Streamlined Domestic Offshore Procedures (SDOP): Qualifications and Filing Requirements

U.S. taxpayers generally must report worldwide income, including interest, dividends, and other income earned through foreign accounts. Certain foreign assets and accounts may also trigger separate reporting requirements, such as an FBAR or Form 8938.

If you missed these obligations unintentionally, the IRS Streamlined Domestic Offshore Procedures—or “SDOP”—may provide a way to correct the filings under reduced penalty terms.

Who May Qualify?

SDOP is generally available to an individual U.S. taxpayer—or the estate of an individual taxpayer—who:

• Resides in the United States or otherwise fails to meet the nonresidency requirement for the foreign streamlined procedures;

• Timely filed, if required, a U.S. income tax return for each of the three most recent covered tax years;

• Failed to report income from a foreign financial asset, pay the related tax, or file required foreign information returns or FBARs;

• Has a valid Social Security number or other qualifying taxpayer identification number; and

• Can certify that the compliance failure resulted from non-willful conduct.

The IRS defines non-willful conduct as conduct resulting from negligence, inadvertence, mistake, or a good-faith misunderstanding of the law.

Who Does Not Qualify?

A taxpayer generally cannot use SDOP if:

• The failure was willful;

• The IRS has already begun a civil examination for any tax year;

• The taxpayer is under an IRS criminal investigation; or

• Required original income tax returns were never filed for the covered three-year period.

Taxpayers concerned that their conduct may have been willful should obtain professional legal and tax advice before communicating with the IRS or submitting amended returns.

What Must Be Filed?

A complete SDOP submission generally includes:

Three years of amended tax returns:

The taxpayer must file Form 1040-X for each of the three most recent covered tax years, including all previously unreported foreign income.

Required international information returns must also be included, when applicable, such as:

• Form 8938, Statement of Specified Foreign Financial Assets;

• Form 3520 or 3520-A for certain foreign trusts or gifts;

• Form 5471 for certain foreign corporations;

• Form 8621 for certain foreign mutual funds or passive foreign investment companies; and

• Other applicable international forms.

The relevant three-year period depends on when you file and whether a valid filing extension remains in effect.

Six years of delinquent FBARs:

You must electronically file missing FBARs for the six most recent years with past FBAR deadlines. The late-filing explanation should state: Streamlined Filing Compliance Procedures

Form 14654 certification:

The taxpayer must complete and sign Form 14654, certifying:

• Eligibility for SDOP;

• That the failures were non-willful;

• That all required FBARs have been filed; and

• That the 5% miscellaneous offshore penalty was calculated correctly.

The non-willfulness narrative is critical to the submission. It should clearly explain the relevant facts, the reason for the filing failures, and how the taxpayer discovered the problem.

Payment:

The taxpayer must pay:

• Additional federal income tax;

• Statutory interest; and

• The 5% Title 26 miscellaneous offshore penalty.

The taxpayer submits the amended returns, information returns, Form 14654, and payment to the IRS on paper. The FBARs are filed separately and electronically through FinCEN.

How Is the 5% Penalty Calculated?

The SDOP penalty generally equals 5% of the highest annual aggregate year-end value of the foreign financial assets subject to the penalty during the combined covered tax-return and FBAR periods.

This calculation generally uses year-end balances or values—not the highest balance reached during each year. Only assets meeting the IRS definition of assets subject to the SDOP penalty are included.

Example 1: Unreported Foreign Savings Account

Maria lives in California and has properly filed her federal income tax returns. However, she unintentionally failed to report interest from a foreign savings account and did not file the required FBARs.

The account’s applicable year-end balances during the covered period were:

• Year 1: $80,000

• Year 2: $100,000

• Year 3: $120,000

The highest annual aggregate year-end balance is $120,000.

SDOP penalty: $120,000 × 5% = $6,000

Maria must also amend the three covered tax returns to report the interest and pay the additional tax and interest.

Example 2: Multiple Foreign Assets

David, a U.S. resident, unintentionally failed to report a foreign bank account and a foreign mutual fund. In the year with the highest combined applicable values, the assets had the following year-end values:

• Foreign bank account: $90,000

• Foreign mutual fund: $60,000

• Total applicable foreign assets: $150,000

SDOP penalty: $150,000 × 5% = $7,500

David may also need to file Forms 8938 and 8621, amend the three covered returns, file six years of delinquent FBARs, and pay additional tax and interest.

What Protection Does SDOP Provide?

An eligible taxpayer who properly completes the procedures generally avoids separate accuracy-related penalties, international information-return penalties, and FBAR penalties for the covered submission.

However, SDOP does not provide a closing agreement or immunity from examination. The IRS may verify the submission or select the returns for audit. Fraud or willful FBAR violations discovered during an examination can result in additional penalties or other consequences.

Before You File

SDOP submissions can involve complex questions concerning residency, non-willfulness, foreign corporations, trusts, mutual funds, retirement accounts, and penalty calculations. Filing incomplete amended returns or making a “quiet disclosure” without following the appropriate procedures can create additional risks.

If you have an unreported foreign account, asset, or income item, contact Kaya Tax before filing amended returns. We can review your circumstances, determine whether SDOP may be appropriate, and help prepare a complete compliance submission.