Delinquent International Information Tax Returns May Extend the Statute of Limitations on Your Entire Federal Tax Return

More and more, U.S. taxpayers are becoming aware of their federal tax reporting obligation for foreign financial accounts, interests and assets. With increased IRS enforcement, broader media coverage of international tax evasion cases, and the implementation of FATCA reporting[1] by foreign financial institutions, the term “FBAR”[2] no longer elicits the unknowing stares it once did. Taxpayers have also become familiarized with IRS Form 8938: Statement of Foreign Financial Assets.[3]

Despite taxpayer’s increased efforts to comply, filing an FBAR and/or Form 8938 may not be enough. Taxpayers may also be required to file additional international information returns depending on the type of foreign accounts, interests or assets they hold.

In most instances, these forms do not create additional tax liability to the taxpayer; they are simply for reporting purposes. However, failure to timely file required international information returns can be detrimental to the taxpayer. First, there are significant IRS penalties, typically $10,000 or more per filing omission. Second, delinquently filing international information returns can extend the standard three-year period of limitations on the taxpayer’s entire tax return indefinitely.

International Information Returns and the Extended Statute of Limitations

Generally, the statute of limitations for IRS assessment of additional taxes is three years from the date the return is filed.[4] Under certain circumstances, this period can be extended. For instance, if the taxpayer has substantially omitted income on his or her return, the limitation period for assessment is six years.[5] For fraudulent returns, tax evasion, or the failure to file a tax return, the statute of limitations can be extended indefinitely.[6]

The HIRE Act of 2010 and Section 6501(c)(8)

The statute of limitations may also remain open indefinitely if taxpayers do not file a required international information return. Under the HIRE Act of 2010,[7] Section 6501(c)(8) of the Internal Revenue Code was amended for certain international information returns to extend the time for assessment of taxes “with respect to any tax return, event, or period to which such information relates.”[8] This is significant because even though the taxpayer may otherwise have filed a timely tax return (i.e., IRS Form 1040), the non-filing or incomplete filing of international information returns keeps the period of limitation open indefinitely, not just on the delinquent international information return, but on the entire tax return.[9]

The following list illustrates international information returns which typically extend the period of limitations under Section 6501(c)(8):

  • Form 926: Return by a U.S. Transferor of Property to a Foreign Corporation;[10]
  • Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts (but only to the extent of Parts I through III[11]);[12]
  • Form 3520-A: Annual Information Return of Foreign Trust With a U.S. Owner;[13]
  • Form 5471: Information Return of U.S. Persons With Respect to Certain Foreign Corporations;[14]
  • Form 5472: Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business;[15]
  • Form 8621: Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund;[16]
  • Form 8858: Information Return of U.S. Persons With Respect to Foreign Disregarded Entities;[17] and
  • Form 8865: Return of U.S. Persons With Respect to Certain Foreign Partnerships.[18]

“With Respect to Any Tax Return, Event, or Period to which Such Information Relates”

Having the entire tax return open to IRS assessment indefinitely may leave the taxpayer unnecessarily vulnerable, especially if their tax return includes complicated positions such as good faith valuations or appraisals subject to interpretation. The extended period of limitations can also impact returns other than Form 1040 since it applies to “any tax imposed by this title with respect to any tax return, event, or period to which such information relates.” In a recently released Chief Counsel Memorandum, this was emphasized when the IRS concluded that an executor’s failure to file Form 8938 with the decedent’s final 1040 “suspend[ed] the period of limitations for assessment for any tax reportable on the individual’s Form 1040 or [the] estate’s Forms 1041 or 706.”[19]

Reasonable Cause Exception

There is an exception to this indefinite limitations period, but it is not automatic. If a taxpayer can show that the non-filing of the international information return was due to reasonable cause and not willful neglect, only the information return will be subject to the indefinite limitations period.[20]

Commencement of Period of Returns

Subsequently filing the international information return does not restore the timely filed tax return’s normal limitations period. Instead the three-year period of limitations for the entire return commences when the delinquent international information return is furnished to the IRS.[21] It is from that point that the statute of limitations begins to run.

Examples

Example 1: Marge Taxpayer has an overseas bank account. Her total account balance with the overseas bank is just under $30,000. In 2011, Marge makes a small investment in a foreign unit trust which the financial advisor employed by the overseas bank describes as “similar to a mutual fund.” The unit trust pays quarterly dividends. The bank reports the unit trust on the statements they send Marge.

In 2012,[22] Marge self-prepares and files her 2011 federal income taxes on a timely basis. Her filing status is single, she itemizes her deductions and reports all income earned from her overseas accounts on Schedule B. She does not file a Form 8938: Statement of Foreign Financial Accounts because she is under the account value threshold. Later that same year, she timely files a correct FBAR.

Marge does not file a Form 8621: Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund; she is not aware she is such a shareholder. Marge has never heard the term “passive foreign investment company” and does not make the connection that her unit trust, described as similar to a mutual fund, is such an entity requiring her to file Form 8621.

Typically, the three-year statute of limitations on a 2011 U.S. tax return timely filed on April 15, 2012 would now have closed. However, Marge has not filed a 2011 Form 8621 at any point. As a result, in 2015 and beyond, the IRS can examine her entire tax return, and may question items such as her itemized deductions, potentially resulting in the assessment of additional taxes, penalties and interest. This can create problems if a significant period of time has passed and Marge no longer has supporting receipts and other documentation. Marge can only avoid this extended limitations period if she can substantiate, to the IRS’ satisfaction, that the non-filing of Form 8621 was due to reasonable cause and not willful neglect.

Example 2: Same as above, except that in late 2014, Marge is reading a financial magazine and discovers that the unit trust she purchased in 2011 required her to file a Form 8621 with her 2011 tax return. Before the end of 2014, she files Form 8621 for tax year 2011 and, at the date of filing, the statute of limitations on the entire return begins to run. Barring other issues, the period of limitations on Marge’s entire 2011 tax return will close three years after the date Form 8621 was filed – sometime in late 2017.

Conclusion

Taxpayers with overseas holdings and interests need to be aware of their complete federal tax reporting obligation and that filing an FBAR and/or Form 8938 may not be enough. International information returns may also need to be filed. Taxpayers should be prepared for potential penalties imposed for delinquent international information returns, as well as the potential for an indefinite extended limitations period imposed on their entire return. Only time, once the taxpayer files the delinquent international information return, or a satisfactory explanation of reasonable cause may protect the taxpayer’s entire tax return from an indefinitely open statute of limitations.

[1] The Foreign Account Tax Compliance Act (FATCA), part of the Hiring Incentives to Restore Employment Act of 2010, requires foreign financial institutions to report, in the aggregate, U.S. accounts held as of December 31, 2014 to the United States Treasury as of March 2015.
[2] “FBAR” is the acronym for a Report of Foreign Bank and Financial Accounts. An FBAR is required for U.S. taxpayers owning or having an interest in certain foreign accounts and is made by filing FinCEN Form 114 through the Bank Secrecy Act (BSA) E-Filing System by June 30th of the year following the calendar year being reported.
[3] IRS Form 8938 requires overseas financial account reporting similar to an FBAR but with differences in the threshold amounts and some of the types of assets to be reported. Also, it must be filed along with the taxpayer’s April 15 annual federal return deadline.
[4] IRC §6501(a).
[5] IRC §6501(e)(1)(A).
[6] IRC §6501(c)(1), (2), and (3).
[7] The HIRE Act, Hiring Incentives to Restore Employment Act, March 18, 2010, amended IRC §6501(c)(8).
[8] IRC §6501(c)(8)(A).
[9] Id.
[10] IRC §6038B.
[11] Instructions for Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, page 2, November 25, 2014.
[12] IRC §6048.
[13] Id.
[14] IRC §6038 and §6046.
[15] IRC §6038A.
[16] IRC §1295(b) and §1298(f).
[17] IRC §6038B.
[18] IRC §6038, §6038B, and §6046A.
[19] Office of Chief Counsel Memorandum POSTN-120589-14, October 3, 2014.
[20] IRC §6501(c)(8)(B).
[21] IRC §6501(c)(8)(A).
[22] It should be noted that this example uses a return filed after 2010 effective date for the HIRE Act. The amendment made under this act to IRC §6501(c)(8) can also have a retroactive effect and reach back to returns filed on or before the HIRE Act effective date (March 18, 2010), if the period of limitations on those returns had not expired as of that date. See §§513(c) and (d) of the Hiring Incentives to Restore Employment (HIRE) Act, Pub. L.No. 111-147, 124 Stat. 112 (2010).

Acknowledgement: With grateful appreciation to Attorney Morris N. Robinson, CPA, LL.M. for his expert input and co-authorship.

If you have questions or need assistance with regard to delinquent international information returns, the attorneys at M. Robinson & Company may be able to assist you. Please feel free to contact us at 617-428-6900.

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