Changes to IRS voluntary disclosure from 2012 and 2014 OVDP

The time is ticking for those hiding foreign assets or accounts overseas. The IRS has announced changes to its (i) Streamlined Program, and its (ii) 2012 Offshore Voluntary Disclosure Initiative. In addition, under FATCA, starting in 2015, foreign banks will be turning over their account holder information to the IRS. Therefore, the 2014 OVDP (described below) could be the last chance for taxpayers with undisclosed accounts to “come clean.”

Brief History of Voluntary Disclosure Programs

The first offshore voluntary disclosure initiative (OVDI) was launched in 2009, with its successor initiative in 2011. And the 2012 initiative was the successor to it. These initiatives offered those who had failed to file timely foreign bank account reports (FBARs) or report income from those accounts (and other undisclosed income generating assets such as clandestine offshore business activity or inherited real estate) a possible means of avoiding criminal prosecution for income tax evasion and the ability to pay reduced FBAR penalties rather than penalties up to 50% of the account balance per undisclosed year that exist outside of these programs. For example, in 2009 taxpayers were required to pay a 20% penalty (the penalty under the IRC) of the highest watermark (fair market value) of an (unreported) foreign account’s balance. In 2011, this figured increased to 25%. In 2012, the penalty increased to 27.5%. This penalty is expected to continue to increase over time.

In 2013, the U.S. government announced its so-called “Streamlined Procedure,” which gave taxpayers a “penalty free option” if they satisfied some rather strict criteria. The 2013 effort was designed to incentivize U.S citizens living overseas to become compliant but in practice was so limited in scope that it was rarely helpful.

Most recently, on June 18, 2014, the U.S. government announced (1) a modification to the Streamlined Procedures, making them much broader in scope than they were previously, and (2) a new offshore voluntary program — the “2014 OVDP.” We discuss these most recent changes below.

Why is the IRS making these changes?

The public, the tax practitioners that represented them criticized the prior programs for various reasons, and the IRS is (attempting) to respond to them. The professional community criticized the prior programs because it was so rigid that the government agents overseeing the program lacked the discretion regarding whether or not to exact penalties in wobbler fact patterns (i.e. 20% or 27.5% FBAR Penalties). Consequently, some taxpayers not wishing to face the rigid application of the penalties decided to “roll the dice” by opting out of the OVDI.

The 2014 changes chiefly benefit U.S. resident taxpayers who are able to make the “certification of non-willfulness” statement that their failure to report their foreign income and file the relevant FBARs was not due to conduct that was willful. However, as explained below, taxpayers must exercise extreme caution regarding whether they can, indeed, safely make such a certification as no amnesty for tax crimes is offered under this program if the government later finds the taxpayers behavior to be willful.

What are the 2014 Changes to the 2013 Streamlined Procedures?

What are the “Streamlined Procedures”? In short, they are a set of procedures, or means, that allow eligible taxpayers to become compliant with the tax laws—the laws that deal with the (i) reporting of income (and offshore information reporting requirements) and (ii) any corresponding tax liability associated with an unreported foreign bank account (or other income generating asset). The Streamlined Procedures require the eligible taxpayer file amended or delinquent income tax returns and pay a reduced penalty of 5% rather than 27.5% of the value of their offshore foreign accounts and the fair market value of their offshore assets that are tainted due to the failure to report the income generated by them over the previous six non-compliant tax years.

Starting July 1, 2014, an (i) eligible U.S. resident or (ii) non-resident taxpayer who has failed to report income from a foreign financial asset (and pay the required tax from it) may become compliant with the tax laws if they (1) file an amended or delinquent income tax return for the last three years; (2) pay all tax and interest that is owed; (3) file the previous six years of delinquent FBARs — that is, FinCEN Form 114 (formerly known at the TDF 90-22.1); and (4) make a “non-willful certification requirement.”

This requires that the taxpayer make a statement under penalties of perjury that his or her failure to file his or her tax returns, report all his/her income, file all required offshore information returns and pay all the corresponding tax was due to his or her “non-willful conduct.” Please see this article from elsewhere on our website on the corresponding risk of criminal prosecution associated with the making this certification.

Non-willfulness typically refers to conduct that is negligence, due to one’s inadvertence, or mistake, and the like. Unfortunately, it is uncertain (and thus problematic) as to how the government in practice will decide to interpret this important adjective. As explained below, a taxpayer should seriously question whether to participate in the Streamlined Procedures if his or her conduct could possibly be viewed as willful.

U.S. residents meeting the above criteria will not have to pay the “failure-to-file” penalty, the “failure-to-pay” penalty, accuracy-related penalty, or the FBAR penalty. Rather, they will only have to pay a five-percent (5%) penalty of the highest watermark on their account balance (contrast this figure with the 27.5% or the 50% — discussed below). However, taxpayers could very well still be subject to a subsequent criminal investigation by the IRS. And it is possible that both draconian civil and criminal penalties would apply if the IRS determines that one’s conduct — one’s tax non-compliance— was “willful.”

The upshot of this is that if a taxpayer is even remotely concerned that his or her non-compliance with the tax laws was possibly the result of his or her willful conduct, then he or she should seriously question whether to participate in the new Streamlined Procedures and this decision should never be made without competent legal counsel. Instead, the taxpayer should consider participating in the 2014 OVDP (discussed below). Once a person submits under the Streamlined Program he cannot later submit under the 2014 OVDP. This is critical because only the latter is an “amnesty” program, effectively giving the taxpayer a “get-out-of-jail-free” card.

What are the 2014 Changes to the 2102 Offshore Voluntary Disclosure Initiative?

Like the Streamlined Procedures, the 2012 OVDI allows eligible taxpayers to come clean with the IRS, while limiting their exposure to criminal and civil penalties. There are some significant changes to the 2012 program, including the following:

a. An increased offshore penalty of 50% (up from 27.5%) IF the bank where one’s foreign account is located is under investigation by the U.S. government. In addition, this draconian penalty will apply if the person who facilitated the taxpayer has been publicly identified as being under investigation by the IRS. Moreover, the program now requires that all of one’s taxes, interest, and penalties be paid at the time he or she submits his OVDI package with the IRS. If one’s bank is not listed as under investigation, then the prior penalty of 27.5% would apply. See this link to determine if your bank is currently on the list of foreign bank or facilitators.

b. The taxpayer discloses detailed information about his or her financial institution used by him/her, and information related to any entity (e.g. business, company) with the account.

Taxpayers desiring to “come clean” after July 1, 2014 are advised to first obtain a “pre-clearance” to be cleared to enter the program. Once this is received the taxpayer submits among other things, an Offshore Voluntary Disclosure Letter (a revised version of the 2012 form), along with a relevant attachment, for each of his foreign financial accounts or assets.

After the taxpayer’s package is approved with the IRS’s Criminal Investigation Department, the taxpayer must submit additional information: (i) a check for all the tax, interest, and penalties owed; (ii) original tax returns (or amended returns) for the past eight (8) years; (iii) a Foreign Account (or Foreign Asset) Statement for each asset/account; (iv) the Taxpayer Account Summary with Penalty Calculation form; (v) a statement authorizing the statute of limitations to be suspended which allowing the IRS to extend the period of time to asses additional tax penalties and interest, as applicable; (vi) FBARS for the 8 years in question; and (vii) all bank statements for the 8 years in question.

A taxpayer will receive a 906 Closing Agreement only after the IRS has reviewed the taxpayer’s offshore voluntary disclosure package and approved it which typically takes in excess of a year once the package is submitted. The taxpayer can then sign the Agreement and the IRS is prevented from assessing any additional tax or criminal liability for the taxpayer’s non-compliance for the 8 years in question and prior to that period.

How does FATCA Effect the 2014 OVDP?

This is a very important question! Starting 2015, under FATCA foreign financial institutions will be required to report their U.S. account holders. In practical terms, the 2014 OVDP could be the very last chance for a non-compliant taxpayer to come clean before they are caught! If they are caught, at best, they will have to pay higher penalties and at worst, possibly face criminal prosecution. Even (most) Swiss banks, which are historically renowned for their “bank secrecy laws,” are going to be turning over their account holders.