The Streamlined Domestic Offshore Procedures (opens the official IRS page in a new tab) charge a miscellaneous offshore penalty of 5% on one figure: the highest aggregate year-end value of the foreign financial assets that were not reported correctly. An asset counts in a year if it should have been on an FBAR or Form 8938 and was not, or if its income was left off the return. Assets reported correctly in every respect add nothing.
This post is for Americans who have come back to the United States from Britain, and for British nationals now living there, who fail the non-residency test and have to use the Domestic route. Our guide for people behind on US taxes in the UK sets the two routes side by side. Here we cover who ends up on the Domestic route, which assets go into the penalty base, which stay out, how the figure is worked out year by year, and how it plays out for a citizen who returned to Boston from Manchester.
Who ends up on the Streamlined Domestic route?
Non-wilful taxpayers who do not meet the non-residency test and who have already filed their US returns for the three most recent years. In practice that is usually someone living in the United States: an American who moved home from the UK, or a British national who became a US tax resident there.
The IRS page for US taxpayers residing in the United States (opens the official IRS page in a new tab) opens the route to US citizens, green card holders and people resident under the substantial presence test (opens the official IRS page in a new tab), and to the estates of such individuals. They must fail the non-residency test that governs the Foreign route (opens the official IRS page in a new tab). For a citizen or green card holder, that test is met by having no US abode and being outside the United States for at least 330 full days in at least one of the three years whose return due date has passed. A person who has lived in Boston throughout those years cannot meet it, however long they spent in Britain before.
The second condition decides many cases. Every required US return for those years must already have been filed, because the Domestic route accepts only amended returns on Form 1040-X. The failures being corrected are unreported income from a foreign financial asset, and often missed FBARs and international information returns as well. All of it must have come from negligence, inadvertence, mistake or a good-faith misunderstanding of the law, and the route closes once the IRS has opened a civil examination of any year.
- A US citizen who returned from the UK and never reported the British accounts left open
- A British national on a work visa who became a US resident by day count and kept UK savings
- A green card holder in the United States with an inherited UK portfolio
- A couple filing jointly where one or both spouses fail the non-residency test
Which foreign assets go into the penalty base?
Foreign financial assets that were not reported as the law required. The IRS tests each asset year by year, and an asset is subject to the penalty in any year where one of three failures applies. Being in the base for one year does not put it in the base for every year.
The look-back runs over two periods. The covered tax return period is the most recent three years for which the return due date has passed, and the covered FBAR period is the most recent six years for which the FBAR due date has passed. The FBAR failure can put an asset in the base in any of the longer period's years. The Form 8938 and unreported income failures apply only within the shorter return period.
The IRS gives examples of the assets it has in mind: accounts at foreign financial institutions, including foreign branches of US banks, foreign shares and securities held outside an account, foreign mutual funds, and foreign hedge funds and private equity funds. It refers to the FBAR and Form 8938 (opens the official IRS page in a new tab) instructions for the full definitions. For UK savers that usually means current and savings accounts, cash and stocks and shares ISAs, and investment platform accounts. Whether a given UK pension belongs on either report depends on the scheme, a point covered in our post on whether a UK pension is reportable on the FBAR.
- Covered FBAR year: the asset should have been on an FBAR filed with FinCEN and was not
- Covered return year: the asset should have been on Form 8938 and was not
- Covered return year: the asset was reported, but gross income from it was left off the return
Which assets stay out of the miscellaneous offshore penalty base?
Assets that were reported correctly, assets that are not reportable foreign financial assets at all, and any part of an asset in which the taxpayer had no personal financial interest. The IRS frequently asked questions on the Domestic route spell these out, and they often reduce the figure a good deal.
Correct reporting is judged year by year. An account that appeared on a timely FBAR for a given year contributes nothing for that year. In the three return years an asset drops out only if it was on Form 8938 where required and its income was on the return as well. The questions and answers add that assets shown on a timely filed Form 3520 or Form 5471 are excluded, while those reported only on late forms stay in.
Ownership matters too. The penalty is not meant to reach an account over which the taxpayer had signature authority only, such as an employer's account, and the base takes the taxpayer's own financial interest in each asset. Directly held foreign property that is not reportable on an FBAR or Form 8938, such as a rented flat, is outside the base, though its rental income still belongs on the amended return. Our post on joint accounts with a non-US spouse covers the reporting side of shared accounts.
- Accounts on a timely FBAR for the year in question
- In the return years, assets on Form 8938 whose income was also reported
- Assets disclosed on a timely Form 3520 or Form 5471
- Accounts held with signature authority only
- Real property held directly, such as a UK buy-to-let flat
How is the highest aggregate year-end balance worked out?
By building a table of years. For each year in either covered period, the taxpayer lists the assets in the base for that year, enters each at its value on 31 December, and adds them up. The highest annual total is the penalty base, and the penalty is 5% of that single figure.
The year-end value is not the figure used on the FBAR. An FBAR reports the maximum value of each account during the year, and the filing threshold of $10,000 is tested on the aggregate at any time. The penalty base uses the balance at the close of the year. An account that peaked in the summer and was run down by December adds only the year-end figure. Our post on FBAR maximum values and exchange rates explains the reporting figure.
Years in which everything was reported correctly are entered as zero. Where the three most recent years were fully compliant and only earlier FBARs were missed, the IRS questions and answers say the penalty is worked out on the earlier years alone, and the certification goes with a Form 1040-X for the most recent year showing no change in tax. The IRS allows any reasonable valuation method for shares in a foreign company, but no valuation discounts.
How does the base work for a citizen back in Boston from Manchester?
A US citizen who worked as an engineer in Manchester for many years and moved back to Boston more than three years ago fails the non-residency test, because he has had a US abode throughout the covered return period. He filed US returns every year, so the Domestic route is open to him.
While in Manchester he reported his salary and claimed credit for UK tax, but never filed FBARs and left off the interest on a UK savings account and the income inside a stocks and shares ISA. When he moved he kept those accounts, his current account and a flat in Manchester that he lets out. He reported the rent each year on his US return. Once he was back in the United States, the lower Form 8938 thresholds (opens the official IRS page in a new tab) for people living there applied, starting at $50,000 at year end or $75,000 at any time for a single filer, and his UK assets passed them without a form being filed.
His base table covers six FBAR years. For each year he enters the 31 December balances of the current account, the savings account and the ISA. In one early year he did file an FBAR, so that year counts as zero for FBAR purposes. The flat is left out in every year. The highest annual total, probably a recent year when the ISA was largest, becomes the base. His amended returns add the missing income, and funds inside the ISA may also need Form 8621. Our IRS streamlined filing service builds this table from statements before any figure is signed.
What does the Domestic penalty replace?
For a taxpayer who qualifies and follows the instructions, the miscellaneous offshore penalty takes the place of the accuracy-related, information return and FBAR penalties that could otherwise apply to the same years. Tax and interest are still due, and everything is paid with the submission.
The protection has limits that the streamlined filing compliance procedures (opens the official IRS page in a new tab) set out. Penalties already assessed for those years are not reversed. If the IRS later finds a further deficiency, it can assert penalties on that amount, and an audit that finds fraud or a wilful FBAR violation ends the protection. The IRS does not acknowledge receipt or sign a closing agreement, and the returns can still be selected for audit. The package is sent on paper, with each amended return marked as the IRS directs, the original Form 14654, the late FBARs filed electronically through FinCEN (opens the official FinCEN page in a new tab), and payment.
The Foreign route differs on the point that matters here: a taxpayer who meets its non-residency test pays no miscellaneous offshore penalty, and late original returns are accepted. That is why the residence history matters before anything else. Our post on choosing between the streamlined routes compares them, our foreign income and FBAR service prepares the reports, and the full sequence is in our guide to IRS streamlined filing from the UK.
General information, not advice. The right answer depends on your circumstances and the tax year concerned.
