On September 28, 2018, the Internal Revenue Service (IRS) ended its 2014 Offshore Voluntary Disclosure Program (OVDP). The 2014 OVDP (which was an extension of the 2009 and 2011 OVDPs) was meant to allow taxpayers who willfully failed to report foreign financial assets and pay tax on those assets to become compliant, and critically, avoid criminal prosecution and the highest civil penalties. The 2018 OVDP still offers relief that is better than facing criminal prosecution and the full force of civil penalties for willfully underreporting foreign financial assets and income, but it now comes at a higher price. Non-willful taxpayers maintain the option of using the Streamlined Filing Compliance Procedures (Streamlined Procedures), the delinquent Foreign Bank Account Report (FBAR) submission procedures, or the delinquent international information return (Information Return) submission procedures.
Background
United States citizens, companies, non-profits, estates, trusts and residents are generally required to pay tax in the United States on their worldwide income. They are also required to report to the IRS or the Department of the Treasury the existence of interests in foreign financial assets on a multitude of sometimes duplicative forms. For example, taxpayers with signature authority or a financial interest in foreign accounts with an aggregate high balance at any time during the year of $10,000 or more must report those accounts to the Department of the Treasury on a FBAR and may need to report the same accounts to the IRS on Form 8938.
Failure to properly report these foreign financial accounts and pay tax can expose the taxpayer to criminal charges as well as civil penalties as high as the greater of $100,000 or 50 percent of the account balance for each account. The IRS OVDP and other programs, thus, offer an alternative to the full force of non-compliance, and encourage taxpayer cooperation with their legal duties without being subject to criminal penalties or the highest civil penalties, if any.
New Guidelines for Voluntary Disclosures
The 2018 OVDP permits a taxpayer who may have willfully violated the taxpayer’s reporting and tax payment duties with respect to foreign financial assets to enter the program, potentially avoid criminal prosecution and pay lower civil penalties. This process commences by the taxpayer requesting preclearance on the Offshore Voluntary Disclosure Letter (Form 14457) from the IRS Criminal Investigation (CI). An updated version of Form 14457 is forthcoming, with the new version requiring information related to taxpayer noncompliance, including “a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance.” If the IRS CI grants preclearance, then the case is forwarded to the IRS Large Business and International (LB&I) Austin unit for civil examination, subject to the standard IRS examination procedures.
After the case has been forwarded to the LB&I for civil examination, the IRS applies the following “civil resolution framework” to resolve taxpayer noncompliance:
-
Voluntary disclosures will generally cover a six-year period, meaning the taxpayer will need to file six years of amended returns or delinquent FBARs and pay delinquent taxes, interest and penalties imposed under the program. However, disclosure and examination periods may vary in the following circumstances: (1) if not resolved by agreement, the examiner has the discretion to expand the period to include the full duration of noncompliance and may assert the maximum civil penalties; (2) if noncompliance is less than six years in duration, then the disclosure period encompasses all of the years; and (3) if the IRS consents to expand the disclosure period (i.e., if the taxpayer would like to correct mistakes that took place more than six years in the past).
-
Taxpayers must submit all required returns and reports for the specified disclosure period.
-
Examiners will determine applicable taxes, interest and penalties under existing law and procedures. Penalties may include:
-
Civil fraud penalties of up to 75 percent of the highest tax liability, which in some circumstances could be expanded to more than one year or beyond the six years if no agreement to resolve the examination is reached or the taxpayer is uncooperative.
-
Willful FBAR penalties of up to the greater of $100,000 or 50 percent of the highest balance in the account, though certain mitigation procedures may apply to reduce this amount.
-
A failure to file penalty, related to Information Returns, ordinarily would not apply.
-
Penalties relating to excise taxes, employment taxes, and estate and gift taxes may apply depending on the circumstances.
A taxpayer may request the IRS impose lesser penalties, and if the taxpayer ultimately disagrees with the IRS’ assessment, the taxpayer retains the right to request an appeal with the IRS Office of Appeals.
Last, it is important to note that, under this new framework, the IRS expects that voluntary disclosures will be resolved by an agreement that involves full payment of taxes, interest and penalties for the specified disclosure period—and if the taxpayer fails to cooperate with the examination, the examiner may request that the IRS CI revoke the taxpayer’s preclearance.
Streamlined Procedures
If the taxpayer believes there was no willful failure to comply, then the Streamline Procedures are still available, for the time being. Under these procedures, the taxpayer must not already be under IRS examination. If the taxpayer (and spouse) resided in the United States for at least 35 days in any one of the last three years or had a United States abode, then the taxpayer must file three years of amended tax returns, file six years of delinquent FBARs, pay all unpaid taxes and interest, and pay a five percent penalty on the highest balance of the unreported accounts for the six-year period. For a taxpayer who was physically outside of the United States for at least 330 full days in any one of the last three years and did not have a United States abode, then the same rules apply except the penalty is zero percent. The taxpayer must additionally submit a narrative explaining in detail why he or she did not act willfully.
Delinquent FBAR/Information Return
Under the delinquent FBAR or Information Return submission procedures, the taxpayer may submit delinquent documents if the taxpayer had reasonable cause for the failure to file. In the case of delinquent Information Returns, the taxpayer must also typically submit the returns with a detailed statement about why the taxpayer had reasonable cause for not filing the returns on time. Other than filing the delinquent forms, the taxpayer does not pay any penalties in the delinquent submission procedures, but the reasonable cause standard is a more difficult standard to meet than the non-willful standard that applies in the Streamlined Procedures.
Conclusion
Although awareness of the reporting and taxpaying obligations of United States taxpayers’ foreign financial assets seems greater now than prior to the IRS’s opening its initial OVDP, non-compliance still continues to be common. Navigating the compliance rules, penalties and options for fixing mistakes takes specific knowledge of complex international tax laws. Taxpayers in need of help would be wise to consult with a professional who is familiar with this complicated area of tax law.
Footnotes:
