On November 20, 2018, the IRS announced a new and updated voluntary disclosure program (UVDP). The UVDP imposes much harsher financial penalties for taxpayers who missed the deadline to enter the 2014 Offshore Voluntary Disclosure Program. It also gives the examining agent tremendous leverage in “negotiating” an agreed case, since in the absence of an agreement the scope of the examination and the magnitude of the penalties at stake likely increase significantly.
The UVDP revises the longstanding practice contained in the Internal Revenue Manual that provides a means to potentially avoid criminal prosecution. The UVDP is only applicable to taxpayers who make “timely voluntary disclosures” and who fully cooperate with the IRS. Taxpayers who did not commit any tax crimes and do not need the UVDP to seek protection from criminal prosecution can correct past mistakes using other existing procedures such as the streamlined programs for resident and nonresident U.S. persons.
The UVDP is effective for all voluntary disclosures received after the closing of the 2014 Offshore Voluntary Disclosure Program (OVDP) on September 28, 2018. All offshore voluntary disclosures received or postmarked by September 28, 2018, will be handled under the procedures of the 2014 OVDP. For all nonoffshore voluntary disclosures received on or before September 28, 2018, the IRS has the discretion to apply the UVDP.
As in prior disclosure programs, a taxpayer may secure “preclearance” from IRS Criminal Investigation as the first step in the UVDP process. Taxpayers who make application to the UVDP while under examination or whose noncompliance is already known to the IRS will be considered “untimely” and not eligible for the UVDP. If preclearance is received, the taxpayer submits a voluntary disclosure letter providing more detail regarding the taxpayer’s noncompliance. Next, “preliminary acceptance” is received, ultimately requiring the submission of additional information including amended tax returns.
An examination of the amended returns and other information submitted will follow. The intent is that the IRS examination will be resolved by agreement. Absent exceptional circumstances, a civil tax fraud penalty of 75 percent of the previously undisclosed tax liability plus interest on the tax and the penalty will be imposed. In addition, the examining agent will impose a willful FBAR (Report of Foreign Bank and Financial Accounts) penalty of the higher of $100,000 or 50 percent of the balance in the account at the time of the violation. If there is no agreement it is likely that the scope of the examination will expand and the severity of the proposed penalties will increase.
Taxpayers dissatisfied with the results of the examination may request an appeal with the IRS Office of Appeals.
Does the UVDP Apply to You?
If a taxpayer has engaged in conduct that rises to the level of a criminal offense, the UVDP is likely a good choice to give the taxpayer “the potential” (not a guarantee) to avoid criminal prosecution. If the taxpayer’s conduct rises to the level of civil fraud, the UVDP may also be a means to mitigate the negative financial impact of that conduct.
Comment — The IRS has spent a lot of time formulating programs that resolve a compliance issue, so it is generally in the taxpayer's interest to use the appropriate established program to correct a “tax sin.” It is likely that a so-called “stealth” or “quiet” disclosure (that does not take advantage of a specific IRS program), upon the almost inevitable discovery by the IRS, will lead to a harsher result than that offered by the UVDP.
Eligibility for the UVDP
The IRS Criminal Investigation voluntary disclosure coordinator in Philadelphia will screen all voluntary disclosure requests to determine if a taxpayer is eligible to make a voluntary disclosure. The basis for determining eligibility for disclosure is as set forth in the IRS Voluntary Disclosure Practice, which in general provides that:
- A voluntary disclosure will be considered along with all other factors in determining whether criminal prosecution will be recommended.
- A voluntary disclosure will not automatically guarantee immunity from prosecution; however, a voluntary disclosure may result in prosecution not being recommended. This practice does not apply to taxpayers with illegal source income.
- A voluntary disclosure occurs when
the disclosure is truthful, timely and complete, and when:
- A taxpayer cooperates with the IRS in determining his/her correct tax liability; and
- The taxpayer makes good faith arrangements with the IRS to pay, in full, the tax, interest and any penalties determined by the IRS to be applicable.
- A disclosure is “timely”
if it is received before:
- The IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;
- The IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;
- The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; and
- The IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).
The eligibility process starts by faxing a form to an IRS office in Philadelphia providing the taxpayer’s identifying information and other data regarding the taxpayer’s noncompliance. Under the 2014 OVDP, that information included:
- The taxpayers’ personal identifying information;
- Identifying information of all financial institutions at which undisclosed foreign assets were held; and
- Identifying information of all foreign and domestic entities (e.g., corporations, partnerships, limited liability companies, trusts, foundations) through which the undisclosed foreign assets were held by the taxpayer.
A forthcoming revision to an IRS form used for this process will likely require disclosure of the foregoing, plus additional information.
Where IRS Criminal Investigation grants preclearance, the taxpayer must then promptly submit all required voluntary disclosure documents related to the taxpayer’s noncompliance. These include a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance. Once Criminal Investigation has received and preliminarily accepted the taxpayer's voluntary disclosure, Criminal Investigations will notify the taxpayer of preliminary acceptance by letter and simultaneously forward the voluntary disclosure letter and attachments to an IRS business unit—Large Business & International (LB&I) in Austin, Texas—for case preparation before examination. IRS Criminal Investigation will not process tax returns or payments.
Once the LB&I Austin unit receives the information sent to IRS Criminal Investigation during the preclearance/preliminary acceptance process, LB&I will assign the matter for “case building and field assignment to the appropriate Business Operating Division and Exam function for civil examination.”
No additional information or payment is due at this time. However, should a taxpayer wish to stop the running of interest on the prospective liability, payments may be remitted to this LB&I unit.
The IRS agents assigned to the voluntary disclosure must develop the case by using appropriate information gathering tools and determine proper tax liabilities and applicable penalties. Taxpayers are required to promptly and fully cooperate with the civil examinations. The IRS expects that voluntary disclosures will be resolved by agreement with full payment of all taxes, interest and penalties for the “disclosure period.” In the event a taxpayer fails to cooperate with the civil examination, the examiner may request that Criminal Investigations revoke preliminary acceptance.
Comment — Whether the taxpayer has or has not cooperated may not be that clear and the examining agent will have significant power and discretion to make that determination. Accordingly, all communications with the agent, especial regarding requests for information, must be carefully documented.
Comment — It is not known how many taxpayers the IRS expects to apply to the UVDP, but given the reductions in IRS staffing, any significant taxpayer participation is likely to result in significant delays in processing UVDP matters.
How Will Each UVDP Case Be Resolved?
For all voluntary disclosures received after September 28, 2018, the “civil resolution framework” will apply. At the IRS’s discretion, this “civil resolution framework” may extend to nonoffshore voluntary disclosures that have not been resolved but were received on or before September 28, 2018.
The Civil Resolution Framework
- Six year disclosure period
- Voluntary disclosures will include a required IRS examination of the most recent six tax years.
- Shorter disclosure period
- In cases where noncompliance involves fewer than the most recent six tax years, the voluntary disclosure must correct noncompliance for all tax periods involved.
- Voluntary longer disclosure period
- Cooperative taxpayers may be allowed to expand the disclosure period in order, for example, to correct tax issues with other governments that require additional tax periods, to correct tax issues before a sale or acquisition of an entity, or to correct tax issues relating to unreported taxable gifts in prior tax periods.
- Involuntary longer disclosure period
- If no agreement is reached, the IRS examiner has discretion to expand the scope of the examination to include the full duration of the noncompliance and may assert maximum penalties under the law with the approval of management.
- Taxpayers must submit all required returns and reports for the disclosure period.
Applicable tax, penalties and interest
- Penalties for income taxes will be
asserted as follows:
- 75 percent civil fraud penalty for
one disclosure year
- A penalty of 75 percent of the previously unreported tax on a filed tax return or a 75 percent penalty of the tax required to be reported where there is a fraudulent failure to file an income tax return will apply to the one tax year with the highest tax liability.
- 75 percent civil fraud penalty for
multiple disclosure years
- In limited circumstances, IRS examiners may apply the civil fraud penalty to more than one year in the six-year scope (up to all six years) based on the facts and circumstances of the case, for example, if there is no agreement as to the tax liability.
- 75 percent civil fraud penalty for
more than the disclosure years
- Examiners may apply the civil fraud penalty beyond six years if the taxpayer fails to cooperate and resolve the examination by agreement.
- 75 percent civil fraud penalty for one disclosure year
Comment — If there is an honest disagreement regarding the tax liability or whether the taxpayer has or has not cooperated, why should the examiner be able to use the threat of an increased penalty as leverage to force an agreement?
- FBAR Penalties
- A willful FBAR penalty will be asserted in accordance with existing IRS penalty guidelines.
- A detailed discussion of the guidelines provided to IRS examining agents with regard to the application of a willful FBAR penalty is beyond the scope of this Alert.
- In general, the penalty is the greater of $100,000 or 50 percent of the balance in the subject account on the date of the violation.
- Under appropriate circumstances the penalty may apply to a single or multiple years.
- The IRS has issued “mitigation” guidelines for agents to guide them in asserting FBAR penalties.
- Assuming the taxpayer qualifies for the mitigation provisions the guidelines then provide for a penalty computation (here a willful penalty where the aggregate balance of all accounts to which the violation relates exceeds $1 million) as follows: For each account for which there was a violation, the greater of 50 percent of the balance in the account at the time of the violation or $100,000 (i.e., the statutory maximum penalty).
- Penalty reduction
- Under “exceptional” circumstances where a taxpayer presents “convincing evidence,” as determined by the agent, a taxpayer may request the imposition of the accuracy related penalty (20 percent) rather than the civil fraud penalty (75 percent) and/or nonwillful FBAR penalties instead of willful penalties.
- International form
penalties might not be imposed
- Penalties for the failure to file information returns (IRS Forms 3520, 3520-A, 5471, 8938, etc.) will not be automatically imposed.
- It is up to the IRS examiner’s discretion to determine if these penalties should be asserted, taking into account the other penalties imposed and if the examination is resolved by agreement.
- More penalties might be
- Penalties relating to excise taxes, employment taxes, estate and gift tax, etc., will be handled based upon the facts and circumstances with examiners coordinating with appropriate subject matter experts.
- More penalties might be imposed
Revocation of preliminary acceptance, threat of criminal prosecution
- The IRS will provide procedures for civil examiners to request revocation of preliminary acceptance when taxpayers fail to cooperate with civil disposition of cases.
- Taxpayers retain the right to request an appeal with the Office of Appeals.
It had been anticipated that once the 2014 OVDP concluded, a new disclosure program would be instituted by the IRS. Now a formula for resolving both foreign and domestic tax compliance issues is in place. Given that the IRS and the Department of Justice are “mining” the data provided under the Foreign Account Tax Compliance Act and the disclosures of data resulting from the Department of Justice-Swiss Bank Program, it is expected that new prosecutions of U.S. persons will be forthcoming. While the UVDP provides an opportunity to avoid criminal prosecution and other benefits, it may be at a very significant cost.
In the past, domestic voluntary disclosures were in many cases resolved without the imposition of civil fraud penalties and willful FBAR penalties. Now, those severe penalties are the starting point in a negotiation where the examiner is made well aware that the IRS has considerable leverage to force settlements far less favorable to the taxpayer than in the past. Given the power and discretion of the examiner to conclude that the taxpayer has not “cooperated,” increase the scope of the examination and impose maximum penalties, there is a risk of the examiner extracting unwarranted financial sanctions. The IRS may feel pressure to resolve these issues quickly but a number of factors, such as reduction in staff and retirement of experience agents, could lead to mistakes. That leaves taxpayers with recourse to the Office of Appeals.
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