California Residents Who Inherit Overseas Financial Accounts Must Comply With International Tax Laws

Changes to the Internal Revenue Service’s Offshore Voluntary Disclosure Program (OVDP) have made headlines in recent months. Although the program currently penalizes taxpayers who willfully fail to timely report their overseas banking income at a rate of 27.5 percent of the highest account balance during the preceding eight years, that penalty will rise to 50 percent for taxpayers who bank with a foreign facilitator that is under investigation by the IRS beginning on August 4th. Interestingly, taxpayers whose failure to report foreign financial income is not deemed willful by the IRS will be penalized at a lower rate. In such situations, non-residents will not normally be required to pay a penalty, and taxpayers living in the United States will be charged five percent of the highest account balance during the relevant time frame. According to the IRS, non-willful conduct is defined as a failure to report income derived from a foreign financial asset “due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”

Modifications to the OVDP, along with other legal requirements for taxpayers with overseas assets, can spell trouble for an unwary heir. For example, all U.S. taxpayers with an aggregate total of $10,000 in offshore financial accounts are required to file an annual Report of Foreign Bank and Financial Accounts (FBAR). This requirement not only applies to the U.S. taxpayer who owns a foreign bank account, but also to any individual who has signature authority over such an asset. This includes an individual with a power of attorney over someone else’s financial account. Inheritors of offshore assets are also required to file the FBAR or risk being penalized. Failure to timely file a completed FBAR can result in a penalty of up to one-half of an overseas bank account’s highest balance and possible criminal prosecution.

Although it is unlikely that an heir who voluntarily reports the existence of a previously undisclosed foreign asset immediately upon discovery will face criminal charges, the estate will be on the hook for any unpaid back taxes, interest, and penalties through the OVDP. In addition, separate FBAR penalties will likely be assessed against the foreign account. In some cases, an heir may be able to convince the IRS to charge a reduced non-willful penalty, but there is no guarantee.

Since the OVDP was initially implemented in 2009, the IRS has collected about $6.5 billion in unpaid taxes from about 45,000 taxpayers with an interest in an offshore financial asset. According to the Government Accountability Office, nearly half of U.S. taxpayers who paid significant penalties on a foreign bank account using the OVDP process in 2013 inherited the asset from a spouse, parent, or another relative.

If you have questions about the OVDP, FBAR requirements, or other international tax law issues, you should speak with a skillful tax lawyer. Attorney William Hartsock has more than three decades of experience advising clients in San Diego about international tax law matters. To speak with a hardworking and committed tax lawyer, please call Mr. Hartsock at (858) 481-4844 today. You may also contact him through his website.

Additional Resources:

Heirs Left With Unpaid Bills May Inherit More Grief Than Gold, by Deborah L. Jacobs, Forbes.com

Photo Credit: Seemann, MorgueFile