One of the major issues that confront taxpayers when deciding to enter the Offshore Voluntary Disclosure Program (OVDP) is why do so if I may only “opt out” later. The main reason to enter the program is to limit exposure to criminal prosecution. A reason to “opt out” is that the cost of the OVDP penalty is too high. Why would a taxpayer consider the cost too great?
If a taxpayer can objectively determine that there failure to file a Report of Foreign Financial Account (FBAR) was due to a reasonable cause then it is possible that opting out may result in a zero FBAR penalty. Reasonable cause is a “facts and circumstances” test applied by the IRS to determine if the taxpayer exercised ordinary care and prudence. Reliance on the advice of professionals who are fully informed and skilled in the area is a basis to asset a reasonable cause position.
Lacking a reasonable cause defense, that is no written advice that could be relied upon, a taxpayer can who asserts, ignorance of the FBAR filing requirement may be able to satisfy the “non-willful” test and be subject to the $10,000 per year per account penalty. If the taxpayer acted with deliberation and did not file an FBAR the willfulness penalty may apply which is $100,000 or 50% of the account balance per year. Prosecution remains an option when willful conduct is involved.
The IRS has published examples of when an “opt out” may be advantageous and when not (see OVDP FAQ 51.1). One point that should not be overlooked is that under OVDP FAQ 36 all assets involved in “tax non-compliance” are included in the penalty base, not just the foreign financial accounts. This fact alone may make the cost of staying in the OVDP too high. Example: in addition to including the foreign financial accounts in the penalty base, if a taxpayer had $1,000 in unreported foreign rental income the VALUE OF THE RENTAL PROPERTY would be included in the penalty base, regardless of the source of funds used to acquire the asset. So, if the value of the asset is $100,000 the penalty base is increased by that amount and the OVDP penalty is increased by 27.5% of the $100,000 in value ($27,500).
Through the above simple illustration taxpayer’s can see that it may clearly be worthwhile to “opt out” . A consideration in the “opt out” is whether there are other risks, which may subject the taxpayer to additional penalties or prosecution. Such risks could include illegal source income, income from Sanction Countries and unreported foreign assets. The risks could produce penalties for tax evasion, money laundering, violations of Sanctions Orders and other risks.
The decision to “opt out” requires careful consideration, but should not be overlooked.