The Streamlined Foreign Offshore Procedure: From A to Z
The Streamlined Foreign Offshore Procedure (SFOP) was developed by the IRS to address noncompliance with the foreign financial assets reporting requirements, an omission of a foreign-source income or a failure to file certain information returns. The streamlined procedure is available to US citizens, expatriates and residents whose noncompliance with the internal revenue laws was not borne by a willful conduct or an attempt to avoid paying taxes in the United States. If you have resided outside the United States and you failed to file returns or under-reported foreign-source income, the SFOP is the shortest way to regain compliance without the burden of severe penalties. So what is the fuss about it?
The SFOP is a tax compliance incentive introduced by the IRS on September 1st, 2012. The incentive was subsequently modified to accommodate a broader group of U.S. taxpayers. The SFOP aims to bring back to compliance U.S. taxpayers who have a record of delinquent or inaccurate individual tax returns and
1) failed to report income from foreign financial assets on a 1040 tax return; or
2) failed to report foreign financial assets on the FBAR Form 114, FATCA Form 8938, or both; or
3) failed to file certain foreign business or trust information returns, such as Forms 926, 5471, 3520 and the like.
If you believe you fall within any of the above groups, the SFOP might be the answer to your needs. But it comes with a bunch of regulatory requirements and restrictions. U.S. citizens, residents, and estates of U.S. citizens and residents must meet three eligibility criteria.
First, the taxpayer must have been physically present outside the United States for at least 330 days in at least one of the previous three calendar years. The first requirement is close to the Physical Presence Test that US expatriates pass to qualify for the foreign earned income exclusion. It requires a mere presence in one or more foreign countries for at least 330 days in any twelve month period that starts or ends in any of the previous three calendar years.
The second requirement aims to restrict access to the program to otherwise qualifying citizens and expats who have maintained a place of abode within the United States. The term place of abode is defined broadly to encompass the location of the home, residence or dwelling to which your personal, family and economic ties are stronger than to other places. Thus, vacation and rental homes in the United States do not count as a place of abode if you have stronger ties to another location. Moreover, even if you have a place of residence within the United States you may still qualify under the terms of the Streamlined Domestic Offshore Procedure (SDOP).
The final provision requires a taxpayer to certify that the failure to file a return or report income was not willful. For instance, taxpayers who failed to file a return or statement due to a medical condition or because of an erroneous advice of a tax preparer or any other reasonable cause will qualify. Negligence, inadvertence or a simple mistake made on a return does also qualify. Finally, a tax return position that was the result of a good faith misunderstanding of the requirements of the law will also be classified as accidental.
It is important to note that married taxpayers, filing a joint return together, must both meet the above three eligibility requirements. On top, if the IRS has already started an audit of any of the returns in question, the taxpayer would no longer qualify even if the examination is not triggered by undisclosed foreign financial assets. In such an event, it is advisable to refer to the Offshore Voluntary Disclosure Program (OVDP) or any of its predecessor programs.
Taxpayers who meet the eligibility requirements must follow the specific instructions of the Streamlined Foreign Offshore Procedure. Start the process by obtaining Form 14653 "Certification by U.S. Person Residing Outside of the United States for Streamlined Foreign Offshore Procedures." The form provides additional guidance about the procedure and is used to describe your circumstances in detail. Moreover, you will need to certify that you are a qualifying individual under the terms of the procedure. It is also a transmittal for all delinquent returns that you are required to file under the provisions of the SFOP.
Once you familiarize yourself with Form 14653, start preparing delinquent 1040 tax returns for the most recent three tax years for which the return due date has passed. You are also required to attach all applicable information returns, such as Forms 926, 5471, 8865, 8868, 8938, and so on. If you have already filed an inaccurate return for any of the previous three years, prepare an amended return on Form 1040X.
Besides, you will need to file Foreign Bank Account Reports (FBAR) on Form 114 for the most recent six tax years. The FBAR is filed electronically with the FinCEN and is not part of your income tax return. However, the information reported on the FBAR must coincide with the income reported on the return. Therefore, make sure that any item of income, gain or loss from foreign financial accounts is also reflected on the 1040 income tax returns. Finally, you will be asked to provide an explanation for filing the FBAR late. Select "Other" from the drop-down menu and enter "Streamlined Foreign Offshore Procedures" in the answer box.
When the returns and the FBAR forms are ready, you may start completing Form 14653. First, enter your name, address and identifying information. Record the amount you owe for each of the previous three years and enter it on the form. Compute the interest due on the amount calculated in the previous step and enter it too. The form will automatically calculate the total amount due based on your entries.
Next, provide a detailed explanation of the circumstances surrounding the failure to the file returns on time or the omission of income. Recall that the facts must clearly indicate that your conduct was not willful. Consequently, provide a factual explanation of your personal and financial background, including information about the source of funds held in each foreign financial account. If you relied on an erroneous advice by a tax return preparer or an IRS officer, disclose the name and contact information of the person involved and include a summary of your conversation. Attach additional records that may reinforce your position. For instance, provide medical records if you failed to file due to a medical condition or a letter from a tax preparer advising that filing a return or statement is not required.
Finally, sign and date the Certification Form 14653. A copy of the form must be attached to each of the delinquent returns. The returns must be filed on paper and include the wording "Streamlined Foreign Offshore" on top. This labeling is required to ensure your returns are delivered to the IRS department dealing with the program. Mail the returns and the certification Form 14653 to the Internal Revenue Service office dealing with the SFOP.
In conclusion, the Streamlined Foreign Offshore Procedure is a convenient way to bring expats and US citizens residing overseas back to compliance with the internal revenue laws. It pledges unconditional acceptance to all taxpayers who meet the eligibility requirements. The most positive outcome of the program is the discharge of the severe penalties that follow a failure to disclose foreign financial assets and accounts. All in all, the SFOP is a great initiative that assures a fresh start for qualifying taxpayers.