Posted by: mstein10 | November 28, 2017

Beware of California Penalties for Failure to Report Foreign Financial Assets on Form 8938 by MICHEL STEIN

The California Franchise Tax Board (“FTB”) recently reminded the public that the State of California (“State”) can and will impose penalties for failing to disclose foreign financial accounts and assets.  In State Legal Ruling 2017-02 (October 16,2017), the State considered whether its conformity to federal information filing requirements relating to foreign financial assets imposed by the Internal Revenue Code (IRC) section 6038D applies to non-resident aliens.   In ruling that it did, it held that a minimum penalty of $10,000 may be imposed by the FTB for failing to provide a copy of the Form 8938 with the State income tax return, unless it can be shown that the failure was due to reasonable cause and not willful neglect.  (Citing to Revenue and Taxation Code (“R&T Code”) Sec. 19141.5(d)(2)).   

The Legal Ruling is significant because California has been largely silent on the enforcement of foreign asset non-compliance since its enactment of Voluntary Compliance Initiative 2 (VCI 2) back in 2011.  Beginning with tax year 2016, however, the State now requires copies of IRS Form 8938 to accompany the State return, and we can expect the imposition of penalties by the State where there is perceived non-compliance. 

State Conformity with 8938 . Under federal law, IRC section 6038D requires specified individuals and business entities to file information with their federal income tax returns relating to their interests in specified foreign financial assets if the aggregate value of those assets exceeds $50,000 or a higher prescribed amount.   Taxpayers with specified foreign financial assets that exceed certain thresholds must report those assets to the IRS on Form 8938, Statement of Specified Foreign Financial Assets, which is filed with an income tax return.  Taxpayers living in the U.S. must report specified foreign financial assets on Form 8938 (filed with their income tax return) if the total value of those assets exceeds $50,000 at the end of the tax year or if the total value was more than $75,000 at any time during the tax year for taxpayers filing as “single” or “married filing separately” (or if the total value of specified foreign financial assets is more than $100,000 on the last day of the tax year or more than $150,000 at any time during the tax year for taxpayers filing as “married filing jointly”). 

In 2015 (beginning with the tax year 2016 ), the State enacted AB 154 (Stats. 2015, ch. 359) amending RTC Sec. 19141.5 to add subdivision (d), which conforms California to IRC section 6038D without any modifications. RTC section 19141.5(d)(2) imposes a penalty determined in accordance with IRC section 6038D.  Legal Ruling 2017-02 clarifies that the State also follows the federal law regarding the application of the IRC section 6038D for nonresident aliens, stating that the disclosure requirement under RTC section 19141.5(e) is a specific exception to the general rule that State conformance rules typically do not apply to nonresident aliens (See RTC section 17024.5(b)(11) which sets forth that unless otherwise specifically provided, when applying any provision of the IRC for California purposes, any provision that refers to nonresident aliens shall not be applicable).    

California Voluntary Compliance Initiative 2 (VCI 2). In 2011, California enacted VCI 2 which provided an opportunity for taxpayers, who underreported their California income tax liabilities by utilizing Anti-abusive Tax Avoidance Transactions (“ATATs”) or offshore financial arrangements, to amend their income tax returns for 2010 and prior tax years and obtain a waiver of most penalties.   Many who participated in the IRS Offshore Voluntary Disclosure Programs or Initiatives also participated in VCI 2.  VCI 2 raised $350 million with $293 million received in cash and later an additional $57 million was raised from installment payments.   

California currently does not have a formal voluntary compliance initiative concerning unreported offshore accounts or income in effect.   However, California taxpayers who participate in a federal offshore program such as the Offshore Voluntary Disclosure Programs or Streamlined Initiatives with respect to foreign financial accounts generally mirror those filings for the State.  Notwithstanding voluntary action to correct, the State can impose its own set of penalties, including accuracy-related penalties (20% or 40%), fraud penalties (75%), delinquency penalties (up to 25%) and failure to furnish information return penalties such as Forms 5471 and 8938 penalties (minimum of $10,000), absent reasonable cause.  Up to this point, the State has not been aggressive in this area.  Given the extent of information sharing between the federal and state Governments, care should be taken when considering the best approach to dealing with the State with respect to foreign account and asset non-compliance. 

Federal Delinquent Filing Options. Taxpayers who are not in compliance with their reporting and filing options regarding undeclared interests in foreign financial accounts and assets should consider various options to come into compliance, including: 

(a)    2014 Offshore Voluntary Disclosure Program (OVDP).   The OVDP is designed for taxpayers seeking certainty in the resolution of their previously undisclosed interest in a foreign financial account. For those who might be considered to have “willfully” failed to timely file an FBAR or similar, the OVDP avoids exposure to numerous additional penalties associated with the income tax returns and various required foreign information reports, a detailed examination, and limits the number of tax years at issue while also providing certainty with respect to the avoidance of a referral for criminal tax prosecution. 

(b)   Streamlined Procedures for Non-Willful Violations. In addition to the OVDP, the IRS maintains other more streamlined procedures designed to encourage non-willful taxpayers to come into compliance. Taxpayers using either the Streamlined Foreign Offshore Procedures (for those who satisfy the applicable non-residency requirement) or the Streamlined Domestic Offshore Procedures are required to certify that their failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to “non-willful” conduct.  For these Streamlined Procedures, “non-willful conduct” has been specifically defined as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” 

(c)    Delinquent Submission Procedures. Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who have reasonable cause for not filing a required FBAR or other international disclosure forms, should considering filing the delinquent FBARs or other delinquent forms according to the instructions, along with a statement of all facts establishing reasonable cause for the failure to file. FBARs or delinquent information returns will not be automatically subject to audit but may be selected for audit through the existing IRS audit selection processes that are in place for any tax or information returns. 

As the State and Federal Government continue to refine the reporting rules for foreign accounts and assets, one should expect continued attention in this area.  Anyone lacking in compliance, should consult a tax professional with experience and expertise with these matters. 

MICHEL R. STEIN – For more information please contact Michel Stein –  Mr. Stein is a principal at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation.  Mr. Stein has significant experience in matters involving previously undeclared interests in foreign financial accounts and assets, the IRS Offshore Voluntary Compliance Program (OVDP) and the IRS Streamlined Filing Compliance Procedures. Additional information is available at



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