Previously published in the NH Society of CPAs Newsletter and SUMNEWS, published by the MA Society of CPAs
Since 2009, the IRS has been offering taxpayers with undisclosed
foreign financial accounts the opportunity to “come
clean” under its Offshore Voluntary Disclosure Initiative
(OVDI), and thousands of individuals have done so. The OVDI program
has been slightly revised over the last three years, but it
basically allows taxpayers who are not under audit or criminal
investigation, and who are not on IRS lists of offshore account
holders (obtained from foreign banks), the opportunity to gain
clearance from criminal prosecution and civil penalties by paying a
one-time FBAR penalty based on the foreign account balances, and
accuracy and failure to file penalties based on the tax
underpayment for the prior 8 years.
The IRS explains why it thinks that a voluntary disclosure should
be made:
Taxpayers with undisclosed foreign accounts or entities should make
a voluntary disclosure because it enables them to become compliant,
avoid substantial civil penalties and generally eliminate the risk
of criminal prosecution. Making a voluntary disclosure also
provides the opportunity to calculate, with a reasonable degree of
certainty, the total cost of resolving all offshore tax issues.
Taxpayers who do not submit a voluntary disclosure run the risk of
detection by the IRS and the imposition of substantial penalties,
including the fraud penalty and foreign information return
penalties, and an increased risk of criminal prosecution. The
IRS remains actively engaged in ferreting out the identities of
those with undisclosed foreign accounts. Moreover, increasingly
this information is available to the IRS under tax treaties,
through submissions by whistleblowers, and will become more
available as the Foreign Account Tax Compliance Act (FATCA) and
Foreign Financial Asset Reporting (new IRC §6038D) become
effective.
The “increased risk” that the IRS refers to is
dramatic, as thousands of names are being disclosed to the IRS by
foreign banks and cooperating tax authorities. The IRS is using
these lists for both criminal prosecutions and civil audits and is
aggressively pursuing information exchange agreements with other
countries.
For calendar year taxpayers the voluntary disclosure period is the
most recent 8 tax years for which the due date has already passed.
The OVDI disclosure is made by filing both the original returns and
amended returns for the prior 8 years that report all income and
disclose the foreign accounts, file all missing FBAR reports,
cooperate fully in the OVDI process, sign agreements to extend the
statutes of limitations, pay a penalty of 27.5% (reduced in only
very limited cases) of the accounts’ highest balance over the
8 year period, pay a 20% accuracy penalty based on the total
underpayment for the 8 years, pay failure to pay penalties, and pay
failure to file penalties, if appropriate.
The filing package is submitted to the IRS after a preliminary
determination is made that the taxpayer is eligible for the
program. Several months after the package is submitted, the IRS
will contact the taxpayer or the representative and let them know
if additional information is required. When all information has
been submitted by the taxpayer, the IRS will issue its proposal and
request that the taxpayer agree.
If the taxpayer agrees with the IRS conclusions, and pays the
appropriate amount due, the case is closed and no further civil or
criminal penalties will be assessed for the foreign accounts unless
the taxpayer has failed to fully disclose all relevant
information.
If the taxpayer does not agree with the IRS conclusions,
“opting out” of the program is an option. An opt
out means that the taxpayer rejects the IRS penalty proposal. If
the taxpayer decides to do this and notifies the IRS in writing,
then a letter is sent by the IRS accepting the opt out decision and
stating that the opt out is irrevocable. That letter requests that
the taxpayer submit a proposed penalty that the taxpayer is willing
to pay. If the IRS agrees to the proposal, the matter will be
settled. If not, a full audit of the taxpayer’s returns for
the 8 years will occur, and if any information is discovered that
is inconsistent with the prior OVDI submissions by the taxpayer,
criminal proceedings could be initiated. Also, civil FBAR penalties
far in excess of the OVDI penalties can be assessed.
The OVDI program is evolving and has many critics. Many innocent
taxpayers are being targeted and forced to pay large penalties for
minor infractions in order to resolve their potential tax
liability. However, the IRS has had tremendous success in raising
revenue—as of June 2012, it collected more than $5 billion in
back taxes, interest and penalties from 33,000 voluntary
disclosures made under the first two programs in 2009 and
2011.
The OVDI program can end at any time determined by the IRS, but
considering its success, practitioners expect it to continue for
the next several years.
From the perspective of practitioners with clients having
undisclosed foreign financial accounts, the OVDI program makes
sense in most cases. Criminal penalties associated with failure to
report a foreign financial account are a maximum fine of $250,000
and up to five years in prison. Moreover, if the failure to file an
FBAR is part of a pattern of illegal activity, the penalties double
to a maximum $500,000 fine and up to ten years in prison. 31 U.S.C.
§5322. The penalty for a non-willful civil violation is up to
a $10,000 fine, however, if the violation is deemed willful, then
the penalty is the greater of $100,000 or 50% of the account
balance at the time of the violation. 31 U.S.C.
§5321(a)(i).
Many clients are indecisive and apprehensive about making a
voluntary disclosure in view of the hefty penalties imposed by the
OVDI. Some clients are willing to “take their chances”
and avoid entering the OVDI. For these clients, it is important to
make them aware of the IRS enforcement initiatives.
The Government has launched investigations of foreign banks which
have resulted in disclosures of account holder information to the
IRS. The Government has also been actively pursuing treaty requests
with countries with which the United States has tax treaties.
Finally, the Government has at its disposal the recently enacted
Foreign Account Tax Compliance Act (FATCA). 26 U.S.C.§1471, et
seq. While the intricacies of FATCA are beyond the scope of this
article, it represents a major enforcement tool for the Government.
FATCA was signed into law in 2010 and already the United States has
agreements with France, Spain, Germany, Italy, the United Kingdom
and Switzerland to implement information exchange regarding foreign
accounts. As of this writing, the Government is aggressively
pursuing agreements with other countries.
The foregoing Government enforcement initiatives make it much more
likely that the IRS will become aware of undeclared foreign
accounts of U.S. taxpayers. Once the IRS is aware of undeclared
foreign account information, the OVDI is no longer an option
available to a client and much more severe penalties, civil and/or
criminal, will likely be imposed.
Peter Anderson is a former trial attorney for the U.S.
Department of Justice, Tax Division. He currently is a
Director at the McLane Law Firm and focuses his practice on white
collar criminal defense and tax litigation.
Rick Stone's practice at the McLane Law Firm focuses on
planning, audits, appeals, and litigation of state, federal and
international tax matters. He is Chair of the Tax Section of
the Massachusetts Bar Association, and is a frequent speaker and
author of tax-related topics of interest to accountants, attorneys
and their clients.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.