Form 8275 Disclosure: The Penalty Shield Most Cross-Border Filers Never Use
A Form 8275 disclosure is a statement you attach to your US tax return to flag a position that the law does not settle clearly, and it can remove the 20% accuracy-related penalty if the IRS later disagrees with you. For Americans in Britain, dual national US UK families and UK company owners with American shareholders, grey areas arise every year. Moreover, they arise far more often than they do for a salaried taxpayer in Ohio, because two tax systems rarely describe the same payment in the same way.
At TaxYork, we prepare US UK tax returns for investment bankers, private equity partners, founders and executives whose income does not fit neatly into American forms. Consequently, we make a deliberate decision on every complex return about whether a position needs disclosure. This guide explains how the form works, which cross-border positions justify it, what it cannot protect, and how it interacts with HMRC's own "white space" rules.
What a Form 8275 Disclosure Protects You From
The form targets two specific parts of the accuracy-related penalty. Specifically, the IRS instructions for Form 8275 confirm that adequate disclosure can avoid the penalty for disregard of rules and the penalty for a substantial understatement of income tax, provided the position has at least a reasonable basis. In practice, those are the two grounds the IRS reaches for when it rejects a cross-border judgement call.
However, the protection is narrow. A Form 8275 disclosure does not excuse negligence, poor records, valuation misstatements, tax shelter items or undisclosed foreign financial assets. Therefore, you should treat a Form 8275 disclosure as a precise instrument rather than a general insurance policy.
Why Cross-Border Returns Need It More Than Domestic Ones
A domestic American return mostly reports figures that third parties have already sent to the IRS. By contrast, an expat return translates British events into American concepts. Sourcing, currency conversion, creditability of foreign tax, entity classification and the timing of UK tax payments all require judgement. Furthermore, many of these questions have no regulation, ruling or case that answers them directly.
As a result, a sophisticated expat return often contains two or three positions where a reasonable professional could reach a different answer. Each one is a potential penalty. Accordingly, a well-drafted Form 8275 disclosure turns those exposures into a straightforward tax-and-interest question if the IRS ever raises them.
The Accuracy-Related Penalty Explained
Before deciding whether to disclose, you need to understand exactly what you are protecting against. The penalty sits in section 6662 of the Internal Revenue Code, and it applies to the portion of an underpayment that falls within one of its listed grounds.
The 20% Charge and Its Grounds
The standard rate is 20% of the underpayment attributable to the relevant ground. The grounds include negligence or disregard of rules or regulations, a substantial understatement of income tax, a substantial valuation misstatement, and several others that rarely touch individuals. Importantly, the IRS can assert more than one ground on the same underpayment, but it cannot stack them; the maximum is still 20% for those grounds.
In our experience, IRS examiners almost always cite both negligence and substantial understatement together. Consequently, you need a defence to each. Good records and a reasoned position answer negligence, while a Form 8275 disclosure answers the substantial understatement ground where the position lacks substantial authority.
The Substantial Understatement Threshold
For an individual, an understatement is substantial if it exceeds the greater of 10% of the tax required to be shown on the return or $5,000. Notably, the 10% figure falls to 5% for any taxpayer who claims the section 199A deduction. For a high earner whose required tax runs into six figures, the 10% test usually governs, so a small error rarely triggers it.
However, cross-border returns behave differently. When foreign tax credits wipe out most of the US liability, the "tax required to be shown" can be modest. Therefore, a single rejected sourcing position can push the understatement over $5,000 easily, even for someone with a seven-figure income. That is precisely the situation in which a Form 8275 disclosure earns its keep.
The 40% Foreign Asset Penalty That Disclosure Cannot Cure
Section 6662(j) imposes a 40% penalty on an "undisclosed foreign financial asset understatement". This applies where the underpayment relates to an asset that you should have reported on Form 8938, Form 5471, Form 8865 or similar information returns, but did not. Critically, the Form 8275 instructions list this penalty among those that disclosure on the form cannot avoid.
The only cure is filing the correct information return. If you have missed reporting on a UK pension, investment account or ISA, our FBAR and FATCA reporting service deals with the underlying failure first. Afterwards, a Form 8275 disclosure can protect the genuinely uncertain positions that remain.
Reasonable Basis, Substantial Authority and the Disclosure Trade-Off
The value of any Form 8275 disclosure depends on how confident you are in the underlying position. The regulations set out a ladder of standards, and each rung changes your penalty exposure.
The Three Standards of Confidence
The lowest useful standard is "reasonable basis". According to the IRS instructions, reasonable basis is a relatively high standard, significantly higher than a position that is merely not frivolous. It must rest on the authorities listed in Treasury Regulation 1.6662-4(d)(3)(iii), which include the Code, regulations, court cases, revenue rulings, treaties and their technical explanations.
Above that sits "substantial authority", which requires the weight of authority supporting your treatment to be substantial compared with the authority against it. Finally, "more likely than not" means a greater than 50% chance of success. If your position reaches substantial authority, you do not need to disclose to escape the substantial understatement penalty. Conversely, if it reaches only reasonable basis, disclosure becomes the difference between 0% and 20%.
Form 8275 Versus Form 8275-R
The two forms serve different purposes. You use Form 8275 for positions that are uncertain but not contrary to a Treasury regulation, including positions that depart from a revenue ruling or IRS notice. By contrast, you use Form 8275-R only when your position contradicts a regulation, typically because you believe the regulation itself is invalid.
Form 8275-R carries a heavier burden. The position must represent a good-faith challenge to the regulation's validity, and the IRS receives far fewer of these forms. As a result, a regulation challenge draws noticeably more attention than an ordinary Form 8275 disclosure. For most cross-border filers, the standard form is the right tool.
What Disclosure Cannot Fix
Disclosure never converts a weak position into a safe one. If a position lacks reasonable basis, a Form 8275 disclosure protects nothing. Similarly, disclosure does not avoid the negligence penalty, which turns on whether you kept adequate books and made a reasonable attempt to comply.
Furthermore, a Form 8275 disclosure offers no protection on tax shelter items, and it does not touch penalties outside section 6662, such as late filing or late payment penalties. If you are catching up on missed US tax returns or a missed FBAR, those failures need their own remedy. Our guide to first-time penalty abatement for expats covers the separate relief available there.
Cross-Border Positions That Justify a Form 8275 Disclosure
The strongest candidates are positions where the facts are clear but the law is genuinely unsettled. In our practice, four families of US-UK positions come up repeatedly on high-net-worth returns.
Sourcing Apportionments on Termination and Covenant Payments
American law sources a restrictive covenant payment to the place where you agreed not to compete. Consequently, a London executive whose covenant covers both Britain and the United States must split the payment between foreign-source and US-source income. No regulation prescribes the method, so the apportionment is a judgement call.
A Form 8275 disclosure setting out the covenant's territory, the revenue weighting used and the resulting split is exactly the kind of statement the IRS instructions contemplate. Our analysis of restrictive covenant payments under US and UK tax explains the sourcing rules in detail, while the case study below shows what disclosure is worth in pounds.
Foreign Tax Credit Timing and Creditability
The foreign tax credit rules generate constant uncertainty for British residents. For instance, the UK tax year ends on 5 April, so UK tax must be allocated across two US calendar years. Additionally, a UK levy may or may not qualify as a creditable income tax under the 2022 regulations, as modified by the temporary relief the IRS extended in Notice 2023-80.
Where your credit depends on how a particular UK charge is characterised, or when it is treated as accruing, a Form 8275 disclosure documents your reasoning. Our tax treaty optimisation service builds this analysis into the credit computation itself, rather than leaving it to be reconstructed during an examination.
Classification Questions on UK Companies and Funds
Whether a UK company is a passive foreign investment company can turn on asset valuations at each quarter end. Similarly, the status of an unusual UK investment vehicle, or the default classification of a UK entity with limited liability, may rest on facts that reasonable people weigh differently.
In these situations, you still file the required information returns in full. Nevertheless, a Form 8275 disclosure explaining a borderline valuation or classification choice can protect the income tax consequences that flow from it. Importantly, it cannot protect a valuation misstatement penalty, so the valuation itself must be defensible.
Where Form 8833 Takes Over
Treaty-based positions follow a different route. Section 6114 requires you to disclose a position that a treaty overrides or modifies the Code on Form 8833, and failure carries a separate $1,000 penalty for individuals. Examples include re-sourcing income under the treaty's relief article or claiming UK residence under the tie-breaker.
Consequently, a treaty claim belongs on Form 8833, not Form 8275. However, where a treaty position also depends on an uncertain factual or non-treaty legal judgement, experienced preparers sometimes attach both. The key is that each form does its own job.
How to Complete and File Form 8275
The form itself is short. The quality of the explanation, however, determines whether it counts as adequate disclosure.
Completing Parts I to IV
Part I identifies each item: a description, the form or schedule and line where it appears, and the amount. Part II then requires a detailed explanation of the relevant facts and the nature of the controversy. The instructions require enough detail for the IRS to identify the item, the amount and the potential dispute.
Part III applies only when the item comes through a partnership, S corporation or other pass-through entity. Part IV provides overflow space for longer explanations. In our experience, the strongest Form 8275 disclosure states the facts neutrally, names the competing authorities and explains why you chose your treatment, all without advocacy.
Adequate Disclosure Without the Form: Rev. Proc. 2026-12
Each year the IRS publishes a revenue procedure listing items where a properly completed return already counts as adequate disclosure. For 2025 returns, that guidance is Rev. Proc. 2026-12, which covers items such as fully completed Schedule A lines for medical expenses, taxes, interest and charitable gifts.
However, the list does not cover the typical cross-border judgement call. Specifically, the revenue procedure states that where an item is not listed, disclosure is adequate only if made on a properly completed Form 8275 or 8275-R. Therefore, a sourcing apportionment or credit timing position needs a standalone Form 8275 disclosure.
Qualified Amended Returns and Carryovers
You file a Form 8275 disclosure with your original return. Alternatively, you can attach it to a qualified amended return, which is one filed before the IRS first contacts you about an examination of that year. Once the IRS makes contact, the window closes.
Carryovers receive helpful treatment. The instructions explain that you disclose a carryover item in the year it originates, and you do not need to repeat the Form 8275 disclosure in later years when the carryover is used. For foreign tax credit carryovers, this makes the originating year's statement especially important.
The Statute of Limitations Bonus
Disclosure also affects how long the IRS can reopen your return. This point is almost entirely missing from the pages that currently rank for this topic, yet it matters greatly to wealthy filers.
The Six-Year Rule for Omitted Income
Normally, the IRS has three years to assess. However, section 6501(e) extends this to six years if you omit more than 25% of the gross income stated on your return. It also extends it to six years if you omit more than $5,000 of income attributable to foreign financial assets reportable under section 6038D.
Crucially, section 6501(e)(1)(B)(iii) excludes from the omitted amount any item disclosed on the return, or in an attached statement, in a manner adequate to apprise the IRS of its nature and amount. Consequently, a clear Form 8275 disclosure can keep an item inside the ordinary three-year window.
Foreign Information Returns Keep the Door Open
Separately, section 6501(c)(8) keeps the whole assessment period open until three years after you file a missing foreign information return, such as Form 8938, Form 5471 or Form 8621. No Form 8275 disclosure closes that gap. If you are unsure which accounts must appear on your FinCEN FBAR report, resolve that before anything else.
Therefore, complete US tax return preparation for expats means filing every information return first and disclosing judgement calls second. If earlier years are missing entirely, our catch-up filing service for delinquent returns addresses that before any disclosure strategy makes sense.
Audit Risk and the UK White-Space Parallel
Clients often worry that flagging a position invites an examination. The evidence suggests otherwise, and British readers will recognise the logic from HMRC's own system.
Does Filing Form 8275 Trigger an Audit?
The IRS receives large numbers of these forms, and most returns carrying one are never examined. In reality, the underlying transaction drives selection, not the disclosure. A seven-figure covenant payment with a split source will attract the same attention with or without a Form 8275 disclosure.
Moreover, if an examiner does raise the item, the disclosure demonstrates good faith from the outset. In our experience, examinations of well-disclosed positions resolve faster, because the examiner starts with your reasoning rather than having to discover it. Our guides to the IRS correspondence audit for Americans in the UK and IRS audit reconsideration explain what happens next.
HMRC's White Space and Discovery Assessments
The UK has a close equivalent. Under section 29 of the Taxes Management Act 1970, HMRC can raise a discovery assessment after the enquiry window closes. However, section 29(5) blocks a discovery where the information you supplied would have made a hypothetical officer aware of the insufficiency.
Consequently, UK advisers use the "any other information" white space on the Self Assessment tax return much as American preparers use Form 8275. Notably, white space disclosure does not stop an assessment where the loss of tax was careless, which extends HMRC's window to six years, or deliberate, which extends it to 20. The same principle applies on both sides of the Atlantic: disclosure protects a reasonable position, never a careless one. For more detail, see our article on the HMRC closure notice for US filers in Britain.
Case Study: A London Managing Director's Covenant Payment
The following illustrative example shows what a Form 8275 disclosure is worth on real numbers. The names and details are hypothetical, but the mechanics reflect the positions we handle for clients.
The Facts
Daniel is a US citizen and UK-resident managing director at a London investment bank. On leaving in 2025, he receives £200,000 for a 12-month restrictive covenant covering the UK, the EU and the United States. Under section 225 of the Income Tax (Earnings and Pensions) Act 2003, HMRC taxes the whole payment as employment income at 45%, producing £90,000 of UK tax.
Using the IRS yearly average currency rate of 0.759 pounds to the dollar for 2025, the payment equals about $263,505 and the UK tax about $118,577. Daniel's covenant restricts him mainly in the markets where his former clients sat. Accordingly, he weights the split by revenue, treating 80% as foreign source and 20%, or $52,701, as US source.
The Numbers With and Without Disclosure
Suppose the IRS later argues for a 50/50 split by territory. That moves a further $79,051 into US-source income, where UK tax cannot be credited against it. At 37%, the additional US tax is roughly $29,249. Because his foreign tax credits keep his required US tax low, the $5,000 floor governs the threshold, so the understatement is clearly substantial.
Without disclosure, the IRS would add a 20% penalty of about $5,850, plus interest on that penalty. However, Daniel attached a Form 8275 disclosure describing the covenant territory, the revenue data behind his weighting and the absence of any regulation prescribing a method. Because his position had a reasonable basis and was adequately disclosed, the disputed item drops out of the understatement calculation. As a result, he pays only the agreed tax and interest, and the penalty disappears. The disclosure also neutralised any argument for a six-year assessment window on that income.
How TaxYork Can Help
Deciding when a Form 8275 disclosure is worthwhile requires judgement across two tax systems at once. At TaxYork, we provide comprehensive US tax return preparation for expats, including the analysis behind every uncertain position and the drafting of each Form 8275 disclosure we attach.
Specifically, we identify positions that lack substantial authority, test whether they reach reasonable basis, and write neutral, complete Part II explanations that satisfy the adequate disclosure standard. Additionally, we make sure every Form 8938, 5471, 8621 and FBAR is filed, so that no 40% penalty or open statute undermines the protection. For clients with missed reporting on a pension, investment account or ISA, we correct the history first and then disclose the genuine grey areas going forward.
Our wider cross-border planning service also helps you structure transactions, such as covenant terms or share sales, so that fewer positions need disclosure in the first place.
Conclusion
A Form 8275 disclosure is one of the most cost-effective protections available to a US taxpayer living in Britain. It removes the 20% substantial understatement and disregard penalties on positions with a reasonable basis, and it can keep disclosed items within the three-year assessment window. However, it cannot rescue a careless position, a valuation misstatement or an undisclosed foreign asset, and treaty claims belong on Form 8833 instead.
Ultimately, the best returns combine complete information reporting, positions backed by authority, and precise disclosure of the few judgement calls that remain. That combination gives the IRS nothing to penalise, even when it disagrees with your answer.
Contact Us
If your US return involves covenant payments, complex foreign tax credits, UK company holdings or any position you are unsure how to report, speak to our specialists. Please book a consultation today, email hello@taxyork.com or call 020 3488 8606. We prepare US UK tax returns for high-net-worth individuals, investors and company owners across Britain.
Disclaimer
This article provides general information about US and UK tax rules as at September 2026 and does not constitute tax, legal or financial advice. Tax outcomes depend on your individual circumstances, and the rules, rates and thresholds described may change. The case study is illustrative and uses hypothetical figures. You should obtain professional advice specific to your situation before taking any action. TaxYork accepts no liability for decisions made on the basis of this article without a formal engagement.