U.S. taxpayers, which include citizens, resident individuals, and domestic entities such as corporations, partnerships, limited liability companies, trusts and estates, are taxed on all their income, whether derived in the U.S or overseas. In addition, U.S. taxpayers are subject to information reporting requirements with respect to their affiliation with certain foreign accounts and foreign assets. Failure to comply with these U.S. tax laws could result in significant penalties, and in some situations, criminal investigation and prosecution.
Since 2009, the Internal Revenue Service (IRS) has implemented three formal offshore voluntary disclosure programs (“2009 OVDP”, “2011 OVDI” and “2012 OVDP”), which were designed to enable U.S. taxpayers to voluntarily disclose previously unreported foreign accounts.
The programs also enable U.S. taxpayers to come into compliance in exchange for non- prosecution criminally, and to receive partial amnesty from the potentially significant penalties for failure to report the existence of income from foreign accounts and assets. As a result of these programs, the IRS has indicated that it has received more than 45,000 voluntary disclosures from individuals who have paid about $6.5 billion in back taxes, interest and penalties.
In its continued effort to combat offshore tax evasion and failure to report required information, the IRS on June 18, 2014 announced changes to its current voluntary disclosure programs, including significant modifications to the 2012 OVDP. In addition, the IRS expanded its streamlined filing compliance process for U.S. taxpayers who have failed to disclose their foreign accounts but who did not willfully evade their tax obligations.
As part of this announcement, IRS Commissioner John Koskinen stated, “This opens a new pathway for people with offshore assets to come into tax compliance.” He further stated, “The new versions of our offshore programs reflect a carefully balanced approach to ensure everyone pays their fair share of taxes owed. Through the changes we are announcing today, we provide additional flexibility in key respects while maintaining the central components of our voluntary programs.” Highlights of these revisions are discussed below.
The new 2014 OVDP, which modifies but does not supplant the 2012 OVDP, makes the following key changes to the 2012 OVDP:
- Requires disclosure of much more substantive information from taxpayers applying for pre-clearance into the program.
- Eliminates the existing reduced penalty percentage for certain non-willful taxpayers in light of the expansion of the streamlined procedures.
- Requires taxpayers to submit all foreign account statements regardless of account balances for the disclosure period.
- Mandates remittance of all taxes, interest and penalties, including the offshore penalty, at the time of the OVDP submission of required documents.
- Enables taxpayers to submit voluminous records electronically rather than on paper.
- Increases the miscellaneous offshore penalty from 27.5% to 50% if, before the taxpayer’s OVDP pre-clearance request is submitted, a public disclosure occurs indicating that a financial institution where the taxpayer holds an account, or another party facilitating the taxpayer’s offshore arrangement is (a) under investigation by, (b) cooperating with, or (c) providing subpoenaed information to the IRS or Department of Justice (DOJ).
The IRS has now identified an initial list of ten such provided institutions, including UBS and Credit Suisse.
As with the 2012 OVDP, the terms of the 2014 OVDP could change at any time. For instance, the IRS could 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 time.
Expansion of Streamlined Offshore Procedures
Previously, streamlined offshore voluntary disclosure procedures were only available to nonresident U.S. taxpayers who had undisclosed foreign financial accounts. The new streamlined offshore program is now also available to certain U.S. taxpayers living in the U.S.
The streamlined offshore procedures purportedly intended to speed up the disclosure/approval process are designed only for individual taxpayers, including estates of individual taxpayers. There are two streamlined procedures: (1) one available to U.S. individual taxpayers who reside in the U.S. and (2) the other available to U.S. taxpayers who live outside of the U.S. Under either program, if the IRS has initiated a civil examination of a taxpayer’s returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets, that taxpayer will be ineligible to use the streamlined offshore procedures. Once a taxpayer makes a submission under the streamlined offshore program, he or she cannot participate in the 2014 OVDP. The converse is also true; once a taxpayer makes a submission under the 2014 OVDP, he or she cannot seek participation in the streamlined offshore procedures.U.S. taxpayers seeking to use the streamlined procedures:
- Must meet residency tests.
- 2. Must have filed tax returns for the three most recent tax years (if applying under the streamlined procedure as a U.S. resident).
- 3. Must have failed to report the income from a foreign financial asset and pay tax as required by U.S. laws.
- 4. May have failed to file an FBAR (FinCEN Form 114, previously Form TD F 90-22.1) or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset.
- 5. Must certify under penalties of perjury that their noncompliance was not willful and provide a specific reason for their failure to comply. (The IRS defines non-willful conduct as conduct that is due to negligence, inadvertence, or mistake; or conduct that is the result of a good faith misunderstanding of the requirements of the law.)
Eligible nonresident taxpayers applying under the streamlined procedure will not be liable for any penalty, whereas U.S. residents will only be subject to a 5% “miscellaneous offshore penalty” on the foreign assets that gave rise to the noncompliance.
Under the streamlined program, eligible participants are not subject to the other applicable penalties such as the accuracy related penalty and the failure to pay penalty required under the 2012 and current 2014 OVDP.
Notably, tax returns submitted under the streamlined offshore procedures will be processed like any other return submitted to the IRS, and consequently, receipt of the returns will not be acknowledged by the IRS. Moreover, the streamlined filing process will not culminate in the signing of a closing agreement with the IRS. The returns also may be selected for audit and may also be subject to verification procedures about accuracy and completeness of submissions, which could result in assessment of civil penalties and even criminal liability.
Taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns may be viewed as willful conduct, and who therefore seek assurances that they will not be subject to criminal liability or substantial monetary penalties, should consider participating in the 2014 OVDP instead of using the streamlined offshore procedures.
Which Choice is the Better Option?
The choice between the 2014 OVDP and streamlined procedures is daunting. The basis for streamlined offshore procedures is non-willful conduct. Making the determination as to whether a taxpayer’s conduct satisfies the non-willful standard will require a careful and complete examination of the taxpayer’s particular facts and circumstances and a clear understanding of the case law assessing willfulness. Taxpayers must be able to provide reasons for the noncompliance that equate to mere negligence and certainly not to “willful blindness” which is sufficient to prove criminally willful misconduct.
The line between the two standards can be very thin. Internal Revenue Manual 22.214.171.124.5.3(6) states:
“[W]illfulness may be attributed to a person who has made a conscious effort to avoid learning about the FBAR reporting and recordkeeping requirements.” [Manual]
Under the streamlined offshore program, the taxpayer has to demonstrate to the IRS that his/her conduct was not a willful failure. If the IRS believes that the tax returns are not filed in good faith, it would deny the taxpayer streamlined treatment, resulting in penalties and leading to possible criminal prosecution. Having a taxpayer certify that he only acted negligently can be an ax the government uses to prosecute the taxpayer for false statements if its view of the facts is different. Making such certification should only be done when the supporting evidence is absolutely clear.
By contrast, the 2014 OVDP offers criminal protection without the taxpayer having to speak to his state of mind, albeit under the 2014 program at a steeper cost than the 2012 OVDP. The miscellaneous penalty under the 2014 OVDP could be as high as 50% of the highest balance in the account, a significant increase over the 27.5% rate set in the 2012 OVDP.
U.S. individual taxpayers who have yet to come into compliance should immediately weigh their options before the IRS discovers their noncompliance. Under various treaties and IRS programs, many Swiss banks are making disclosures to the IRS about foreign accounts held by U.S. taxpayers. The U.S. investigation of UBS in 2009 opened up the Pandora’s box of profligate offshore tax evasion.
The odds today are much higher that the IRS will learn about undisclosed foreign accounts and income before the U.S. foreign account holder decides to seek acceptance in a voluntary disclosure program, a circumstance disqualifying the U.S. taxpayer from acceptance into the program. Once the IRS has information about a U.S. taxpayer’s noncompliance, neither the 2014 OVDP nor the streamlined offshore program is an option.