[author: Thomas R. Wechter]
After two successful offshore voluntary disclosure programs, the IRS on Jan. 9 announced a new 2012 Offshore Voluntary Disclosure Program (2012 OVDP). Under the previous two programs, the 2009 Offshore Voluntary Disclosure Program (2009 OVDP) and the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI), which closed on Sept. 9, 2011, the IRS received over 33,000 disclosures and collected more than $4.4 billion in taxes and penalties (IR-2012-5).
Update of Frequently Asked Questions
On June 26, 2012, the IRS released IR-2012-64, announcing the release of updated frequently asked questions (FAQs) on the IRS website to provide guidance for the 2012 OVDP, and IR-2012-65, which announced new procedures for U.S. taxpayers living abroad who have failed to timely file returns with respect to foreign accounts or FBARs.
The Basics of the 2012 OVDP
The 2012 OVDP is essentially the same as the 2011 OVDI, except the maximum penalty has been increased to 27.5% from 25% and there is no deadline for taxpayers to apply. However, as Commissioner Douglas Shulman warned in announcing the 2012 OVDP, the terms of the program could change at any time, e.g., the IRS could increase the penalties for all taxpayers or a defined class of taxpayers or even decide to end the program entirely at any point (IRS, Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers, FAQ No. 1).
The 27.5% penalty applies to the highest aggregate value of foreign accounts and assets during the eight full tax years prior to the disclosure (see FAQ No. 8). This penalty applies to all the taxpayer's offshore holdings that are related in any way to tax noncompliance, including bank and financial accounts, tangible assets, and intangible assets. If the assets were acquired with funds on which the taxes due were not paid or if the income from the assets was not reported during the period covered by the 2012 OVDP, then the assets would be tax noncompliance related and the penalty would apply (see FAQ No. 35).
Certain taxpayers are eligible for reduced penalties of 5% or 12%. The eligibility requirements for these reduced penalties remain the same as under the 2011 OVDI. Taxpayers whose foreign account balances during the eight years covered by the 2012 OVDP did not exceed $75,000 are eligible for the 12.5% penalty. (See FAQ No. 53). Three categories of taxpayers, as specifically described in FAQ No. 52, are eligible for the 5% penalty.
As in the prior programs, taxpayers must file all original and amended tax returns and include payment for back taxes and interest, as well as pay an accuracy-related and or delinquency penalty, for the eight years before disclosure. The 2012 OVDP, like the 2011 OVDI, forces an eight-year lookback period on the taxpayer, even though the eight-year period covers closed years and possibly only a three-year statute of limitation would apply (see FAQ No. 9).
Participation in 2012 OVDP Unnecessary in Some Cases
If a taxpayer has reported all the income from offshore assets and paid the taxes due but has failed to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), or the other information returns, such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, or Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, the taxpayer should not participate in the 2012 OVDP. The taxpayer should instead file the delinquent FBARs or information returns. The IRS has stated that no penalties will be imposed for the failure to file the delinquent FBARs or information returns as long as there are no underreported tax liabilities and the taxpayer has not been contacted regarding an income tax examination or a request for the delinquent returns (see FAQ Nos. 17 and 18).
The long-standing voluntary disclosure requirements that a taxpayer make a truthful and complete disclosure, cooperate with the IRS, and arrange in good faith to pay what is due still apply. However, a taxpayer is ineligible if the IRS or the Department of Justice obtains information under a John Doe summons, treaty request, or similar action that identifies the taxpayer as being noncompliant with U.S. tax laws or reporting requirements. Under the previous programs, those circumstances meant that the taxpayer "may become ineligible."
Also, if a taxpayer appeals a foreign tax administrator's decision authorizing providing account information to the IRS and fails to serve notice of the appeal to the U.S. attorney general at the time of such appeal, the taxpayer is ineligible to participate in the 2012 OVDP. The IRS may terminate at any time the eligibility of certain groups of taxpayers that have or had accounts at specific financial institutions due to certain U.S. actions in connection with those specific financial institutions (see FAQ No. 21).
A special mechanism is provided for a taxpayer's representative to secure preclearance—prior to making a voluntary disclosure under the 2012 OVDP—by contacting the IRS Criminal Investigation Lead Development Center with the taxpayer's name, date of birth, Social Security number, address, and an executed power of attorney. Upon acceptance, the Criminal Investigation (CI) Office will notify the taxpayer's representative that the taxpayer is cleared to make an offshore voluntary disclosure (see FAQ No. 23).
The long-standing practice of CI with respect to voluntary disclosures is to take into consideration the timely, accurate, and complete voluntary disclosure in deciding whether to recommend that the taxpayer be criminally prosecuted, but a voluntary disclosure does not automatically guarantee immunity from prosecution. The 2012 OVDP provides somewhat more comfort that when "a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice" (see FAQ No. 3).
The IRS position that the examiner does not have the discretion to settle voluntary disclosure cases on the basis of reasonable cause, willfulness, mitigating facts, or other circumstances that might reduce the taxpayer's liability is carried over. FAQ No. 50 also provides that "under no circumstances will taxpayers be required to pay a penalty greater than what they otherwise would be liable for under the maximum penalties imposed under existing statutes."
In a case where the taxpayer would pay a lesser penalty under existing statutes as a result of the penalty's only applying to financial accounts, the taxpayer would only pay the lesser amount of the FBAR penalty. However, if the FBAR penalty would be less than the offshore penalty under the 2012 OVDP because the taxpayer was not willful in failing to file a FBAR, the examiner would not have the option to settle the case on that basis, and the only option available to the taxpayer would be to opt out of the 2012 OVDP.
A taxpayer who disagrees with the application of the offshore penalty under the 2012 OVDP has the option only to opt out of the program. The election to opt out must be made in writing and once made is irrevocable. An opt-out election subjects the taxpayer to the standard audit process and the normal applicable statute of limitation; the taxpayer has available the mitigation defenses to the FBAR penalty (see FAQs No. 51.1, 51.2, and 51.3).
The Opt Out and Removal Guide for 2009 OVDP and 2011 OVDI, published in June 2011, which is also applicable to the 2012 OVDP, can be found on the IRS website.
New Procedures for Nonresident U.S. Taxpayers
At the same time it announced the 2012 OVDP, the IRS also announced new procedures, effective Sept. 1, 2012, for current nonresidents, including dual citizens, who have not filed U.S. income tax returns and FBARs, who are low compliance risks, to become current. In general, taxpayers will be considered a low compliance risk if they have simple tax returns and owe $1,500 or less in tax for any of the covered years.
Under the procedure, taxpayers must file delinquent U.S. income tax returns for the past three years and delinquent FBARs for the past six years, as well as additional information regarding compliance risk factors as required by future instructions, and pay any unpaid taxes and interest at the time of the submission. Taxpayers who present a higher compliance risk are subject to more-thorough reviews and possibly an audit (IR-2012-65).
The announcement of an indefinite offshore voluntary disclosure program is certainly welcome news. But the retention of the one-size-fits-all penalty structure is not. For taxpayers who have intentionally not reported offshore assets or who have not reported the income from offshore assets and paid tax on the income, the 2012 OVDP is generally the best option, while for taxpayers who have made an innocent mistake, have not willfully failed to file the FBAR, or who would not be subject to an extended statute of limitation, the best option generally is not to participate in the 2012 OVDP or to opt out.
Thomas R. Wechter, J.D., LL.M. (Tax), is a partner with Duane Morris LLP in the Chicago office and concentrates his practice in tax planning for individuals, corporations, and partnerships and in tax controversy matters in front of the IRS and before the Tax Court, U.S. Court of Federal Claims, and the district courts.
Reprinted by permission.