U.S. taxpayers (or estates of individual U.S. taxpayers) seeking to use the Streamlined Domestic Offshore Procedures must satisfy the following requirements:

(1) Fail to meet the non-residency requirement (for joint return filers, one or both spouses must fail to meet the non-residency requirement);

(2) Have previously filed a U.S. tax return (if required) for each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed;

(3) Have failed to report gross income from a foreign financial asset and pay tax as required by law. Even if the taxpayer reported gross income from the foreign asset and paid all taxes relating to that asset, this element is satisfied if the taxpayer failed to file an FBAR (FinCEN Form 114) and/or one or more international information returns with respect to the foreign financial asset. By information returns, the IRS is referring to Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621); and

(4) The failures enumerated in number three must have resulted from non-willful conduct. Non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

With respect to the second requirement, it is easy to overlook a subtle, yet rippling effect of this rule. Very simply, a U.S. taxpayer who has not filed a U.S. tax return in the last three years or filed a timely request for an extension to do so is ineligible for the streamlined domestic offshore program.

Definition of U.S. Taxpayer

U.S. taxpayers include the following groups of people: (1) U.S. citizens, (2) lawful permanent residents, and (3) those meeting the substantial presence test of IRC section 7701(b)(3).

Scope and Effect of Procedures

U.S. taxpayers who are eligible to use the Streamlined Domestic Offshore Procedures and wish to apply must submit the following information:

(1) For each of the most recent three years for which the U.S. tax return due date – or extended due date – has passed (the “covered tax return period”), file amended tax returns, together with all required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621);

(2) For each of the most recent six years for which the FBAR due date has passed (the “covered FBAR period”), file any delinquent FBARs; and

(3) Pay a miscellaneous offshore penalty. The full amount of the tax, interest, and miscellaneous offshore penalty should be submitted with the amended tax returns.

The miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance of the taxpayer’s foreign financial assets that are subject to the penalty during the years in the covered tax return period and the covered FBAR period. For this purpose, the highest aggregate balance is determined by tallying the year-end account balances and year-end asset values of all the foreign financial assets subject to the penalty for each of the years in the covered tax return period and the covered FBAR period and selecting the highest aggregate balance from among those years.

When is a foreign financial asset subject to the 5-percent offshore penalty in the covered FBAR period? If the asset should have been, but was not, reported on an FBAR in a year that falls within the FBAR period. The asset would be subject to the penalty in the year that it should have been, but was not, reported.

When is a foreign financial asset subject to the 5-percent offshore penalty in a given year in the covered tax return period? A foreign financial asset is subject to the 5-percent offshore penalty in a given year in the covered tax return period if at least one of the following conditions exists:

(1) The asset should have been, but was not, reported on a Form 8938 for that year; and/or

(2) The asset was properly reported for that year, but gross income from the asset was not reported in that year.

Foreign financial assets include any one of the following:

1. Financial accounts held at foreign financial institutions;
2. Financial accounts held at a foreign branch of a U.S. financial institution;
3. Foreign stock or securities not held in a financial account;
4. Foreign mutual funds; and
5. Foreign hedge funds and foreign private equity funds.

Under the Streamlined Domestic Offshore Procedures, eligible taxpayers will only have to pay the miscellaneous offshore penalty and will not be subject to accuracy-related penalties, information return penalties, or FBAR penalties.

Taxpayers should be aware that their returns could be selected for audit under existing audit selection processes. However, no accuracy-related penalties (relating to amounts reported on the return), information return penalties, or FBAR penalties will be assessed.

Immunity from penalties, even in the wake of an audit, comes with a few exceptions. It is a good idea to pay special attention because in the right circumstances, these exceptions could swallow up the rule. First, any previously assessed penalties relating to the years that are selected for audit will not be abated. Second, as with any U.S. tax return filed in the normal course, to the extent that the IRS determines an additional tax deficiency for a return submitted under these procedures, it may assert additional tax and penalties relating to that additional deficiency.

Finally, the IRS will unleash the full arsenal of penalties if the examination results in a determination that the original return was fraudulent and/or that the FBAR violation was willful.

For returns filed under these procedures, retroactive relief will be provided for failure to timely elect income deferral on certain retirement and savings plans where deferral is permitted by treaty. The proper deferral elections with respect to such plans must be made with the submission.