, Forms 3520, 3520-A, 5471, 8865, 8938) and would be subject to penalties totaling $70,000.
A Brief History of the Penalty Increases
In 1995, the individual’s failure to file Form 5471 could result in two $1,000 penalties (failure to report becoming a U.S. person while owning at least 5% of a foreign corporation [the threshold became 10% in 1998] and failure to report control of a foreign corporation).
The increases in penalties include:
- Starting in 1996, the transfer to the foreign trust made in the year preceding U.S. residency is deemed to have been made on the day the individual became a U.S. person (rather than prior to U.S. residency). See Code §679(a)(4). The unreported transfer to the foreign trust could result in a penalty of 5% of the amount transferred to the trust, but such penalty was capped at $1,000.
- Starting in 1996, a penalty of 5% of the value of the trust could be imposed for failing to report a U.S. owner of a foreign trust.
- Starting in 1996, the penalty for unreported transfers to foreign trusts was increased to 35% of the unreported amount. In the case of $25,000 being transferred to a foreign trust, the penalty would be $8,750.
- Starting in 1998, a penalty of $10,000 could be imposed for failing to file Form 8865 with respect to a controlled foreign partnership.
- Starting in 1998, the two penalties for failing to file Form 5471 were each increased to $10,000.
- Starting in 2005, a penalty of $10,000 could be imposed for non-willfully failing to file the FBAR.
- Starting in 2010, the penalty for failing to report a U.S. owner of a foreign trust increased to the greater of $10,000 or 5% of the value of the trust.
- Starting in 2010, the penalty for unreported transfers to foreign trusts was increased to the greater of $10,000 or 35% of the amount transferred to the foreign trust.
- Starting in 2011, a penalty of $10,000 could be imposed for failing to report foreign financial assets on Form 8938.
The increasing burden of U.S. tax compliance and increasing cost of non-compliance over the past twenty years is likely contributing to the increased incidence of expatriation.