23 March 2018
In the wake of the UBS litigation seeking the identity of U.S, taxpayers with accounts in Switzerland, the Internal Revenue Service offered a special new voluntary disclosure program for U.S. taxpayers with undisclosed offshore financial accounts and unreported offshore income. Approximately 15,000 taxpayers came forward under a special IRS program that ended Oct. 15, 2009, and many others applied after the deadline with the expectation of another offshore program. The new offshore disclosure program was announced by the IRS on Feb. 8, 2011.
For those of us who have handled voluntary disclosures prior to the 2009 special offshore program and continue to process disclosures, the 2009 offshore disclosure process was an arduous, expensive and time consuming process. The IRS has since worked with members of the bar to find ways to streamline the process; however, the service has become increasingly more aggressive in imposing penalties. The 2009 offshore program provided the IRS with a plethora of information which it used in establishing the new offshore disclosure program which is officially named the 2011 Offshore Voluntary Disclosure Initiative (OVDI).
What will be needed to make a timely voluntary disclosure? As a starting point, all the financial records for 2003-2010 and all the filed tax returns (federal and state) to build the amended return models. The assessment of penalties is based upon a full disclosure of all worldwide income and foreign financial assets as defined in the FBAR rules and regulations.
Who Must File?
Any U.S. person, whether residing in the United States or abroad, who has a financial interest in or signature authority over any financial account in a foreign country must file a Report of Foreign Bank and Financial Accounts (FBAR) disclosing their interest in such accounts if the aggregate value exceeds $10,000. FBARs are due by June 30 of the year following the year that the account holder meets the $10,000 aggregate threshold.
There is no extension for filing an FBAR. Accordingly, if you have clients that are U.S. persons with an interest or signature authority over a foreign financial account and they have not previously filed an FBAR with respect to such account(s), you should strongly consider advising them to take advantage of the voluntary disclosure program now before the IRS discovers the account and the client.
FBARs, if not previously submitted, need to be completed for the past eight years for all foreign accounts. The latest FBAR form requires the determination of the highest balance in the account at any time during the year. Under the new OVDI program, the non-compliance penalty is 25 percent of the highest aggregate balance at any time during the eight-year period. Simply put, $1,000,000 highest balance means in most cases a $250,000 penalty. If there are mitigating factors that establish the failure as non-willful, reduced penalties may apply. However, experience to date indicates that the IRS employs a relatively low standard for determining willfulness.
Preparing amended returns can be difficult, especially if information is not easily available. Replicating the original returns and analyzing considerable numbers of financial transactions has fallen on the CPAs’ shoulders. After the data is analyzed, the amended returns are prepared.
One of the twists in this process has been the identification of foreign mutual funds, which are considered Passive Foreign Investment Companies (PFICs) under the IRS rules. There are provisions in the old and new voluntary disclosure programs that attempt to streamline the PFIC calculation process, but it remains a complicated process, made more difficult by currency conversion issues.
In addition, if the client has an interest in a foreign trust, controls a foreign corporation, has made transfers to trusts or foreign corporations, or received gifts from non-U.S. persons during the eight-year disclosure period, additional filings may be required.
Once the tax due from the amended federal returns is determined, there will be a 20 percent negligence penalty plus interest on taxes due, plus a failure to file and failure to pay penalty, if applicable.
Another disclosure issue can be state amended returns. Many states have a voluntary disclosure program, which if the taxpayer applies and is accepted, will reduce the risk of criminal prosecution as well as waive or reduce penalties. In New York, we note that the assistant attorneys general have been attending sessions with members of the U.S. Attorney’s Office where proffers have been made. Connecticut has also been seeking this information for Connecticut residents.
After the attorney has completed interviews with the taxpayer, gone through a financial analysis and history of the account, and sent in the request for voluntary disclosure program acceptance, the IRS Criminal Investigative Division runs a check to see if the taxpayer is otherwise in the crosshairs of the U.S. government. Not just taxes, other issues can result in rejection. So, a careful debrief of your client is critical to avoid a rejected disclosure and possible prosecution.
The attorney will inquire to be sure that there are no outstanding IRS civil examinations or criminal investigations of the taxpayer, that the IRS has not received information from a third party regarding the taxpayer’s non-compliance, that the IRS has not already instituted a civil examination or criminal investigation of the taxpayer or that the IRS has not acquired information in connection with a criminal enforcement action (subpoena or litigation, for example).
To protect the work product of financial analysis and preparation of the required returns and amendments, most attorneys engage an independent CPA under the so-called Kovel doctrine. The incumbent tax preparer is not usually employed to prepare the amended returns and FBARs as establishing privilege may be difficult.
Once the Criminal Investigation Division of the IRS has made a determination that the taxpayer is eligible for acceptance into the voluntary disclosure program, it will send a letter indicating conditional acceptance. The case is then assigned to a Revenue Agent to verify the information submitted and determine the applicable penalties. At the end of the process, the taxpayer and Treasury sign a Closing Agreement.
The new OVDI borrows heavily from the terms offered in 2009 with several significant changes. First, the time period at issue has been increased from six to eight years. Taxpayers will now be required to pay back taxes, interest, and accuracy or delinquency penalties for tax years 2003 through 2010.
Additionally, taxpayers must now pay a penalty of 25 percent of the total asset value in all unreported foreign financial accounts and entities (calculated by reference to the year in which the value of such accounts and entities was the highest during the eight year period). This penalty, along with the penalties listed above, is “in lieu of” all other penalties that the IRS could assert, and was increased from the 20 percent penalty in the 2009 program.
Although the “in lieu of” penalty has increased, the IRS has expanded the group of individuals who may qualify for a reduced penalty rate. Individuals with smaller offshore accounts (i.e., where the value of the unreported accounts or assets did not surpass $75,000 in any year during the period) may qualify for an “in lieu of” penalty of 12.5 percent.
Inherited accounts are eligible for a reduced “in lieu of” penalty of 5 percent where the taxpayer 1) did not open the account in question, 2) exercised only minimal control over the account, 3) has not withdrawn more than $1,000 from the account in any year in the disclosure period, and 4) can show that all applicable U.S. taxes have been paid on funds deposited into the account. This is somewhat more favorable than the treatment of inherited accounts under the 2009 program.
Individuals classified as “accidental Americans” may qualify for a 5 percent “in lieu of” penalty if such persons were unaware that they had U.S. citizenship, for instance because they were born in the U.S. to non-U.S. parents and were raised outside the U.S.
Individuals who wish to take advantage of the OVDI must act quickly. The IRS must receive all amended income tax returns, amended information filings, full payment of the amount due, as well as various other documents by Aug. 31, 2011. A complete application is required for acceptance into the OVDI. IF you are under examination or if the IRS has received information already regarding your foreign assets, you will not be eligible to participate in the new OVDI.
For further information visit our IRS voluntary disclosure dedicated web feature.