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OVDI Compliance

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    An experienced FBAR tax attorney can help you decide which steps to take next. At the Tax Law Office of David Klasing, our experienced international tax attorneys have developed a national practice as to federal income tax issues administered by the top tax attorney IRS, so no matter what state you are from, if you are presently out of OVDI compliance concerning Foreign Accounts or income generating assets, we can help bring you back into compliance.

    Disclosing Foreign Accounts and Assets Through the OVDI Program

    On June 26, 2012 the Internal Revenue Service released updated Q&A’s on the third and some to believe to be final version of the offshore voluntary disclosure program, while at the same time announcing the collection of more than $4.4 billion so far from the previous two version of the program (Over 6 Billion to date). This final version is called the 2012 Offshore Voluntary Disclosure Initiative (OVDI).

    The objective of the 2012 OVDI program is the same as with previous programs: to bring taxpayers that have knowingly or merely negligently used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into OVDI compliance with United States tax laws, and to increase revenue collections utilizing the most cost efficient means possible.

    Accordingly, this program provides two main benefits to its participants:

    • Removal, in the vast majority of cases, of the possibility that participants that have committed domestic or foreign income tax evasion will be criminally prosecuted based on the fact that where a taxpayer makes a truthful, timely and completely cooperative voluntary disclosure of his or her domestic and foreign income tax evasion the IRS will not recommend criminal prosecution even where criminal tax acts were willfully committed.
    • Making a voluntary fbar disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

    What Does This Mean for Individuals with Foreign Assets?

    The cold hard truth is that the IRS foreign income and asset detection net is closing in on those that have failed to make a voluntary disclosure to date. Taxpayers that fail to take advantage of this program run the risk of being detected by the IRS, at which point the program will no longer be available to them. Increasingly, information regarding foreign activity is becoming available to the IRS through tax treaties with foreign nations, intelligence gathered from other voluntary disclosures, information gathered from paid informants and whistleblowers and the most threatening development of all, the imposition of the Foreign Account Tax Compliance Act (FATCA) and Foreign Financial Asset Reporting under the new IRS form 8938 which is required with the filing of a taxpayers personal income tax return. An experienced FBAR lawyer can help you navigate the complicated process.

    The ever increasing publicity concerning the IRS’s efforts to reduce the Tax Gap for income taxes evaded related to Foreign Accounts and Assets coupled with the publicity surrounding the addition of form 8938 to the individual tax returns of U.S. citizens and residents creates an ever increasing risk that an out of compliance taxpayer’s non-compliance discovered by the taxing authorities will be viewed as purposeful and willful rather than merely negligent or even grossly negligent. The associated risk of facing criminal rather than civil consequences is also rising because only willful conduct can be criminally prosecuted. Keeping in mind that the difference between willful and negligent behavior is merely a state of mind, and the IRS is increasingly becoming of the opinion that taxpayers could not conceivably have been ignorant about the requirement of filing an FBAR TDF 90-22.1 (FinCen 114) or reporting foreign income because of the 8938 requirement and the public notice surrounding the imposition of this form.

    What’s more, although a willful violation must generally be supported by substantial circumstantial evidence, failing to acknowledge foreign income when expressly asked in question 7 of Part III on the Form 1040 schedule raises suspicion. Non-compliant taxpayers should enter the 2012 OVDI program as soon as possible rather than face the possibility of defending a criminal charge which would largely focus on circumstantial evidence surrounding their state of mind at the time of their noncompliance.



    Penalties for Ignoring OVDI Compliance

    It’s also important to note that for each tax year that a taxpayer is convicted on income tax evasion a 5 year jail term is possible. Given that there is a 5 year criminal statute of limitations, a jail sentence of up to 25 years in jail is at least conceivably possible along with a fine of up to $250,000 along with the cost of prosecution. Moreover, criminal charges can be asserted for filing a false return and willfully failing to file an FBAR. Taxpayers that file false returns can spend up to 3 years in jail per count (up to 20 years for 5 counts). Failing to file an FBAR can subject a person to up to ten years in jail and a penalty of up to $500,000.

    Stated simply, this program generally provides willful and or negligent non-compliant taxpayers the opportunity to cure all Foreign Reporting Filing Deficiencies, including outright Tax Fraud, with certainty and no jail time. In addition, all of the possible information return penalties that can be individually asserted are rolled into the 5 / 12.5 or 27.5 % FBAR penalty and thus substantial savings for civil penalties that would routinely be individually asserted outside of the program for these information returns is possible for participants in the 2012 OVDI. Lastly, any income tax evasion that took place before 2003 (or the earliest of the eight years included in the Offshore Voluntary Disclosure) is considered to be included with the FBAR penalty and amended returns will generally not be required

    The most common civil penalties that are forgiven because they are considered included with the 5 / 12.5 of 27.5% FBAR penalty include the following:

    1. FBAR failure to file penalty of $10,000 a year for each unfiled FBAR that was not filed due to reasonable cause (i.e. Taxpayer did not know of the filing requirement) Note: FBAR has been around for over 20 years… 20 times $10,000 = $200,000 owed. Note this is a strict liability penalty and intent is irrelevant and no apparent statute of limitations exists.

    2. Civil penalty for willfully failing to file an FBAR – Greater of $100,000 of 50% of the total balance in the foreign accounts per violation. Note: If your hit with this for just a four year period on $1,000,000 overseas you could be looking at a $2,000,000 owed (50% of the account balance times four).

    3. Penalties surrounding form 3520 which is required where foreign gifts or inheritances in excess of $100,000 are received within one calendar tax year by a U.S citizen or resident. The penalty is the greater of $10,000 or 35 percent of the gross reportable gift.

    4. Fraud penalties imposed under IRC §§ 6651(f) or 6663 where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties , that, although calculated differently, essentially amount 75 percent of the unpaid tax.

    3520A for information returns of foreign trusts with U.S. Owners. The higher of $10,000 or 5% of trust assets determined to be held by U.S. persons on an annual basis.

    Penalties for failure to file form 5471 Information Return of U.S. Persons with Respect to Foreign Corporations. $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

    A penalty for failing to file Form 5472 Information Return of a 25% or greater Foreign Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business with reportable transactions in the U.S. with a related party. $10,000 with an additional $10,000 added for each month the failure continues beginning 90 days after the Taxpayer is notified of the failure.

    The 2012 offshore voluntary disclosure program is similar to the 2011 OVDI program in most ways, but for a few key differences. Unlike the previous program, there is no set deadline for people to apply with the current program. However, the terms of the program could change at any time going forward including increasing penalties,limit eligibility in the program for all or some taxpayers or defined classes of taxpayers or the IRS could decide to end the program entirely at any point without notice.

    The overall penalty structure for the new program is currently the same as in the 2011 Offshore Voluntary Disclosure (OVDI) program, except for taxpayers in the highest penalty category which has been raised from 25 percent to 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. That is up from 25 percent in the 2011 program. Some taxpayers will be eligible for 5 or 12.5 percent penalties; these remain the same in the new program as in the 2011 OVDI Program.

    Participants must file all original and amended tax returns and include payment for back-taxes and interest for up to the most recent eight years that are out of compliance (original due date has passed or return that was filed did not accurately report foreign or domestic income) as well as paying a 20% accuracy-related and/or applicable delinquency penalties. For most 2012 OVDI participants the eight years of returns will be 2003 through 2010 with 2011 income tax returns (entity and individual) accurately reporting foreign income. Where 2011 personal and entity income tax returns either become delinquent or did not report foreign income accurately, the eight years of returns will be 2004 through 2011.

    Taxpayers in limited situations can still qualify for a 5 percent penalty and taxpayer’s whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the new OVDI program will still qualify for a12.5 percent penalty. As under the prior programs, taxpayers who feel that the penalty is disproportionate may opt instead to be examined by opting out of the program. Note: Entering the program is the only assured way of mitigating the risks of criminal prosecution even where an opt-out may be contemplated.

    Accuracy related penalty calculation Example – if the amended or original 2008 return shows $1,000 of additional tax, the participant will owe $1,200 and interest calculated on both the tax and the 20 percent penalty from 4/15/2009 through the date of payment. To stop the running of interest participants in the 2012 OVDI should consider making a deposit or paying the taxes penalties and interest due as soon as possible.

    Intentional vs. Unintentional Non-Reporting (it Doesn’t Matter)

    One of the most basic premises, but often the least understood by taxpayers, is that U.S. Citizens and Residents are taxed on their worldwide income. This misunderstood concept coupled with the fact that, until recently, the vast majority of U.S. tax advisors were unaware of the information reporting requirements surrounding foreign accounts, foreign investments and foreign business activity have created a massive tax trap for unwary taxpayers.

    The government has identified the following three actions, found in three or more tax years, as resulting in a high probability for consideration for criminal charges for income tax evasion.

    1. Repeated failure to file Form TDF 90-22.1 (FinCen 114) where a citizen or resident has greater than $10,000 on deposit in a foreign bank or institution at any one time during a given tax year
    2. Repeated failure to include the investment income generated by the account as income on the taxpayer’s income tax return.
    3. Repeated failure to indicate the existence / location of the foreign account on schedule B of the taxpayer’s income tax return.

    Each of these actions is considered a badge of tax fraud; however, a distinction must be made between a taxpayer’s negligence versus a taxpayer’s willful behavior. The government’s hardest element in proving a tax crime is to prove, beyond a reasonable doubt, a taxpayer’s intentional violation of a known legal duty. Many of the taxpayers that I have taken through a voluntary disclosure wanted to avoid having the government second guess their actions as being willful rather than negligent where the unreported income was significant and a consistent pattern of non-reporting existed between the tax years 2003 through 2010. Many taxpayers’ chose to disclose and pay penalties even where they were convinced their actions were merely negligent rather than leaving open the possibility of a criminal conviction.

    Additional badges of fraud in this area may include:

    • Transferring your foreign account from a foreign bank under investigation to a foreign bank not under investigation.
    • Failing to complete form 8939 during the 2011 tax filing season
    • Failing to report income earned through foreign business activity
    • Failing to report foreign income from assets held overseas – i.e. rental income Failing to file from 3520 for foreign inheritances or distributions from foreign trusts
    • Failing to file from 5471

    The government views noncompliance surrounding foreign income as its number one compliance problem and has successfully lobbied congress to draft some of the most draconian penalties ever written in the income tax arena to date. Because of its lobbying efforts the IRS now has the power to penalize taxpayers with simultaneous criminal and civil sanctions for noncompliance surrounding foreign accounts.

    From a civil perspective, the non-reporting of the TDF 90-22.1 (FinCen 114), carries a $10,000 a year penalty for each failure to file where a taxpayer’s failure to file is deemed merely negligent. If however, the taxpayer’s non-reporting is deemed willful, the penalty is ½ of the account balance for each year the form was not filed. Where willful failure to file is asserted the penalty for not filing the form can easily result in a multiple of the account balance being assessed. For example, a foreign account with a $1,000,000 balance could be assessed a $3,000,000 penalty. From a criminal perspective a taxpayer can be prosecuted for income tax evasion which carries the potential for a 5 year jail sentence, $250,000 fine, and restitution for the cost of the prosecution.

    Options to Bring Yourself into OVDI Compliance

    The IRS can detect a quiet disclosure by looking at FBAR data. Taxpayers that either just learned they have the problem delineated above or those that have willfully chosen to pass on entering the 2009 or 2011 voluntary disclosure programs both have the following options.

    1. Do nothing
    2. Get into compliance on a go forward basis
    3. Make a quiet disclosure (or take no further action where a quiet disclosure was already made)
    4. Make a loud disclosure by entering the 3rd version of the Offshore Voluntary Disclosure Initiative (OVDI).

    1. Do nothing

    Taxpayers that do nothing when faced with this problem are gambling that the IRS does not have the resources to detect their foreign account. In my opinion this is a grave mistake. Every participant in the 2009 and 2011 voluntary disclosure initiatives was required to provide the government with “intel” on the foreign bank(s) they had deposits with. In fact, data mining is considered a key feature of the voluntary disclosure regime. Participants have been required to provide information related to the creation and maintenance of their foreign accounts as well as identify advisors, and others who promoted tax evasion. The government routinely gathered information about activity that formed the basis of the UBS litigation. UBS bankers were coming onto US soil and counseling US taxpayers that they could deposit funds overseas and that the existence of the account would never be revealed to the US government. Moreover they were advising that any investment income generated by the account would be tax free because if the US government did not know about the income generated by the account it could not tax the investment income. These actions were argued to be aiding and abetting income tax evasion and formed the basis of the suit against UBS. Many other banks around the world are suspected of doing the same thing. In fact, currently there is litigation against 11 additional Swiss banks for the same type of activity. As part of this litigation the main information sought by the US government is the names and account balances of US citizens and residents that have deposits with these Swiss Institutions.

    If you are thinking that your foreign bank is not located in Switzerland and is a tiny hole in the wall in the middle of nowhere so I am safe, think again! Recently legislation called FATCA is expected to result in the submission of the names and account balances of every US resident and Citizen worldwide starting in 2014. FATCA forces foreign banks to turn over this information or face a 30% withholding requirement on transfers from U.S. institutions to the foreign bank. Most banks are expected to comply and turn over the names of US Citizens and Residents rather than lose 30% of deposits to the institution from US financial institutions. Up to now, only the United Kingdom has finalized a FATCA pact, pending approval by parliament. France, Germany, Italy, Spain, Switzerland and Japan have pending agreements and the Treasury is negotiating with at least 40 other countries for FATCA agreements.

    Since the US government will eventually have actionable knowledge concerning your foreign account doing nothing is not a viable option in the face of the draconian penalty regime at the government’s disposal.OVDi compliance lawyer

    2. Get into compliance on a go forward basis

    Some advisors are recommending that taxpayer’s merely get into compliance on a go forward basis and do nothing to address the past non-compliance gambling that the IRS does not have the resources to detect the foreign account. In my opinion this option is also not viable because of the ease with which the U.S. government can flag TDF 90-22.1 (FinCen 114) with large balances on its radar screen. I have heard rumors that the Criminal Investigation Division (CID) has assigned a special agent to monitor for just this occurrence.

    If I were a CID agent my thought process would be as follows for example.

    John Smith has just reported a 1.3 million dollar account balance in the Cayman Islands. Let’s take a look at his prior returns. Hmmmm… for the last 3 years he has made $50,000 a year or so… Thus… the deposit could not have come from previously taxed U.S. income. Did Mr. Smith inherit this money? If he did he better have filed a form 3520 to report the inheritance or I get to hit him with a 35% penalty on the amount of the inheritance! Hmmmm…. No 3520 was filed. Gee… Since I can determine that the funds did not come from previously taxed earnings or from an inheritance there must be something fishy afoot here… Let’s audit this taxpayer. Matter of fact; let’s have the criminal investigation division take a look as well…

    As you can see, this is not a viable option.

    3. Make a quiet disclosure

    Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.

    Some advisors are proponents of quiet disclosures. A quiet disclosure is where prior tax returns are amended to report the previously omitted foreign income and the delinquent TDF 90-22.1 (FinCen 114) are filed. In a quiet disclosure the Criminal Investigation Division of the IRS is not made aware of the disclosure and again the taxpayer is banking that the IRS does not have the resources to detect the quiet disclosure. This approach has many proponents because if it successful the taxpayer only pays the additional income taxes they should have paid if they would have filed the previous returns correctly plus interest. Often, no penalties are assessed.

    The problem with this approach is the IRS has stated publicly that they will criminally prosecute any taxpayer they detect has done this. To make things worse, many unscrupulous tax preparer advisers are advising this approach out of their own self-interest to the detriment of their client’s best interests. This approach results in a revenue stream for them in that they get to prepare the delinquent returns and TDF 90-22.1 (FinCen 114). Additionally they are able to protect their long-term relationship and future revenue streams with their client. If the tax preparer does what he or she is ethically required to do, refer the client to a reputable tax attorney and have no further communication with the client upon discovery of the foreign account, the preparer knows that the tax attorney is ethically required to hire a new tax preparer to prepare the amended returns and TDF 90-22.1 (FinCen 114) because the original preparer is likely to be the first witness called to testify against the taxpayer should the government criminally prosecute the taxpayer. To add insult to injury the preparer’s lack of knowledge as to the reporting requirements surrounding foreign accounts could have contributed to the creation of this tax nightmare as well.

    Imagine how easy it would be for the IRS to detect a quiet disclosure. They receive at least 2 amended returns. The current year correctly reports the foreign income and the two open tax years are amended. The IRS receives the current year FBAR timely and the previous two tax years are amended. All the IRS has to do is look for this pattern of reporting to identify taxpayers that are making quiet disclosures.

    To make matters worse the government upon discovering a quiet disclosure will deem the act of a quiet disclosure itself as an additional badge of fraud for a subsequent criminal prosecution. It is important to note that a subsequently discovered voluntary disclosure will not automatically result in a criminal conviction for tax fraud as the government still has to prove willfulness and be willing to commit significant resources to prosecuting the case. Each case must be analyzed on an individual facts and circumstances basis but for the reasons cited above this is not ordinarily a viable option except where exposure for criminal liability is determined by an experience tax attorney as extremely remote and a taxpayer is willing to gamble on the attorney’s judgment.

    Note: It is still possible to convert a quite disclosure into a loud disclosure by entering into the third version of the OVDI program.

    4. Make a loud disclosure

    By entering into the third version of the OVDI program a taxpayer makes a loud disclosure. A loud disclosure consist of knocking on the front door of the IRS Criminal Investigation Division and disclosing in writing that you have foreign and possibly even domestic non-compliance issues which may or may not rise to the level of outright criminal behavior that you wish to correct. In essence, a deal is struck with the Criminal Investigation Division that goes like this – in exchange for the taxpayer’s promise to correct all foreign and domestic noncompliance with US tax law (including U.S. Government information reporting requirements) through full cooperation with the IRS’s civil division, the Criminal Investigations unit promises not to prosecute the taxpayer for any applicable tax crimes provided the taxpayer makes a full honest and complete effort to correct their prior income tax returns including paying (or arranging to pay) the additional taxes, penalties or interest.OVDI compliance

    My Clients routinely and understandably want to know what the worst case scenario is where they come forward. I tell them that the draconian penalties that are on the books were written to give the IRS a club to force people to come forward. The U.S. taxing system is based on voluntary compliance. From a policy perspective it makes little sense to bring the full force of law against those that make a voluntary effort to correct their non-compliance as this would discourage others from doing so as well.


    What Happens if You Don’t Report the Foreign Income or Assets?

    As an incentive to drive taxpayers into the OVDI program the U.S. government continues to ramp up its efforts in searching for and flushing out income tax evaders who continue to utilize undisclosed foreign accounts, entities or assets to hide income. Because the IRS has devoted massive resources to publicizing the reporting requirements for offshore assets along with implementing the 2009 and 2011 and the current foreign bank account and asset voluntary disclosure initiatives, taxpayer’s that are investigated or audited for non-compliance surrounding the reporting of foreign bank accounts or overseas assets, will face an uphill battle in proving they were unaware of their tax reporting obligations. Or, said another way, that their actions were merely negligent based on ignorance rather than willful with the intent to evade taxation.

    The U.S. Government is currently devoting significant resources to attempting to flush out noncompliance concerning foreign accounts, assets or business activity.

    Get an Experienced Foreign Asset Disclosure Attorney on Your Side

    For the reasons cited above I believe taxpayers with compliance problems surrounding foreign accounts have only one viable option where the risk of criminal prosecution is assessed as high by a reputable international tax attorney. Make a loud disclosure as soon as possible before the opportunity to do so is foreclosed through the government’s extraordinary efforts to detect your foreign accounts succeeds. Lastly, if you also have domestic non-compliance issues that could lead to criminal prosecution in their own right, they can be addressed at the same time as your foreign non-compliance issues through a voluntary disclosure.

    The Tax Law Offices of David W. Klasing can help you get back into OVDI compliance and avoid the impending wrath of the IRS and state taxing authorities. The first step is to determine how severe a problem you have. It could be as simple as filing the missing FBARs and requesting penalty abatement for reasonable cause where all of the foreign income has been duly reported. Or as involved as filing 8 years of amended returns to report the foreign income, 8 years of FBAR’s and then guiding you through making a Voluntary Disclosure to the criminal investigations division of the IRS.

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