The US voluntary disclosure landscape has changed dramatically over the last 12 months. As a result, the options to voluntarily disclose previously unreported offshore accounts and assets have evolved to allow unprecedented relief for a broader group of US taxpayers. This is particularly true for those whose mistakes were inadvertent, innocent, "less guilty" or "non-willful," and may now be able to voluntarily disclose these accounts and assets with little or no penalty (aside from attorney and accountant fees).
However, US taxpayers that want to voluntarily “fix” their compliance issues related to offshore accounts and assets must make their way through a maze of seemingly constantly changing Internal Revenue Service policy and guidance. During the last 12 months, the IRS has amended some of its policies to reflect the fact that all failures to file FBARs are not equal and should not be treated as such.
In order to effectively navigate the options for relief, they first must be clearly understood and quantified in order to evaluate the costs, risks and rewards of the different possible approaches.
At a recent tax conference, Senior Litigation Counsel to the US Department of Justice announced that taxpayers can expect to see additional waves of enforcement as a result of new sources of information being received by the government in relation to both noncompliant taxpayers, and those that have previously "quietly disclosed." Furthermore, those taxpayers that quietly disclosed are very easily spotted in IRS data. Taxpayers who have previously made the decision not to participate in a voluntarily disclosure are urged to reevaluate their decision(s) with an eye towards the relief afforded by these new options.
Changes in IRS policy can occur overnight and without prior notice, frequently making current and yet-to-be established strategy a moving target. Oftentimes, potential FBAR penalties are the primary concern in the calculation of costs, risks and rewards of one approach over another due to the potentially onerous civil monetary penalties that may be imposed for the failure to file. In a recent policy shift, the IRS released guidelines as to how it will impose FBAR penalties that limit these penalties in different cases. These guidelines must also be incorporated into the determination of the most effective option(s) to take based upon attendant costs, risks and rewards.
Commissioners Heather Malloy, Karen M. Schiller and Sunita B. Lough, who are in charge of the three IRS Divisions involved with offshore accounts and assets, joined in a Memorandum (and attachments) that details the manner in which the IRS will impose FBAR penalties (the “Memorandum” or “Guidance”) in an FBAR examination, or if a taxpayer has decided to "opt out" of the Offshore Voluntary Disclosure Program (Note: the Guidelines are not applicable to a taxpayer that is participating in the foreign or domestic streamlined procedures). While its provisions are at times somewhat ambiguous, the Memorandum details those cases in which and to what extent FBAR penalties will be imposed. While in some cases the Memorandum reiterates certain IRS policies, in others, it provides a distinct shift. This may in part be due to the potential challenge to FBAR penalties under the 8th amendment as being excessive, a position advocated by many taxpayers and practitioners.
Generally, the Memorandum:
- Reiterates that the IRS has the burden to show that an FBAR violation occurred and, if willfulness is asserted, that the violations were willful
- Reiterates that IRS personnel have discretion in imposing amounts that are less than the maximum penalties proscribed by FBAR guidance (found under Title 31 of the US Code and Federal Regulations), based on “the facts and circumstances of each case”
- States that these new procedures are designed in order to “ensure consistency and effectiveness” in the decision as to if and to what extent penalties should be imposed
- Reiterates that IRS personnel must use their “best judgment” when an FBAR penalty is proposed
- States that an agent must provide adequate support for the determination that FBAR penalties are warranted
The provisions of the Memorandum will be found in the Internal Revenue Manual at 4.26.16.
Memorandum Key Points
Willful FBAR penalties:
- In most cases will not exceed 50% of the maximum account balance
- In no event will be more than 100% of the maximum account balance for particularly egregious violations
- Will be reviewed by multiple layers of IRS management, technical personnel and counsel
Non-willful FBAR Penalties:
- In most cases will be $10,000 per one undisclosed account for years under examination
- In some cases management permission may be requested by the examiner to propose only one $10,000 penalty for all years
- In particularly egregious circumstances may warrant the proposition of one $10,000 penalty per year per account
- Will in no event exceed 50% of the highest aggregate balance of all unreported foreign financial accounts for years under examination
- Will not be proposed if reasonable cause exists and taxpayer later files correct and complete FBARs
- Are subject to IRM mitigation provisions and must be reviewed for applicability
While this article is intended primarily to provide a brief overview of the considerations and options available to disclose offshore noncompliance and specific commentary in relation to the Guidance, it is important to understand that each element of a submission must be reviewed carefully, since the decision to enter a program or utilize the Programs should not be made lightly, and, accordingly, is made more complicated by the many subtleties that may adversely affect results.
In 2008, the US indicated that it would aggressively pursue taxpayers who maintain undisclosed offshore accounts and assets. In addition to unprecedented enforcement and information gathering, the IRS instituted a new civil framework to be applied in conjunction with its already existing policies relating to voluntary disclosure (in large part found in the Internal Revenue Manual). Since 2009, those US taxpayers who wanted to voluntarily disclose the existence of offshore accounts and assets were able to do so through the Offshore Voluntary Disclosure Program or Initiative (the “Programs”) in its number of ever-evolving iterations.
Under the Programs, a penalty was initially imposed that was calculated at 20% of the previously non-disclosed financial account balances for failure to file an FBAR. US taxpayers who innocently and inadvertently failed to report their accounts were treated in the same manner as those who pursuant to a plan to evade tax did not disclose their accounts by utilizing various trusts and/or entities.
For example, consider an 80 year old taxpayer who was born and lived in France for a number of years. During that time, she opened a bank account, did nothing to obscure the fact that she was its beneficial owner, and subsequently, having moved to America in 1958, kept the account but failed to properly disclose it to the IRS. Under these rules, she would be treated in the same manner as a US resident taxpayer who never lived outside of the US and, in an effort to obscure his ownership by utilizing foreign trust and entity structures, funneled untaxed money offshore.
As the result of this treatment, many decided to "quietly disclose" their violations to the US. Quiet disclosures will generally take the form of filing a number of amended tax returns and FBARs without participating in one of the Programs. While clearly a very inexpensive method to disclose, these quiet disclosures do not benefit from any of the protections offered by the Programs.
In response to practitioner objections, political pressure and reports to Congress by the US National Taxpayer’s Advocate Nina Olson, the Programs as they exist today have evolved towards the notion that certain FBAR violations are less egregious than others and differentiate between the less and more culpable. These changes are most welcome.
As most recently evidenced by the Guidance outlined below, the IRS has changed direction somewhat and provided a number of options based on taxpayers' unique set of facts and circumstances, including but not limited to: intent in failing to file the required returns, the amount of omitted income, and whether an individual lives within the US or offshore.
What follows is a very brief general discussion of some of the current options (as of the date of this article) for voluntarily disclosing previously undisclosed foreign accounts and assets.
Offshore Voluntary Disclosure Program (OVDP)
The OVDP is the gold standard option for those who have omitted income and are unable to counter allegations made by the IRS that they willfully failed to file FBARs. Next to being involuntarily dragged into an investigation for willfully failing to file FBARs, this will be the most expensive of the options for the taxpayer. It is expensive in large part as a result of a miscellaneous penalty imposed in lieu of FBAR penalties. However, as the relief granted takes the form of a Closing Agreement that will be signed by both the taxpayer and the IRS, the taxpayer can be confident that all issues relating to the noncompliance are concluded (except under limited circumstances).
Participation generally involves:
- Filing 8 years of amended tax returns
- Paying all indicated tax, interest and applicable non-FBAR penalties
- Filing 6 years of FBARs
- In lieu of imposing FBAR penalties, paying a 27.5% or 50% “miscellaneous” penalty based upon the highest aggregate account balances in a particular year
Importantly, there is a procedurally well-defined but potentially risky option where if a taxpayer believes that she would fare better in an IRS FBAR focused examination/audit than in the OVDP, she can “opt out” and hope for a more beneficial audit result. Taking this option is fraught with risk and should not be taken without careful assessment and, potentially, reassessment. That being said, the Guidance may cause many to think more seriously of opting out as a result of its limitation of potential FBAR penalties. Indeed, the terms of the Guidance may indicate a shift in IRS thinking that could ultimately result in the removal of the OVDP entirely.
Streamlined Offshore Domestic and Foreign Procedures
In addition to the Offshore Voluntary Disclosure Program, there are two other options that may be utilized: the Streamlined Offshore Domestic Procedures and the Streamlined Offshore Foreign Procedures. Both of these options are geared towards those US taxpayers who have omitted income and who are able to state under penalties of perjury that their failure to file FBARs was not willful. Importantly, consideration must be given to the fact that recently, “willfulness” has been defined by certain courts as willful blindness or recklessness, and the IRS has thus far declined to give examples of willfulness for FBAR purposes. The IRS approach is somewhat akin to “you know it when you see it.”
A participant utilizing either of these procedures will generally file:
- Three years of amended tax returns, paying all applicable tax and interest
- Six years of FBARs
In both of these options, only those taxpayers who are “domestic” to the US will pay a 5% miscellaneous penalty, (similar to the OVDP calculation of the highest aggregate account balance). Those participants that are “offshore” pay no penalties.
Delinquent FBAR and International Informational Return Submission Procedures
Additionally, there is another alternative that can be pursued called the Delinquent FBAR and International Informational Return Submission Procedures. These options should be considered by taxpayers whose situation meets all of the following criteria:
- There was a failure to file the applicable information returns with no omitted income
- The taxpayer did not willfully fail to file
- The taxpayer has reasonable cause for failing to file
Generally, for those who failed to file FBARs, all open years will be filed, and for those who failed to file International Informational Returns all delinquent returns will be filed. There are no penalties for participation in either of these procedures.
The decision as to which path to compliance to take is often complicated. There may be two or more entirely viable and appropriate options that result from the myriad of considerations that must be closely examined. Facts can blend together resulting in a recommendation that a taxpayer participate in a more costly and conservative program than necessary or appropriate. By contrast, failing to recognize the true risks of an option can result in pursuing a path that is too aggressive for the facts and circumstances. In more complicated cases, it is required to review in detail all facts and omissions, and independently measure the potential risks of each program or procedure.
In deciding whether or not to opt out of the OVDP and therefore be subject to an IRS FBAR focused examination, the Guidance may be quite helpful and may in fact encourage more opt outs as a result of the potential decrease in the associated monetary risks as described below.
Practical Effects of the Guidance
The Guidance is good news for taxpayers because at its core it appears to signal a change in IRS policy as to appropriate FBAR penalties and the manner in which they are imposed. It provides the upper end of applicable penalties in more egregious cases which is comforting. Although the IRS operational definition of "in most cases" is not specifically known, leaving open the potential for the use of an overly expansive definition resulting in penalties approaching the cap in some cases. That being said, from a risk/reward perspective, taxpayers and advisors are now better able to quantify potential penalties should FBAR penalties be asserted.
IRS agents should no longer be able to use the potential imposition of willful FBAR penalties in excess of the 100% cap (absent fraud or criminal charges) to keep taxpayers from opting out. As a result of these new procedures even the most aggressive IRS agents should not be able to violate the terms of the Memorandum without facing its multiple layers of review.
Likewise, in most cases non-willful penalties will be $10,000 for one undisclosed account for each year the statute of limitations remains open, but in no event will these penalties total more than 50% of the balance of the account.
The Guidance, in essence, establishes on a new norm for the imposition of penalties because it remains to be seen as to what “in most cases” encompasses. In addition the Guidance provides a ceiling for penalties (absent alleged fraud and/or criminal charges).
CAVEAT: Importantly, the Memorandum only provides IRS policy as it exists today, which is always subject to change because it is not pursuant to current case law, statute or regulation. Thus, the IRS can change the manner in which it imposes FBAR penalties at any time.
As the voluntary offshore programs and procedures evolved, the correct or best path to voluntary compliance was something of a moving target and it continues to be so. IRS policy can change rapidly, frequently and without warning. The determination as to how to proceed based on costs, risks and rewards can result in a number of different options which must be carefully examined. Further, in order to effectively react to the ever changing information as to IRS policy, we must reevaluate the risks and rewards of original decisions, so long as there is the possibility of adaptive and ameliorative action.
As stated at the beginning of this article, the costs, risks and rewards of participating in a voluntary disclosure have changed dramatically over a relatively short period of time. Those taxpayers who have previously decided not to come forward are urged to reevaluate their prior decisions and consider participation in one of the current IRS voluntary disclosure programs and procedures.