U.S. taxpayers who own offshore accounts or other foreign assets may struggle to understand their requirements for reporting foreign investments to the Internal Revenue Service (IRS) and paying taxes on foreign income. In some cases, these matters have become even more confusing following recent changes to the programs the IRS has made available to taxpayers. In 2018, the IRS ended the Offshore Voluntary Disclosure Program (OVDP), and recently, it also took down the Delinquent International Information Return Submission Procedures (DIISP) from its website. This has left many taxpayers concerned about their ability to become compliant with IRS requirements and avoid penalties related to reporting foreign assets and income.

What Is DIISP?

Previously, the DIISP allowed taxpayers to receive a waiver of the penalties that would normally apply to unreported foreign assets. Taxpayers could qualify for the DIISP if they did not have any unreported income, as long as they could show that they had reasonable cause for their non-compliance, such as death, serious illness, natural disasters, or ignorance of tax laws.

The IRS quietly ended the DIISP in November 2020 without providing any notice that these procedures would no longer be available. Without this option, taxpayers will be required to follow other procedures to become compliant, and they may be subject to tax penalties.

Tax laws in the United States change regularly at both the federal and state levels. In the 2020 election, California voters passed a ballot measure that made some changes to how property taxes are addressed when a person moves to a new home or transfers ownership of real estate property. Taxpayers will want to understand how this new law will affect them and what they can do to avoid tax increases.

Proposition 19 and Property Tax Reassessment

Under Proposition 13, which passed in 1978, property taxes in California are based on the purchase price of a property, and they are subject to small annual increases. When a property is sold or transferred to a new owner, property taxes are reassessed based on the market value of the property. However some homeowners have been allowed to transfer their property tax assessments to a new home. In addition, parents or grandparents could transfer a primary residence to their children or grandchildren without the need for reassessment, and they could transfer other types of property with the first $1 million in value being exempt from reassessment.

Proposition 19 has expanded some homeowners’ ability to transfer their tax assessment to a new home of an equal or lesser value. While this type of transfer was previously only allowed within the same county, a tax assessment will now be allowed to be transferred anywhere within the state of California. An assessment can also be transferred to a new home of a higher value while making adjustments to reflect this increase. Homeowners over the age of 55 were previously limited to one tax assessment transfer, but they will now be allowed to transfer a tax assessment up to three times.

The IRS pays close attention to taxpayers’ income and financial transactions, and there are a variety of reasons it may conduct tax audits. In recent years, virtual currencies such as Bitcoin have been a growing concern for the IRS, and many cryptocurrency owners have received notices regarding their requirements for reporting transactions involving these currencies. This scrutiny is likely to increase in the future as the use of virtual currencies becomes more widespread. In fact, the IRS released a draft of the 1040 tax form for 2020, and one of the first questions that is included on this form is “At any time during 2020, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” This indicates that those who own or trade cryptocurrency may face audits if they do not meet their requirements for reporting transactions and paying applicable taxes.

Tax Issues Related to Virtual Currency

Even though cryptocurrencies may be used similarly to currency issued by the United States or other countries, they are not recognized as legal tender. Instead, virtual currencies are considered property, and taxes may apply to transactions involving these currencies. If a person receives virtual currency in exchange for performing services, either as an employee or an independent contractor, this will be considered taxable income.

When virtual currency is sold or exchanged for other property, a taxpayer will be required to report gains or losses on a federal income tax return. These gains or losses are calculated by comparing the taxpayer’s basis in the virtual currency, or the fair market value of the currency at the time it was acquired, with the amount received in exchange for the virtual currency. Capital gains taxes may apply to gains made when selling virtual currency, and a taxpayer may be able to deduct losses in these transactions.

The U.S. Tax Code is very complex, and taxpayers will often struggle to understand their tax obligations, their requirements for filing tax returns and other forms, and the steps they should take to avoid penalties. Nonresident aliens (NRAs), or those who are not U.S. citizens or U.S. nationals and do not maintain a substantial presence in the United States, may have certain tax obligations, including the requirement to pay taxes on income generated by rental properties. Failure to file the proper forms and pay taxes on this income may result in tax audits and penalties.

Tax Requirements for Rental Income From Real Property

When an NRA acquires real property in the United States, that person will usually not be required to file any forms with the IRS or pay taxes. However, there will be tax on any income earned through the rental of this property. The tax rate that applies to this income will depend on whether it is considered passive income (known as FDAP income) or effectively connected income (ECI) that is associated with a U.S. trade or business.

FDAP income is generally taxed at a rate of 30% of the gross amount of income earned by a rental property. These taxes will usually be withheld by a withholding agent (such as a property manager, renter, or lessee) who will send this amount to the IRS. ECI, on the other hand, is subject to graduated tax rates, and taxes apply to net income earned after deductions and expenses.

U.S. taxpayers are required to report foreign financial accounts and other offshore assets and investments, and taxes may apply to income earned from foreign sources. In the past, the IRS allowed taxpayers who had not met these requirements to become compliant through the Offshore Voluntary Disclosure Program (OVDP). This program is no longer available, and it has left some taxpayers unsure about how to report their foreign assets and pay any taxes owed while minimizing the potential penalties that may apply. 

One issue that the IRS has identified as an area of concern involves taxpayers who applied for pre-clearance with the OVDP but did not complete this program. Specifically, some taxpayers may have been denied access to the program, or they may have voluntarily withdrawn their requests. The IRS’s Large Business & International (LB&I) division will be investigating these taxpayers, and tax audits may be performed in cases involving continued noncompliance.

Options for Compliance With Foreign Tax Reporting Requirements

In some cases, taxpayers who were unable to become compliant through the OVDP may be eligible for the Streamlined Domestic Offshore Procedures (SDOP) or Streamlined Foreign Offshore Procedures (SFOP) programs. A person will qualify for this program if he or she can show that his or her noncompliance was non-willful, meaning that the taxpayer did not know about or did not understand the requirements for reporting foreign assets and income. These taxpayers will be required to comply with tax return requirements for the past 3 years, Foreign Bank and Financial Account Reports (FBAR) requirements for the past 6 years, and other required information. They must provide information about the balances of unreported foreign accounts for the past 6 years, and they must pay all outstanding taxes and interest. In most cases, a 5% penalty will apply to the taxpayer’s highest aggregate foreign account value, although this penalty may be waived in certain cases.