United States: Offshore Tax Enforcement Update: IRS Unveils Major Changes To Voluntary Disclosure Program

Last Updated: July 9 2014
Article by Matthew D. Lee, Jennifer L. Bell and Jeffrey M. Rosenfeld


Since the 1970s, U.S. taxpayers with foreign banks accounts have been required to annually report their foreign bank account information to the Department of Treasury on a Report of Foreign Bank and Financial Accounts ("FBAR") by June 30th of each year. In addition to requiring the filing of an FBAR, the United States, unlike many other jurisdictions in the world, taxes worldwide income, meaning that a U.S. taxpayer's income is subject to tax, regardless of where it is earned. The failure to file an FBAR or to report foreign income can subject a taxpayer to significant civil, and sometimes criminal, penalties.

On June 18, 2014, in an attempt to allow more taxpayers with offshore bank accounts to "get right with the government," the Internal Revenue Service announced major changes to its offshore voluntary compliance programs.

Since 2009, the IRS has offered amnesty from criminal prosecution for non-compliant taxpayers in return for the payment of back taxes, interest, and penalties through its Offshore Voluntary Disclosure Program (the "OVDP"). Subject to limited exceptions, in the three previous iterations of the OVDP (2009, 2011, and 2012), all taxpayers were subject to a uniform penalty structure. In other words, a taxpayer who willfully and knowingly violated the tax law was subject to the same penalty as those taxpayers who had a good-faith misunderstanding of the law.

In 2012, the IRS announced the Streamlined Filing Compliance Procedure (the "Streamlined Procedure") which was designed to provide an easier road to compliance for taxpayers who non-willfully failed to report their foreign accounts and income. While originally hailed by then-IRS Commissioner Doug Shulman as a "series of common-sense steps," the practical reality was that the qualifications for the Streamlined Procedure were very narrowly tailored to include only certain U.S. citizens residing abroad who owed little or no back taxes.

Many taxpayers with non-willful conduct were ineligible to take advantage of the Streamlined Procedure, and in many instances, were forced to accept the strict penalties of the OVDP in order to come into tax compliance.

Changes to the OVDP and Streamlined Procedure

To solve the problem of the uniform penalty, the IRS has made two major changes in its offshore compliance programs.

Expansion of Streamlined Filing Compliance Procedures to All Taxpayers with Non-Willful Conduct

The IRS has now expanded the Streamlined Procedure to provide more taxpayers with an easier way to voluntarily come into compliance. The new Streamlined Procedure rules can be found at http://www.irs.gov/Individuals/International-Taxpayers/Streamlined-Filing-Compliance-Procedures.

Taxpayers residing in the United States are now eligible to use the Streamlined Procedure if they (1) previously filed a U.S. tax return (if required) for each of the most recent 3 tax years, (2) failed to report gross income from a "foreign financial asset" and pay tax as required by U.S. law, and may have failed to file an FBAR and/or one or more international information returns (e.g., Forms 5471, 8938, etc.) with respect to the "foreign financial asset," and (3) such failures resulted from non-willful conduct. For these purposes, a "foreign financial asset" includes traditional bank accounts and securities accounts, as well as the broader group of assets that are required to be reported on a Form 8938 such as a real property lease with a foreign lessee. Unlike the old Streamlined Procedure, there is no requirement that the taxpayer have $1,500 or less of unpaid tax per year and no requirement that the taxpayer live abroad.

To participate in the new Streamlined Procedure, taxpayers meeting the above criteria will, among other requirements, be required to submit three years of amended tax returns and six years of FBARs, and sign a certification (under penalty of perjury) that the failure to report all income, pay all tax, and submit all required information returns (including FBARs) resulted from non-willful conduct.

Perhaps most importantly, under the new Streamlined Procedure, taxpayers living in the United States will only be subject to a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that gave rise to the tax compliance issue. This represents a significant decrease from the 27.5 percent penalty imposed by the 2012 OVDP. For taxpayers residing outside the United States, there is no penalty under the new Streamlined Procedure.

Changes to the OVDP

The IRS also reshaped the OVDP for certain taxpayers whose failure to comply is willful in nature, and therefore do not qualify for the Streamlined Procedure. The updated OVDP Frequently Asked Questions can be found at http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised.

Beginning on August 4, 2014, the new 2014 OVDP increases the offshore penalty percentage from 27.5 percent to 50 percent if, before the taxpayer's OVDP pre-clearance request is submitted, it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer's offshore arrangement is (1) under investigation by the IRS or Department of Justice, (2) cooperating with the IRS or Department of Justice in connection with accounts beneficially owned by a U.S. person, or (3) has been identified in a court-approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a "John Doe summons") at the foreign financial institution.

"[W]e want to send a message to anyone who continues to willfully and aggressively evade our tax laws by hiding money overseas that they will pay a higher price for the noncompliance" Commissioner Koskinen said. A list of the foreign financial institutions or facilitators currently meeting the above criteria can be found at http://www.irs.gov/Businesses/International-Businesses/Foreign-Financial-Institutions-or-Facilitators. This list includes, but is not limited to, UBS AG, Credit Suisse AG and HSBC (India).

Any taxpayer who has an undisclosed foreign bank account at one of these financial institutions should immediately consult a tax advisor. Depending on the circumstances, a taxpayer may be eligible for the old 27.5 percent offshore penalty in lieu of the new 50 percent offshore penalty, but only for a limited amount of time.

In addition to the increase in penalty, taxpayers applying to the OVDP will now be required to (1) provide more comprehensive information regarding their offshore bank accounts, (2) submit all account statements, regardless of the amount that is in their offshore accounts, and (3) pay the total amount of the 27.5 percent or 50 percent offshore penalty, along with back taxes and interest, at the time of submitting the complete package of voluntary disclosure documents to the IRS.

The new 2014 OVDP program also eliminates the previous lower-tier penalties for certain non-willful taxpayers, and adopts new procedures for taxpayers who have failed to file an FBAR and/or information form, but correctly reported all gross income on their tax returns.

Definition of "Willfulness"

A critical issue that taxpayers and practitioners will now have to confront is whether the conduct in question was "willful." The willfulness determination will dictate whether a taxpayer should proceed with the new Streamlined Procedure (designed for non-willful conduct) or the 2014 OVDP (designed for willful conduct). As noted, an individual choosing to proceed under the new Streamlined Procedure will be required to sign a certification, under penalty of perjury, that the "failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct." Many factors that will have to be considered in determining if an individual's failure to report a foreign bank account to the IRS was willful including, but not limited to, the following:

  • Whether the offshore account was funded with unreported income;
  • Whether the taxpayer employed a structure/entity to hold the offshore account;
  • Whether the box on Line 7, Schedule B was checked "no" indicating that the taxpayer did not have a foreign bank account;
  • Whether the taxpayer failed to advise the return preparer of the existence of the offshore account;
  • Whether the taxpayer transferred the offshore funds to another institution to avoid detection;
  • The sophistication of taxpayer; and
  • Whether the taxpayer was "willfully blind" to the income tax and FBAR reporting obligations with respect to foreign bank accounts.

None of these factors are likely to be determinative, standing alone, on the question of willfulness but each factor will certainly affect whether the taxpayer's behavior is ultimately deemed to be willful.

Transitioning from the OVDP to the Streamlined Procedures

Taxpayers "currently participating in the OVDP," but who have not yet completed the program, may be eligible to transition into the Streamlined Procedure. Frequently asked questions related to the transition rules can be found at http://www.irs.gov/Individuals/International-Taxpayers/Transition-Rules-Frequently-Asked-Questions-FAQs.

A taxpayer is considered to be "currently participating in the OVDP" only if: (1) the taxpayer submitted a voluntary disclosure letter and attachment before July 1, 2014, (2) the IRS has not yet executed a Closing Agreement (Form 906) with respect to the voluntary disclosure, and (3) if a taxpayer has opted out of the OVDP, the taxpayer has not yet received a letter initiating an examination and enclosing Form 609. Note that a taxpayer is ineligible for transitional treatment if the taxpayer has not submitted a voluntary disclosure letter and attachment before July 1, 2014, even if the taxpayer had made a pre-clearance request prior to July 1, 2014.

After July 1, 2014, a taxpayer who chooses to enter the OVDP will no longer be eligible to participate in the Streamlined Procedure, and a taxpayer who makes a submission under the Streamlined Procedures will not be eligible to participate in the OVDP.

In order to transition to the Streamlined Program, an eligible taxpayer must provide the IRS with the following: (1) all submission documents required under the OVDP, (2) a certification that the failure to report all income, pay all tax, and submit all required information returns, including FBARs, was due to non-willful conduct, and (3) full payment of tax, interest, and accuracy-related penalties (the payment of the offshore penalty is not required to request transitional relief).

Transitional treatment is not automatic, however. Before transitional treatment is granted, the IRS must agree that its records with respect to the taxpayer are consistent with the taxpayer's certification of non-willful conduct.

Individuals with questions about foreign bank accounts, or who are considering making a voluntary disclosure to the IRS regarding foreign bank accounts, should consult experienced tax counsel to understand the benefits and risks of the voluntary disclosure process.

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.

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Matthew D. Lee
Jennifer L. Bell
Jeffrey M. Rosenfeld
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