The number one question I get from Americans considering opening an offshore bank account or forming an international corporation is, “will this increase my audit risk?”
The answer is simple: No, it makes little to no difference
So long as you keep your account in compliance by filing the required forms, an offshore bank account or structure will have a de minimis impact on your risk of being audited by the IRS.
The reason an offshore bank account doesn’t change your audit risk is two fold:
First, 95% of your probability of being audited is based on your income. If you make less than $200,000, your risk is low. If you earn more than $1 million, your risks are relatively high. I’ll get into specifics below.
Second, since FATCA, offshore banks are reporting to the IRS much like U.S. banks. The IRS computers will compare this data with what you report. So long as they match, your audit risk is minimal.
If you sell stocks in the U.S. and don’t report them on your return, you’ll get a notice from the IRS. If you have a foreign bank account and don’t report it on Schedule B of Form 1040 and on your FBAR, you’ll get a notice from the IRS.
The big difference here is the cost of non-compliance, not an increased risk of being audited.
If you get caught failing to report a domestic stock sale, the cost is 25% of the unpaid tax plus interest. If you missed a $1,000 gain, the cost is $250.
However, the penalty for failing to file an FBAR is $10,000 per year. If you also failed to report a corporation, you could be looking at a minimum penalty of $20,000.
Again, the risks associated with an offshore bank account aren’t an increase in your chances of being audited. The real exposure lies in your failing to keep up with your filing requirements.
Let’s get to the numbers. Will an offshore bank account increase my chances of being audited?
Less than 1% of personal returns are audited by the IRS each year. Of course, many of these are low income or W-2 wage earners. Their chances of being audited are minimal.
As an expat or international investor, you’re presumably in a higher income bracket. Thus you do have some risk of an audit. But that risk is based on your income and not your offshore holdings.
If you earn between $25,000 and $199,999, your chances of being audited are less than 0.8%. Earn between $200,000 and $499,999 and your risk goes up to 1.75%.
The more you make, the higher your chance of having the pleasure of meeting the IRS. Those with incomes over $10 million have more than a 16% chance of an audit.
If you have a business and report zero net profit, your risk of audit is 5 to 7% depending on a variety of factors (such as whether you took an auto or home office deduction). Basically, anyone reporting their business on Schedule C is at a higher risk of audit.
In fact, a small business in the U.S., reported on Schedule C, will have a significantly higher risk of audit than an offshore business reported on Form 5471.
This assumes you’re not doing anything to draw attention to yourself. Just like a U.S. business, if your offshore corporation loses money each year, the IRS will want to know why. But, this increased risk of an audit is caused by your reporting, not the fact that you have an offshore bank account.
Here’s a table that will help you identify your risk of being audited:
|Returns by Income||Percent of Tax Returns
Audited in 2014
|No adjusted gross income||5.26%|
|$1 to $24,999||0.93%|
|$25,000 to $49,999||0.54%|
|$50,000 to $74,999||0.53%|
|$75,000 to $99,999||0.52%|
|$100,000 to $199,999||0.65%|
|$200,000 to $499,999||1.75%|
|$500,000 to $1 million||3.62%|
|$1 million to $5 million||6.21%|
|$5 million to $10 million||10.53%|
|Over $10 million||16.22%|
If you’re living and working abroad, and have an offshore bank account, the way to lower your audit risk is to reduce the number of red flags your tax return puts up. Here are my tips for avoiding an expat audit:
- Carefully review your bank and brokerage statements to ensure your return matches up exactly with what is reported to the IRS.
- Home office, auto mileage deduction, non-cash charitable contributions, and rental real estate losses are red flags.
- Using the physical presence test to qualify for the FEIE is a red flag. If the IRS can prove you’re in the U.S. for one extra day, you lose the exclusion in its entirety. These audits are very profitable for the government. I strongly recommend you because a resident of some country (such as Panama who has the lowest cost residency program).
- Filing as an expat real estate professional or reporting a foreign 1031 exchange of international real estate are major red flags.
- Claiming to be a professional trader of your own brokerage account is a major red flag. This is a common mistake with retired expats.
- Claiming business losses for activities which are hobbies are red flags for expats. Your horse, race car, and anything you don’t work at full time, is not a business.
- Claiming offshore gambling losses against U.S. wins is a guaranteed audit.
The bottom line is that an offshore bank account does not increase your chances of being audited. So long as you keep up with your reporting obligations, you can relax.
I hope this article on whether an offshore bank account increase my chances of being audited has been helpful. If you’d like information on how to structure your business offshore, open an offshore bank account, or to be introduced to an international tax expert, please contact me at firstname.lastname@example.org or call us at (619) 550-2743. All consultations are free and confidential.