By: Philip Panitz, Tax Attorney | When one reads the title of this piece, it is probably a natural assumption to think of little green men. Did some space alien make a wrong turn at Pluto and end up in the pine forest in Flagstaff?1 This article would probably be a lot more interesting and exciting if it were. However, we are talking about tax concepts here, something much more mundane; unless you happen to be here from another country, of course.
A person from a foreign country who is permitted to live in the United States typically falls into one of three categories. They are here legally as a resident alien, they have passed rigorous examinations about our culture and history to become citizens, or they are here illegally. Since this is a tax article, we will omit any political discussion related to who should be allowed privileges of citizenship and stick to the tax ramifications. If the resident alien or newly minted citizen is going through the process or has just been through the process, it is very likely that they know more about our culture and history at this moment than some of our own children. Unfortunately, the one thing they are not informed of is their rights and obligations under our extensive and complicated tax system.
Many Americans who have investments overseas or foreign bank accounts have been informed about the requirement to disclose these accounts. This has been covered in the news media, the Internet, and the newspapers. What is not being covered is the obligation that resident aliens and new citizens have in relation to money that they earned while living in their native land. Too often I have met with new clients who have been referred to me by a CPA because the client was from a foreign country, and failed to disclose accounts, homes, assets that are left behind in their native land. Once the CPA ultimately ascertains that the individual has not disclosed these accounts or foreign assets, the ramifications are so frightening that the referral is made immediately to a tax attorney like myself.
The first meeting goes something like this: “I earned the money in France. I was not a United States citizen at the time. Why would the United States get to tax that money?” The answer is: The United States taxes you on your world-wide income when you become a resident alien or a U.S. Citizen, just like it taxes people that were born here. So, if you have 500,000 Euros in a Swiss Bank Account when you become a resident alien or U.S. Citizen, it is a logical assumption that the money is not sitting in a non-interest bearing account. Typically, the alien is earning interest, or if invested in some type of pension, is earning dividends or capital gain upon sales. Once the alien becomes a resident alien (not a little green man but a green card holding taxpayer); or a U.S. Citizen, than taxes must be paid upon that earned income even if the principal was never earned in the United States.
But wait, it gets worse. Not only did the alien have to report the income earned upon becoming a resident alien or citizen, but they also must separately report the amounts in accounts or assets held. The income is reported on a regular tax return, due on April 15 each year, with extensions through October 15th. The assets are reported on a foreign bank account form called an FBAR. The FBAR is not a taxing event, it is simply a reporting event, and is due June 30th each year. There are no extensions. The FBAR puts the government on notice of what assets are held by the alien overseas. The income earned on those assets is fully taxable on the alien’s personal tax return. Many aliens inherit property from family and friends from their native land. These assets must be reported on the FBAR as well. Reporting the income on the tax return is fine, but failing to report the assets that earned the income by not filing an FBAR can be a catastrophe.
The penalties for non-compliance are very onerous, and this writer would add the adjective “confiscatory.” Intentional misrepresentation could lead to criminal prosecution. For example, willful failure to file the FBAR allows for fines up to $250,000 and five years in jail or both. For civil penalties, they fall into different categories. For each account not disclosed in the FBAR there is a $10,000 penalty. Additionally, civil penalties for willful failure to file can be the greater of $100,000 or 50% of the amounts in the accounts. Obviously, this can be fairly shocking to the alien when they were never informed of this legal requirement as part of their admission. The 50% penalty is the top tier, it can be argued down depending upon whether the failure to file the FBAR was not based on willfulness, but mere negligence.
In response to the outcry from both aliens and U.S. Citizens to this new and unexpected trap for the unwary, and also to encourage people to come in from the cold, Congress initiated the OVDP program (Offshore Voluntary Disclosure Program.) This was like an amnesty with teeth. The OVDP, unlike the failure to file FBAR penalties, had a sliding scale of penalties, from 27.5% down to 12.5% down to 5% depending upon the gravity of the omissions. However, the penalties are imputed back for eight years! The good news about submitting under the OVDP is if there is a voluntary disclosure, it is supposed to take all potential criminal charges off the table. Of course, if the alien is being audited, it is too late to seek amnesty.
The problem with this entire tax regime is the inherent unfairness to aliens who have earned or inherited their money overseas, prior to becoming resident aliens or citizens of the United States. The confiscatory penalty regime was really enacted by Congress in response to Americans who were hiding money overseas, avoiding the tax man. Aliens are, with a few exceptions, not in that category. Most of the aliens I have encountered were ignorant of the requirements, and made assumptions that only money earned here in the United States should be taxable here. This was not an unreasonable assumption, since most countries in the world tax their citizenry exactly that way, only upon money earned in the country. It is even a greater trap for the unwary alien that they have additional reporting requirements related to disclosing assets on a separate form and on a separate due date, with outrageous penalties for failing to disclose. Unfortunately, I have seen all too many aliens when confronted with this financial nightmare, climb back into their spaceships and fly home.
Philip Garrett Panitz is a tax attorney and a certified tax specialist, and has an LL.M. in taxation from New York University. He litigates tax court cases against the IRS nationwide. In 1995, he argued the landmark tax case Williams v. United States to the United States Supreme Court, leading to a victory that changed the way the IRS can seize properties from third parties. For more information, please call 805-379-1667.
1 This writer expresses no opinion as to why Flagstaff seems to be the capital of alien abductions.
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