The Internal Revenue Service has recently announced that more than 35,000 taxpayers have taken advantage of its voluntary disclosure programs for offshore bank accounts since their inception in 2009, and that those programs have generated more than $5 billion in additional revenue for the U.S. Treasury. Notwithstanding the unprecedented success of these efforts, the IRS nonetheless believes that more taxpayers with secret foreign bank accounts have not yet taken advantage of these amnesty programs. To encourage reluctant taxpayers to come forward, the IRS re-opened its offshore voluntary disclosure program for a third time in January 2012, and recently published further guidance clarifying the parameters of the new program. In a press release accompanying the new guidance, IRS Commissioner Douglas Shulman proclaimed that "[w]e continue to make strong progress in our international compliance efforts that help ensure honest taxpayers are not footing the bill for those hiding assets offshore. People are finding it tougher and tougher to keep their assets hidden in offshore accounts." The current IRS amnesty program—named the "2012 Offshore Voluntary Disclosure Program"—does not have a definitive end date and is subject to termination or change at any moment. In a related move, the IRS has announced new compliance procedures to enable U.S. or dual citizens who reside overseas to return to compliance with their U.S. tax obligations without the risk of substantial penalties, a move welcomed by thousands of expatriates who live abroad and may not be fully compliant with, or even aware of, their U.S. tax and FBAR obligations.
The 2012 Offshore Voluntary Disclosure Program
The IRS has issued long-awaited Frequently Asked Questions and Answers (FAQs) regarding its 2012 Offshore Voluntary Disclosure Program which provide additional specificity and make some key changes relative to the prior amnesty programs.1These changes are summarized below.
Eligibility for the 2012 OVDP
In an important development, the IRS has tightened the eligibility requirements for taxpayers who wish to enroll in the 2012 OVDP. According to FAQ 21, the mere fact that the IRS has served a "John Doe" summons, submitted a treaty request, or taken similar action with the respect to a particular foreign financial institution does not render every member of the "John Doe" class or group identified in the treaty request or other action ineligible to participate in the 2012 OVDP. However, once the IRS or the Justice Department obtains information under a "John Doe" summons, treaty request, or similar action that provides evidence of a specific taxpayer’s non-compliance with tax laws or FBAR reporting requirements, then that particular taxpayer will be ineligible for participation in the 2012 OVDP. The FAQs expressly warn that "a taxpayer concerned that a party subject to a John Doe summons, treaty request or similar action will provide information about him to the Service should apply to make a voluntary disclosure as soon as possible."
The new FAQs also identify two new categories of taxpayers who are deemed ineligible to participate in the 2012 OVDP. First, a taxpayer who appeals a foreign tax administrator’s decision authorizing the release of account information to the IRS and fails to serve notice of such appeal on the Attorney General of the United States (which is required under federal law) will be rendered ineligible to participate in the 2012 OVDP. Second, the IRS may in its discretion announce that certain taxpayer groups that have or had accounts at specific financial institutions will be ineligible due to U.S. government actions in connection with the specific financial institutions in question. This second category is particularly troublesome for U.S. taxpayers with accounts at certain banks in Switzerland and Israel which have been identified in the press as targets of criminal investigations by the Justice Department.2Taxpayers holding accounts at these institutions would be well advised to commence the voluntary disclosure process as soon as possible or else risk being deemed ineligible by the IRS at some future date by virtue of the authority specified in this particular FAQ.
Taxpayers accepted into the 2012 OVDP must file amended tax returns for an eight-year period and pay all back taxes, interest, and an accuracy-related penalty calculated at 20 percent of the taxes due. In a change from the prior program, the top-tier offshore or FBAR penalty has been increased from 25 percent to 27.5 percent, and this penalty is calculated based upon the highest aggregate value of the taxpayer’s foreign bank accounts during the eight-year disclosure period. The program retains the lower tier penalties of 12.5 percent and 5 percent which apply in only limited circumstances. In order to quality for the 5 percent FBAR penalty, taxpayers must establish that they did not open the foreign account in question, they exercised minimal contact with the account, they have not withdrawn more than $1,000 from the account in any year, and all U.S. taxes were paid on the funds. In addition, the 5 percent penalty may be applied in the case of taxpayers who are foreign residents and were unaware they were U.S. citizens, as well as in the case of taxpayers who reside in a foreign country, are fully compliant with the tax laws of their country of residence, and have $10,000 or less of U.S. source income each year. Taxpayers whose highest aggregate bank balance is less than $75,000 will qualify for the 12.5 percent penalty.
For taxpayers unwilling to accept the 2012 OVDP penalty structure, the ability to "opt out" of the program remains an option. The decision to opt out is irrevocable and may not be revisited, and taxpayers who opt out will be subject to a full audit with all applicable penalties available. The IRS recognizes that there may be instances in which opting out is the preferred approach, particularly for taxpayers with minimal tax deficiencies who are facing a substantial FBAR penalty.
Clarification of Disclosure Period
The new FAQs contain a significant clarification of the period of time covered by the 2012 OVDP program. In its prior offshore voluntary disclosure programs, the IRS generally required participants to file amended tax returns for a period of eight years starting with tax year 2003. The new FAQs clarify that the disclosure period is "the most recent eight tax years for which the due date has already passed. The eight year period does not include current years for which there has not yet been non-compliance." This means that for taxpayers who submitted a disclosure prior to the due date for their 2011 tax return (including extensions), the disclosure period includes 2003 through 2010. For taxpayers who submit their disclosure after the due date for their 2011 tax return (including extensions), the disclosure period includes 2004 through 2011. The new FAQs further specify that for taxpayers who have previously filed original, compliant tax returns fully reporting previously undisclosed offshore bank accounts before they made their voluntary disclosure—such as taxpayers who have filed compliant tax returns and FBARs for 2010 and 2011—the compliant years will be excluded from the disclosure period under the new program terms.
No Current Deadline for 2012 OVDP
The new FAQs emphasize that there is no current deadline for participating in the 2012 OVDP. The FAQs warn, however, that "the terms of this program could change at any time going forward. For example, the IRS may increase penalties or limit eligibility in the program for all or some taxpayers or defined classes of taxpayers—or decide to end the program entirely at any point." The FAQs also make clear that participants in the program must agree "to cooperate with the IRS offshore enforcement efforts by providing information about offshore financial institutions, offshore service providers, and other facilitators, if requested." This statement memorializes the practice that the IRS and Justice Department have been utilizing with regard to participants in the 2009 and 2011 voluntary disclosure programs and is part of a broader data mining effort that both agencies are utilizing to gather information from voluntary disclosure participants to be used in future enforcement actions.
Continuation of FAQ 17/18 Relief
The new FAQs also continue an important provision that was part of the prior voluntary disclosure programs applicable to taxpayers who filed tax returns reporting all of their foreign income but failed to file FBARs in prior years to report their foreign bank accounts. Taxpayers in this situation may take advantage of a special procedure specified in FAQ 17 which allows them to file delinquent FBAR forms with an explanation as to why they are being filed late. If this procedure is utilized, the IRS has stated that it will impose no penalty for the failure to file the delinquent FBARs as long as there are no underreported tax liabilities and the taxpayer has not been previously contacted regarding an income tax examination or a request for delinquent tax returns. FAQ 18 provides that the same penalty relief is available to taxpayers who have simply failed to file information returns—such as Forms 5471 or Forms 3520— but otherwise reported all of their taxable income in prior years. In this situation, the IRS will not impose a penalty for the failure to file the delinquent information returns as long as the taxpayer has not been previously contacted regarding an income tax examination or a request for delinquent returns.
New Filing Compliance Procedures for U.S. Taxpayers Residing Abroad
In conjunction with the new FAQs for offshore voluntary disclosures, the IRS also announced new compliance procedures to enable U.S. taxpayers residing overseas, including dual citizens, to become compliant with their U.S. tax obligations.3 IRS Commissioner Shulman described the new procedure—which will go in to effect on September 1, 2012—as "a series of common-sense steps to help U.S. citizens abroad get current with their tax obligations and resolve pension issues." The IRS formulated this procedure in response to revelations that many U.S. taxpayers living abroad only recently became aware of their U.S. tax and FBAR obligations.
Assessment of "Compliance Risk"
Taxpayers who wish to take advantage of the new procedure will be required to file delinquent tax returns for the past three years and delinquent FBARs for the past six years. Payment in full of taxes and interest due must accompany the submission. According to the new procedure, all submissions will be reviewed by the IRS but the "intensity of review will vary according to the level of compliance risk presented by the submission." Taxpayers presenting low compliance risk will receive expedited review and the IRS will not assert penalties or pursue follow-up actions. The IRS has stated that tax returns showing little or no U.S. due will generally be considered "low risk."
On the other hand, submissions that present higher compliance risk are not eligible for the new procedure and will be subject to a more thorough review and possibly a full examination, which in some cases may include more than three years, and may include imposition of interest and penalties. The IRS guidance provides that "the risk level will rise as the income and assets of the taxpayer rise, if there are indications of sophisticated tax planning or avoidance, or if there is material economic activity in the United States." Other risk factors include any additional history of noncompliance with U.S. tax laws and the amount and type of U.S.-source income.
Reasonable Cause for Penalty Relief
The new IRS guidance provides that penalty relief may be available based upon a showing of reasonable cause. This includes penalties for failure to file FBARs which can be significant in the case of willful violations. Any taxpayer claiming reasonable cause for failure to file tax returns, information returns, or FBARs must submit a sworn statement setting forth reasonable cause. The IRS refers taxpayers to IRS Fact Sheet FS-2011-13 issued in December 2011 for examples of reasonable cause. In that pronouncement, the IRS stated that factors suggesting that the failure to file the FBAR was due to reasonable cause may include the following: (1) the taxpayer’s reliance upon the advice of a professional tax advisor who was informed of the existence of the foreign financial account, (2) the unreported account was established for a legitimate purpose and there were no indications of efforts taken to intentionally conceal the reporting of income or assets, and (3) little or no tax deficiency related to the unreported foreign account. On the other hand, factors that may tend to negate reasonable cause for a FBAR violation include (1) whether the taxpayer’s background and education indicate that he or she should have known of the FBAR reporting requirements, (2) whether there was a tax deficiency related to the unreported foreign account, and (3) whether the taxpayer failed to disclose the existence of the account to the person preparing his tax return.
Relief for Certain Foreign Pensions and Retirement Plans
In another important development, the IRS is offering retroactive relief for failure to timely elect income deferral on certain retirement and savings plans (such as Canadian Registered Retirement Savings Plans) where deferral is permitted by a relevant treaty. In some circumstances, tax treaties allow for income deferral under U.S. tax law, but only if an election is made on a timely basis. The streamlined procedures will be made available to resolve low compliance risk situations even though this election was not made on a timely basis. Any taxpayer seeking such relief will be required to submit a statement requesting an extension of time to make an election to defer income tax and identifying the pertinent treaty position; for relevant Canadian plans, a Form 8891 for each tax year and description of the type of plan covered by the submission; and a statement describing (1) the events that led to the failure to make the election, (2) the events that led to the discovery of the failure, and (3) if the taxpayer relied on a professional advisor, the nature of the advisor’s engagement and responsibilities.
No Protection From Criminal Prosecution
The IRS warns taxpayers that the new compliance procedures for non-resident taxpayers do not provide protection from criminal prosecution if the IRS and Department of Justice determine that the taxpayer’s particular circumstances warrant prosecution. Taxpayers with concerns about criminal prosecution should consider enrolling in the 2012 OVDP described above which offers another vehicle for taxpayers with undisclosed offshore accounts to become compliant. Once a taxpayer makes a submission under the new compliance procedures for non-resident taxpayers, the 2012 OVDP is no longer available. Also, taxpayers who are ineligible to participate in the 2012 OVDP are also ineligible to participate in the new compliance procedures for non-resident taxpayers.
Taxpayers who are non-compliant with their U.S. tax and/or FBAR obligations are well-advised to consider taking advantage of either the 2012 OVDP or the new compliance procedures for non-resident taxpayers, depending upon their circumstances. The 2012 OVDP offers taxpayers with secret foreign bank accounts the opportunity to "come clean" by disclosing their foreign accounts and paying back taxes, interest, and penalties in exchange for amnesty from criminal prosecution. With the IRS and Justice Department continuing their global crackdown on international tax evasion and bank secrecy laws, the risk of detection is greatly increased and the threat of criminal prosecution is real. Similarly, the new compliance procedures for non-resident taxpayers offer a streamlined process for U.S. and dual citizens residing abroad to return to compliance with minimal penalty exposure in most instances.