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IRS Expands Voluntary Disclosure Program for Offshore Assets
June 25, 2014
On June 18, 2014, the Internal Revenue Service announced significant changes to two programs designed to encourage taxpayers to disclose and comply with U.S. tax obligations on offshore assets. Taxpayers with undisclosed foreign income and assets should seriously consider the benefits afforded by these programs, particularly in light of the rapidly approaching July 1st effective date of the Foreign Account Tax Compliance Act (FATCA). FATCA is expected to cause thousands of foreign financial institutions to begin reporting U.S. accounts to the IRS.
The affected programs are the Streamlined Filing Compliance Procedures (“Streamlined Procedures”) and the Offshore Voluntary Disclosure Program (OVDP), which implement a “carrot and stick” regime for taxpayers who have undisclosed foreign financial accounts or entities or unreported income generated in foreign countries. Participating taxpayers who voluntarily, accurately, and timely disclose and pay tax on this unreported income are rewarded with considerably lower penalties and protection from criminal prosecution. Conversely, those who refuse to reveal foreign income and assets face far more severe monetary penalties, as well as potential criminal sanctions, once discovered by the IRS.
Streamlined Filing Compliance Procedures
In 2012, the IRS established a set of Streamlined Procedures for individual U.S. taxpayers living abroad (or their estates) to cure delinquent U.S. federal income tax returns and Reports of Foreign Bank and Financial Accounts (FBARs). The 2014 revisions to these procedures are notable in several respects, including the (1) extension of eligibility to U.S. taxpayers residing in the United States; (2) expansion of eligibility to taxpayers owing more than $1,500 in unpaid tax per year; and (3) elimination of the risk assessment questionnaire.
The Streamlined Procedures include filing amended income tax returns and paying all taxes due (with interest) for each of the most recent 3 years for which the U.S. tax return due date has passed, as well as filing delinquent FBARs for each of the most recent 6 years for which the FBAR due date has passed. Nonresident taxpayers who follow the Streamlined Procedures will not be subject to failure-to-file or failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties, so long as they follow the procedures set forth by the IRS. By contrast, resident taxpayers are required to pay a reduced offshore penalty of 5% of the highest aggregate balance of the taxpayer’s applicable foreign financial assets during the years in the covered tax return and FBAR periods.
Although some differences remain between the treatment of resident and nonresident U.S. taxpayers, any taxpayer whose previous non-compliance arose from “willful conduct” or who is presently under criminal investigation by the IRS is not eligible for the Streamlined Procedures. In fact, each taxpayer must certify that his or her non-compliance was the result of “non-willful conduct.” The IRS defines non-willful conduct as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.”
Taxpayers should carefully consider the circumstances of their non-compliance, as those who falsely certify non-willful conduct will remain exposed to heavier civil penalties and criminal sanctions. Taxpayers who previously entered the OVDP may be able to take advantage of the 2014 Streamlined Procedures’ expanded eligibility and reduced penalty regime. Conversely, taxpayers who opt for the Streamlined Procedures are not permitted to change course and enter the OVDP. Thus, taxpayers who are concerned that their conduct might be viewed as willful by the IRS should strongly consider participation into the OVDP discussed below.
Offshore Voluntary Disclosure Program
Currently, the OVDP is an attractive program for individuals and entities that may have willfully concealed foreign income and assets from the IRS. The offshore penalty for willful non-disclosure can be assessed at the greater of $100,000 or 50 % of the total balance of the foreign financial account per violation, per year. The criminal implications are even more alarming. A person convicted of tax evasion is subject to imprisonment of up to 5 years and a fine of up to $250,000, while failing to file an FBAR can result in imprisonment of up to 10 years and fines of up to $500,000.
The OVDP enables taxpayers to reduce their exposure to these liabilities, pursuant to which the IRS will (1) assess a reduced off-shore penalty at 27.5% of the highest aggregate balance; and (2) not recommend criminal prosecution. To qualify for these benefits, participating taxpayers must fulfill all of the program’s requirements, which include:
- Disclosing unreported assets and foreign income for the most recent 8 tax years for which the due date has already passed;
- Paying the tax on the unreported income (with interest);
- Paying an accuracy related penalty of 20% on the tax due; and
- Paying the above-mentioned 27.5% offshore penalty on these undisclosed assets.
The 2014 changes to the OVDP turn up the heat on taxpayers to enter the program sooner rather than later. Beginning on August 4, 2014, any taxpayer who has an undisclosed foreign financial account will be subject to the enhanced 50% offshore penalty if, at the time of submitting the OVDP preclearance letter to the IRS, the foreign financial institution holding the assets has been:
- Publicly announced as under investigation by the IRS;
- Cooperating with the IRS with respect to U.S. account owners; or
- Identified in a court-approved summons requesting information about U.S. account owners.
This means that a taxpayer who attempts to enter the program after August 3rd – with expectations of a reduced penalty rate – may nonetheless end up paying the full 50% penalty. Given the July 1st start date of FATCA, many taxpayers will have a narrow window to qualify for the reduced penalty rate.
From all of these changes, the focus has become clearer. It appears that if you have undisclosed offshore income or assets, the time to act has come. The requirements for both the Streamlined Procedures and the OVDP are more extensive than the overview provided in this Alert, but we would be more than happy to explain them to you in greater detail.
If you have any questions about this or other tax law matters, please contact Steven Meyer at firstname.lastname@example.org or any other attorney in our Tax Group.
Client Advisory is provided for information purposes only, and does not constitute legal advice. According to Mass. SJC Rule 3:07, this material may be considered advertising. ©2014 Posternak Blankstein & Lund LLP. All rights reserved.