Many American citizens who have lived in Israel for years aren’t aware that they’re required to report every financial account they own to the IRS, even accounts held in Israel. Failing to report these accounts is considered a serious offense, sometimes even a criminal one. The case of the A.A. couple shows how you can get out of a situation that looks hopeless, without paying a single penny in penalties.
The Background: A Successful Doctor Who Relocated to the United States
A.A. is a highly successful doctor from Israel who relocated to the United States to work at a university hospital in a senior position. He is a U.S. citizen, and the couple has lived there for many years. A colleague referred them to Eli Jacoby, CPA.
For many years, the couple filed tax returns with the U.S. tax authorities and never reported financial accounts they held in Israel. As far as the federal tax authority (IRS – Internal Revenue Service) is concerned, this is an offense that could be considered criminal, with penalties that include forfeiture of the account and heavy fines.
How Did It All Blow Up? The Banks in Israel Entered the Picture
The banks in Israel discovered that the couple was residing in Israel, and that’s where the whole ordeal began. The accounts were frozen, and steps were taken to transfer their identity details to the American tax authority.
The banks didn’t act on their own initiative. They acted exactly according to the law. A detailed provision on this matter, known as FATCA (Foreign Account Tax Compliance Act), was incorporated into the Israeli Income Tax Ordinance, alongside the tax treaty between Israel and the United States.
Which Assets Weren’t Reported?
The couple’s financial picture included several types of assets, and each one carried a separate reporting obligation.
Among the assets that weren’t reported:
- Continuing education funds (keren hishtalmut)
- Israeli pension funds
- Checking accounts
- Shares in a foreign company engaged in real estate investments
Their shareholding in the foreign company was at a rate that required them to detail the company’s activity on two separate forms, Form 5471 and Form 8621.
Form 5471 and Reporting a Foreign Company
Form 5471 deals with detailed reporting of investments in a foreign company. Its full name is Information Return of U.S. Persons With Respect To Certain Foreign Corporations.
The penalties for failing to file Form 5471 on time start at $10,000 per return per year and climb quickly to $50,000 per year.
Form 8621 and PFIC Holdings
Form 8621 deals with reporting holdings in PFIC-type companies (Passive Foreign Investment Company). Its full name is Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.
Heavy penalties are also imposed for failing to report on Form 8621. When it comes to income-producing real estate assets, the tax authorities treat the lack of reporting similarly to the failure to report financial assets, which is required on the FBAR form (Foreign Bank Account Report).
The Voluntary Disclosure Program: The Possible Solution
A little over a decade ago, the IRS introduced a voluntary disclosure program for situations of this kind. The program is called the Streamlined Foreign Offshore Voluntary Disclosure Program, and it still exists for U.S. citizens residing outside the country.
For citizens living abroad, the program is called the Streamlined Foreign Offshore Voluntary Disclosure Program for U.S. Citizens and Permanent Residents (Green Card Holders) Living Abroad. But this is exactly where the couple’s problem lay.
Why Did Their Situation Look Hopeless?
The couple are American citizens who have lived in the United States for many years, not abroad. In such a case, an automatic penalty of at least about 5% of the value of the investments applies. This penalty applies even to a citizen living in the United States who has successfully cleared the hurdle of being accepted into the program, and even when it has been proven that the noncompliance stemmed from good faith (Unintentional Non-Compliance with U.S. Tax Law).
On the face of it, the couple’s situation looked hopeless.
What Did We Actually Do?
We decided to help submit an application for their acceptance into the voluntary disclosure program and to request a sweeping exemption from any penalty. The IRS requires filing tax returns and FBAR reports for a limited number of years.
The documents we submitted included:
- Personal tax returns (U.S. Individual Income Tax Returns – Form 1040)
- FBAR reports (Foreign Bank Account Reports)
- Form 14654, titled Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures
Form 14654 is intended for a citizen who is also a resident of the United States. For a citizen who does not reside in the United States, there is a different form – Form 14653, titled Certification by U.S. Person Residing Outside the United States for Streamlined Foreign Offshore Procedures.
The Personal Story That Made the Difference
The IRS requires the taxpayer to tell their personal story and explain why they should be accepted into the program. This isn’t a technical clause. It’s the heart of the application.
In this case, the taxpayer was accepted into the program, and no penalty was imposed on him, including the 5% set in the regulations.
What Can We Learn From the A.A. Couple’s Case?
An American citizen who lives in Israel and holds bank accounts, pension funds, continuing education funds, or shares in a foreign company here is at real risk with the IRS, even if they never intended to hide anything. FATCA turned the banks in Israel into a direct information pipeline to the American tax authority, and the penalties for failing to report can reach tens of thousands of dollars per year.
There is a way out, but it requires precise wording of the application, choosing correctly between the forms and the tracks, and above all, the ability to present the personal story in a way that convinces the IRS. Guidance from a CPA who deeply understands the voluntary disclosure programs, the difference between the domestic and foreign tracks, and the requirements of forms like 5471 and 8621 is what separates a case that closes with no penalty from heavy penalties that drag on for years.
