The IRS has developed a new initiative that may significantly lower the penalties for those who voluntarily disclose their offshore accounts and entities. The IRS’s objective is to bring taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with U.S. tax laws. A new penalty framework under the initiative is intended to provide taxpayers with the opportunity to calculate, with a reasonable degree of certainty, the civil penalties that may be imposed as a result of the delinquent filings. The framework applies only to those taxpayers who come forward on or before September 23, 2009.
The new penalty framework, publicized in a series of informal press releases and internal IRS memoranda over the last six weeks, is intended to be guidance for IRS examination personnel who are addressing voluntary disclosure requests involving unreported offshore income. The IRS has provided information on the initiative in a piece-meal fashion, and it is not clear whether any additional information is forthcoming. Thus, the following discussion should be read as a general framework that may not necessarily be binding on IRS personnel and that may be further refined.
Under the new penalty framework, for qualifying voluntary disclosures the IRS has indicated that it will asses all taxes and interest due for the past six years, and require the taxpayer to file or amend all returns, including information returns (e.g., Forms 3520 and 3520-A related to foreign trusts and Form 5471 related to foreign corporations) and Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts), commonly referred to as the “FBAR,” for those years. The IRS also will assess either an accuracy or delinquency penalty on all years. In lieu of all other civil tax penalties, including onerous FBAR penalties, that might apply, the IRS will assess a penalty “equal to 20% of the amount in foreign bank accounts/entities in the year with the highest aggregate account/asset value.” The 20% penalty could be reduced to 5% in certain circumstances. While the 20% penalty may be a material amount, it still may be significantly lower than the potential draconian civil penalties that the IRS could otherwise assert.
The new penalty framework will apply only to taxpayers who make a qualifying voluntary disclosure and fully cooperate with the IRS, both civilly and criminally. All voluntary disclosures filed under this initiative will be initially screened by IRS Criminal Investigation to determine if the taxpayer is eligible to make a voluntary disclosure. A taxpayer currently under examination by the IRS for any reason is not eligible to make a voluntary disclosure. Nor is a taxpayer for whom the IRS has acquired information from a criminal enforcement action (e.g., grand jury subpoena) directly related to the taxpayer’s liability or from a third party (e.g., informant or the media) alerting the IRS to the taxpayer’s noncompliance.
The IRS has stated that for those taxpayers eligible to make a voluntary disclosure, doing so generally should reduce, and perhaps even minimize, the chances of criminal prosecution. Because the initial disclosure, including identifying the taxpayer, is made to IRS Criminal Investigation to determine whether the taxpayer is qualified to make a voluntary disclosure, any disclosure should be made with the advice of tax counsel familiar with the issues.
Those taxpayers who have previously filed amended returns and paid any related tax and interest for previously unreported offshore income without first contacting the IRS directly should contact their tax counsel to determine it they should file again under this new initiative.
The IRS has reported that those taxpayers who have properly reported all of their taxable income but have failed to file the FBARs as required should not follow the voluntary disclosure process. Instead, they should file the delinquent FBARs, by September 23, 2009, with the Philadelphia Offshore Identification Unit in accordance with the FBAR instructions, attach a statement explaining why the reports are filed late and include copies of tax returns for all relevant years. The IRS has indicated that it will not impose a penalty for the failure to file those FBARs.