On February 8, 2011, the Internal Revenue Service (IRS) announced a second voluntary disclosure initiative (“2011 OVDI”) which limits the potential penalties associated with the failure to disclose foreign accounts and assets and/or report the income generated from them. The 2011 OVDI is designed to encourage taxpayers with undisclosed offshore accounts and assets to come forward by limiting their exposure to penalties, such as the penalty for failure to report a foreign financial account on a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) and taxrelated penalties. Under the 2011 OVDI, a single 25 percent FBAR penalty will generally be imposed based on the highest value in the account over an eight-year period instead of a penalty which could be as high as 50 percent of the value of the account in each year. Taxpayers that wish to participate in the 2011 OVDI must not wait since the initiative terminates on August 31, 2011, and taxpayers must complete all requirements under the 2011 OVDI by the deadline.

The offered 25 percent FBAR penalty is only slightly higher than the 20 percent penalty that was offered in the IRS’s first offshore voluntary disclosure initiative in 2009 (“2009 OVDI”). Under the 2009 OVDI, taxpayers that disclosed before October 15, 2009, received the 20 percent penalty on the highest balance in their offshore accounts during the period from 2003 through 2008. (For more information regarding the 2009 OVDI, see April 2009 GT Alert and May 2009 GT Alert.) The IRS estimates that since the closure of the 2009 OVDI approximately 3000 taxpayers have made a voluntary disclosure involving offshore accounts. These taxpayers, whose cases were held up in processing while the IRS determined how to treat them, are eligible to participate in the 2011 OVDI.

The 2011 OVDI covers the tax years 2003 through 2010. (The 2009 OVDI was limited to 2003 through 2008.) In order to participate, taxpayers will be required to file or amend all tax returns, including information returns and FBARs, and pay all of the tax and interest due for the years 2003 through 2010. In addition, the taxpayers will be subject to a 20 percent accuracy-related tax penalty and/or delinquency penalties on the amount of tax due in each of the eight years. These penalties are in addition to the 25 percent FBAR penalty. The 25 percent FBAR penalty will also be asserted against the value of those assets held in a foreign jurisdiction that are related to any tax non-compliance. The IRS has stated that assets will be treated as related to tax non-compliance if the income generated from the assets was not reported during the eight-year period or the taxpayer failed to pay the U.S. tax that was due with respect to the funds used to acquire the assets.

The 2011 OVDI is noteworthy for including a further reduced FBAR penalty in certain circumstances. For instance, if the highest aggregate balance of the undisclosed accounts and assets does not exceed $75,000 in any of the eight years under the initiative then the penalty will be cut in half to 12.5 percent. A taxpayer can also qualify for a 5 percent penalty if all of the following factors apply: (i) the accounts could not have been opened by the taxpayer (i.e., inherited or gifted accounts); (ii) there was minimal contact between the taxpayer and the bank; (iii) no more than $1,000 was withdrawn from the accounts in any year under the 2011 OVDI (except if the account was closed and the funds were repatriated to the U.S.); and (iv) the taxpayer can establish that all U.S. taxes have been paid on the funds deposited in the accounts. (The IRS will presume that funds deposited into an account before January 1, 1991, have been appropriately taxed.) Taxpayers can also qualify for a 5 percent penalty if they can show that they are a foreign resident and they were unaware that they were U.S. citizens. A 5 percent penalty was offered in the 2009 OVDI but was never clearly defined and was applied inconsistently. Therefore, the announcement of the 2011 OVDI contains provisions to allow taxpayers that participated in the 2009 OVDI and who qualify for the newly defined 5 percent or 12.5 percent penalties to reopen their cases in order to have the lower penalty imposed.

In order to participate in the 2011 OVDI taxpayers must come forward and complete all filing requirements on or before August 31, 2011. A disclosure is made by a taxpayer by submitting a letter signed under penalties of perjury that includes complete identifying information of the taxpayer and details of the foreign accounts/assets, such as the institutions where they are held, the years the accounts were open, the balances in the account and the income generated in the accounts, the identification of all people or entities affiliated with the account, the contacts at the bank and a description of any face to face meetings. Upon submission of this letter, the IRS Criminal Division will check to see if the taxpayer has made a timely disclosure and is eligible to make a voluntary disclosure. The 2011 OVDI also provides a formal pre-clearance process whereby a taxpayer can submit limited identifying information before a full disclosure is made to find out if they qualify to make a voluntary disclosure.

Once a taxpayer submits the voluntary disclosure letter and has been cleared by the IRS Criminal Division they must submit a complete package to a centralized IRS location consisting of the following:

  1. Copies of the previously filed tax returns for the years 2003 through 2010;
  2. Complete and accurate amended tax returns for the years 2003 through 2010;
  3. Completed statements such as (i) a Foreign Account or Asset Statement for each undisclosed foreign account or asset; (ii) for accounts over a $1 million, a completed Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer had an undisclosed account; and (iii) a Taxpayer Account Summary with Penalty Calculation. These forms require detailed information regarding the financial accounts and assets, as well as answers to questions about the financial institutions and any promoters of the accounts;
  4. Payment of all tax, interest and income tax penalties asserted in each year. If full payment cannot be made then the taxpayer must submit a proposed payment arrangement;
  5. For accounts with a value over $500,000, copies of the bank account statements showing all account activity during the years at issue; and
  6. A signed extension of the statute of limitations for all taxes and penalties.

Upon receipt of the package a revenue agent will be assigned to review the documents and work with the taxpayer to enter into a closing agreement resolving the matter.

Taxpayers that comply with these voluntary disclosure provisions will benefit under this new structure, as did those that participated in the 2009 OVDI, by limiting their exposure to potential criminal prosecution and avoiding additional penalties, such as: (i) the annual FBAR penalty for the failure to report a foreign account, which could be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account each year; (ii) a fraud penalty equal to 75 percent of the unpaid tax; and (iii) the penalties for the failure to file information returns (such as Form 5471- Information Return of U.S. Persons With Respect To Certain Foreign Corporations and Form 3520 - Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, among others).

The announcement of the 2011 OVDI included statements from the IRS that those taxpayers that do not come forward will bear the risk of criminal prosecution and higher penalties if they are detected by the IRS. The IRS has expanded its focus on foreign banks from Europe to banks in Asia, the Middle East and Central America and has obtained information about the banks’ U.S. accountholders from treaty requests, summonses and whistleblowers. The IRS also will begin to receive additional information about foreign accounts when the new Foreign Account Tax Compliance Act and the Statement of Foreign Financial Assets Form become effective. As the IRS continues to erode bank secrecy, the Commissioner of the IRS has pointed out that the 2011 OVDI “is the last, best chance for people to get back into the system.”