Since 2009, the Internal Revenue Service has offered a variety of offshore voluntary disclosure programs (collectively, OVDP) under which a U.S. taxpayer can disclose previously undisclosed offshore activities. However, these programs carry a fairly stiff penalty (currently 27.5%), albeit typically less than what could be assessed if a taxpayer is caught on audit. Nevertheless, if the offshore penalty is not acceptable to a taxpayer, then the taxpayer has the option of opting out of the program. By opting out, the taxpayer agrees for the IRS to handle his or her case under the standard audit process. However, whether or not to opt out is not always an easy decision to make. As the IRS states in its 2014 OVDP FAQ:
There are different considerations for taxpayers whose participation in the OVDP began prior to, or on or after July 1, 2014. For taxpayers who participated in the OVDP prior to July 1, 2014, they have the opportunity to apply for transition relief which, if granted by the IRS, would subject them to a much lower – or NO – offshore penalty. To qualify for transition relief, a taxpayer must prove that his or her failure to properly disclose the offshore assets or activities was due to non-willfulness. There is no concrete definition as to what constitutes “non-willfulness,” as it is determined under all facts and circumstances. The IRS has been extremely strict and selective in granting transition relief, which leaves participants stuck with the harsh penalties under the OVDP.
For taxpayers who applied for OVDP on or after July 1, 2014, transition relief is not available at all, as they had a choice between one of the streamline programs or OVDP. A switch from one program to the other cannot be made after their initial selection. These taxpayers are unfortunately stuck with the severe offshore penalty under the OVDP. Again, if the harsh penalties imposed by the IRS are unacceptable, then opting out may be a viable path for such taxpayers.
Before making the final decision of opting out, a taxpayer should be aware of the risks associated with it. Once the opt out process is complete, they may be subject to fines and penalties far exceeding the penalties they would have been subject to had they stayed in the OVDP. That being said, if the fact pattern presents itself as a good opt out candidate, then it is very well possible for a taxpayer to negotiate a much reduced penalty.
We've been able to achieve opt out successes for several of our OVDP clients, including one very recent success for a taxpayer. The husband and wife lived in Germany for many years, during which time, the husband set up a bank account in Switzerland for retirement purposes. All income from the account was declared in Germany, and all taxes due in Germany were paid. Due to the decline of the husband’s health, and subsequent passing, the account was later switched to the wife’s name. However, the couple was not aware of the FBAR filing requirements. They participated in the OVDP, prior to the IRS introducing the streamline programs. Under the OVDP, the IRS wanted the offshore program penalty at 27.5%, or a total of more than $213,000. Instead, the wife decided to opt out. During the opt out process, the IRS conducted a full audit and decided to assert only non-willful FBAR penalty for a number of years and a failure to file Form 8938 penalty, totaling approximately $50,000. By opting out, the wife saved nearly $175,000 from the offshore penalty, making the opt out decision was a very wise choice.
Despite the benefits and successes achieved through opting out, it cannot be emphasized enough, that it is not an easy decision to make. All facts and circumstances should be taken into consideration to weigh its merits against the risks. An OVDP participant should consult with their tax advisor before making a decision to opt out.