Q7: What are the terms of the 2011 Offshore Voluntary Disclosure Initiative?
A7: Under the terms of the 2011 Offshore Voluntary Disclosure Initiative, taxpayers must:
- Provide copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for tax years covered by the voluntary disclosure;
- Provide complete and accurate amended federal income tax returns (for individuals, Form 1040X, or original Form 1040 if delinquent) for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account or entity (e.g., Schedule B for interest and dividends, Schedule D for capital gains and losses, Schedule E for income from partnerships, S corporations, estates or trusts).
- File complete and accurate original or amended offshore-related information returns (see FAQ 29 for certain dissolved entities) and Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”) for calendar years 2003 through 2010; Cooperate in the voluntary disclosure process, including providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing tax and penalties;
- Pay 20% accuracy-related penalties under IRC § 6662(a) on the full amount of your underpayments of tax for all years; Pay failure to file penalties under IRC § 6651(a)(1), if applicable; Pay failure to pay penalties under IRC § 6651(a)(2), if applicable;
- Pay, in lieu of all other penalties that may apply, including FBAR and offshore-related information return penalties, a miscellaneous Title 26 offshore penalty, equal to 25% (or in limited cases 12.5% (see FAQ 53) or 5% (see FAQ 52)) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure;
- Submit full payment of all tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties with the required submissions set forth in FAQ 25 or make good faith arrangements with the IRS to pay in full, the tax, interest, and these penalties (see FAQ 20 for more information regarding a taxpayer’s ability to fully pay) (the suspension of interest provisions of IRC § 6404(g) do not apply to interest due in this initiative); and
- Execute a closing agreement on final determination covering specific matters, Form 906.
Q8: How does the penalty framework work? Can you give us an example?
A8: The values of accounts and other assets are aggregated for each year and the penalty is calculated at 25 percent of the highest year’s aggregate value during the period covered by the voluntary disclosure. If the taxpayer has multiple accounts or assets where the highest value of some accounts or assets is in different years, the values of accounts and other assets are aggregated for each year and a single penalty is calculated at 25 percent of the highest year’s aggregate value. For example, assume the taxpayer has the following amounts in a foreign account over the period covered by his voluntary disclosure. It is assumed for purposes of the example that the $1,000,000 was in the account before 2003 and was not unreported income in 2003.
Year Amount on Deposit Interest Income Account Balance
2003 $1,000,000 $50,000 $1,050,000 2004 $50,000 $1,100,000 2005 $50,000 $1,150,000 2006 $50,000 $1,200,000 2007 $50,000 $1,250,000 2008 $50,000 $1,300,000 2009 $50,000 $1,350,000 2010 $50,000 $1,400,000
(NOTE: This example does not provide for compounded interest, and assumes the taxpayer is in the 35-percent tax bracket, does not have an investment in a Passive Foreign Investment Company (PFIC), files a return but does not include the foreign account or the interest income on the return, and the maximum applicable penalties are imposed.)
If the taxpayers in the above example come forward and their voluntary disclosure is accepted by the IRS, they face this potential scenario:
They would pay $518,000 plus interest. This includes:
- Tax of $140,000 (8 years at $17,500) plus interest,
- An accuracy-related penalty of $28,000 (i.e., $140,000 x 20%), and
- An additional penalty, in lieu of the FBAR and other potential penalties that may apply, of $350,000 (i.e., $1,400,000 x 25%). If the taxpayers didn’t come forward, when the IRS discovered their offshore activities, they would face up to $4,543,000 in tax, accuracy-related penalty, and FBAR penalty. The taxpayers would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution. The civil liabilities outside the 2011 Offshore Voluntary Disclosure Initiative potentially include:
- The tax, accuracy-related penalties, and, if applicable, the failure to file and failure to pay penalties, plus interest, as described above,
- FBAR penalties totaling up to $4,375,000 for willful failures to file complete and correct FBARs (2004 – $550,000, 2005 – $575,000, 2006 – $600,000, 2007 – $625,000, 2008 – $650,000, and 2009 – $675,000, and 2010 – $700,000),
- The potential of having the fraud penalty (75 percent) apply, and
- The potential of substantial additional information return penalties if the foreign account or assets is held through a foreign entity such as a trust or corporation and required information returns were not filed. Note that if the foreign activity started before 2003, the Service may examine tax years prior to 2003 if the taxpayer is not part of the 2011 OVDI.
Q9: What years are included in the 2011 OVDI disclosure period?
A9: Calendar year taxpayers must include tax years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities. Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010.
Q10: What are my options if my account involves passive foreign investment company (PFIC) issues?
A10: To date, a significant number of cases submitted under the 2009 OVDP involve PFIC investments. A lack of historical information on the cost basis and holding period of many PFIC investments makes it difficult for taxpayers to prepare statutory PFIC computations and for the Service to verify them. As a result, resolution of voluntary disclosure cases could be unduly delayed. Therefore, for purposes of this initiative, the Service is offering taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in Internal Revenue Code § 1296 but will not require complete reconstruction of historical data.
The terms of this alternative resolution are: If elected, the alternative resolution will apply to all PFIC investments in cases that have been accepted into this initiative. The initial MTM computation of gain or loss under this methodology will be for the first year of the 2011 OVDI application, but could be made after 2003 depending on when the first PFIC investment was made. Generally, the first year of the 2011 OVDI application will be for the calendar year ending December 31, 2003. This will require a determination of the basis for every PFIC investment, which should be agreed between the taxpayer and the Service based on the best available evidence.
A tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the 2011 OVDI period, in lieu of the rate contained in IRC § 1291(a)(1)(B) for the amount allocable to the current year and IRC §1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.
A rate of 7% of the tax computed for PFIC investments marked to market in the first year of the 2011 OVDI application will be added to the tax for that year, in lieu of the interest charge mechanism described in IRC §§ 1291(c) and 1296(j).
MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment-by investment basis in the same manner as IRC § 1296. During the 2011 OVDI period, these MTM losses will be treated as ordinary losses (IRC 1296(c)(1)(B)) and the tax benefit is limited to the tax rate applicable to the MTM gains derived during the 2011 OVDI period (20%). MTM and/or disposition losses in any subsequent year on PFIC assets with basis that was adjusted upward as a result of the alternate resolution in voluntary disclosure years, will be treated as capital losses. Any unreversed inclusions at the end of the 2011 OVDI period will be reduced to zero and the MTM method will be applied to all subsequent years in accordance with IRC § 1296 as if the taxpayer had acquired the PFIC stock on the last day of the last year of the 2011 OVDI period at its MTM value and made an IRC § 1296 election for the first year beginning after the 2011 OVDI period. Thus, any subsequent year losses on disposition of PFIC stock assets in excess of unreversed inclusions arising after the end of the 2011 OVDI period will be treated as capital losses.
Regular and Alternative Minimum Tax are both to be computed without the PFIC dispositions or MTM gains and losses. The tax from the PFIC transactions (20% plus the 7% for 2003, if applicable) is added to (or subtracted from) the applicable total tax (either regular or AMT, whichever is higher). The tax and interest (i.e., the 7% for the first year of the 2011 OVDI) computed under the 2011 OVDI alternative MTM can be added to the applicable total tax (either regular or AMT, whichever is higher) and placed on the amended return in the margin, with a supporting schedule. Underpayment interest and penalties on the deficiency are computed in accordance with the Internal Revenue Code and the terms of the 2011 OVDI.
For any PFIC investment retained beyond December 31, 2010, the taxpayer must continue using the MTM method, but will apply the normal statutory rules of section 1296 as well as the provisions of IRC §§ 1291-1298, as applicable.
Before electing the alternative PFIC resolution, taxpayers with PFIC investments should consult their tax advisors to ensure that the issue is material in their cases and that the alternative is in fact preferable to the statutory computation in their situation. If the taxpayer does not elect to use the alternative PFIC computation, the PFIC provisions of §§ 1291-1298 apply.
Q11: What happens if I fail to make a voluntary disclosure by the August 31, 2011 deadline?
A11: Although the terms of this initiative are available only to taxpayers who complete the voluntary disclosure process on or before August 31, 2011, Criminal Investigation’s Voluntary Disclosure Practice remains available to taxpayers who wish to disclose voluntarily their tax violations after that date. However, these taxpayers will not be eligible for the special civil terms of this initiative and will be liable for all applicable civil penalties, including the willful FBAR penalty. In addition, the civil resolution of their cases may extend to tax years prior to 2003.
