For most U.S. taxpayers who have undeclared foreign financial accounts entering the Offshore Voluntary Disclosure Initiative of 2012 (OVDI) is appropriate. Many people have contacted me and have decided not to enter the OVDI because of their legitimate concern about paying the 27.5% FBAR penalty, (actually a civil miscellaneous penalty). The penalty civil miscellaneous penalty is a substitute for the FBAR penalties which could be assessed, both civil and criminal for failure to timely file FBAR’s. The penalty base is the highest single year account balance of the offshore accounts plus assets acquired with those funds.
After meeting with dozens of U.S. taxpayers since the 2009 OVDP it is clear that most owners of foreign financial accounts should be subject to issues of an FBAR Warning Letter, as provided in the Internal Revenue Manual, in addition to paying the state and federal income tax on an unreported income, plus interest and the accuracy related penalty of 20% of the tax. I have consistently taken this approach with OVDI filings and asked for an FBAR penalty Waiver Letter in lieu of the civil miscellaneous penalty. At least one IRS lawyer seems to agree with this approach.
In a statement reported in Tax Notes Today (May 18, 2012) an IRS associate area counsel (Philadelphia) in the Small Business/Self-Employed Division seems to agree with my position, that a Warning Letter is sufficient to bring the taxpayers into compliance. From a policy standpoint, this may or may not be significant, as no IRS official pronouncement on the point has been made. From a practical point, however, this statement should encourage some taxpayers who are on the fence about coming forward and entering the OVDI program to give it further consideration. IN particular, for those taxpayer’s who have unreported foreign gifts or bequests, which created the offshore accounts, or for those who have accounts they established while citizens of another county, the OVDI may be very important.
The penalties for failing to file a Report of foreign Gift or Bequest (Form 3520) of $100,000 or more in a single year is from 25% -35% of the gift or bequest even though there is no tax due. These penalties are waived as part of the OVDI process.
It is therefore potentially less costly to enter the OVDI with a request for a Waiver Letter and argue the merits, than to hide and hope to avoid discovery. FBAR penalties for “willful” non-disclosure are the greater of $100,000 or 50% of the aggregate account balance, per year for each year of non-compliance, plus the risk of criminal prosecution. Other penalties for the income tax violations may also apply. For Green Card holders, prosecution may also mean deportation. As foreign financial institutions begin cooperating with the IRS in reporting U.S. taxpayer’s who have or are beneficiaries of foreign accounts,as required under the Foreign Account Tax Compliance Act (FATCA) the odds of discovery are increasingly against U.S. taxpayers. The result is that U.S. taxpayer’s who avoid disclosure now, may regret the decision later.