A Critical Time for Voluntary Disclosure of Foreign Assets
On June 18, 2014, the Internal Revenue Service introduced significant changes to both its Offshore Voluntary Disclosure Program (OVDP) and its Streamlined Filing Compliance Procedures (Streamlined) and posted updated Frequently Asked Questions on its website.1 These changes apply to new OVDP “submissions” (which most practitioners believe refer to the Offshore Voluntary Disclosure Letter and Attachment, not the preclearance request or final OVDP filing) made on or after July 1, 2014. The changes increase the penalties payable under OVDP for certain taxpayers seeking preclearance to apply for OVDP on or after Aug. 4, 2014, increase the volume and breadth of information requested by the IRS within OVDP and accelerate payment of the OVDP miscellaneous offshore penalty. At the same time, however, the changes broaden the availability of Streamlined, including making it available to U.S resident taxpayers, and permit those already in OVDP who qualify for Streamlined to apply the Streamlined penalty to their OVDP matters in certain cases. On the whole, according to the IRS, the changes reflect a balanced approach by recognizing that a different penalty structure might be more appropriate for certain taxpayers whose failures to disclose may not have been willful.
OVDP and Streamlined are part of a wider effort to stop offshore tax evasion, including enhanced enforcement of FinCEN 114 (formerly, the Foreign Bank and Financial Accounts Report (FBAR)), used to disclose offshore financial accounts; additional (and sometimes duplicative) reporting of offshore financial assets on Form 8938;2 criminal prosecutions of foreign banks that facilitate the maintenance of unreported foreign accounts; and implementation of third-party reporting via the Foreign Account Tax Compliance Act (FATCA), which went into effect on July 1, 2014.3
Background
Since March 23, 2009, the IRS has had in place multiple versions of OVDP, which have resulted in the collection of about $6.5 billion in taxes, interest and penalties.4 The 2009 and 2011 versions closed after running for several months, but the last version of OVDP, announced on Jan. 9, 2012 (the 2012 OVDP), remains open-ended. It’s the 2012 OVDP that’s been continued with modified terms as per the June 18, 2014 changes (the 2014 OVDP). The 2014 OVDP and its predecessors are based on existing voluntary disclosure practices used by IRS Criminal Investigation, which offer U.S. taxpayers not currently under audit or criminal investigation an opportunity to avoid criminal prosecution and a settlement of a variety of civil and criminal penalties in the form of a single miscellaneous offshore penalty. This penalty is imposed on the highest value of the undisclosed assets over a look-back period. Unsurprisingly, the penalty has increased with each subsequent version of OVDP—from 20 percent to 25 percent to 27.5 percent—and the look-back period has likewise increased, from six to eight years.
2012 OVDP
Under the 2012 OVDP, a delinquent taxpayer could achieve U.S. tax compliance and avoid criminal prosecution by: (1) filing eight years of delinquent tax returns or amended tax returns, including information returns, (2) paying all tax due, (3) paying a 20 percent accuracy-related penalty on the tax due, (4) paying interest, (5) filing eight years of FBARs, (6) filing other narrative information required under the program, and (7) paying a miscellaneous offshore penalty of 27.5 percent of the highest aggregate value, calculated annually for each of the prior eight years, of all previously undisclosed foreign accounts and assets.
In some cases, a reduced penalty of 5 percent or 12.5 percent was available. More specifically, under prior FAQ #52 of the 2012 OVDP FAQs posted on the IRS website, the 5 percent penalty was available for: (1) inherited accounts over which the taxpayer exercised minimal and infrequent contact and made limited withdrawals, and (2) accounts held by foreign residents who were unaware they were U.S. citizens or those who were compliant in their country of tax residence and met certain other requirements. Under prior FAQ #53, the 12.5 percent penalty was available when the highest aggregate value of the undisclosed foreign accounts and assets never exceeded $75,000 during the look-back period.
In addition, FAQs #17 and #18 indicated, generally, that if there were no underreported tax liabilities associated with the taxpayer’s failures to file FBARs or information returns and the IRS hadn’t previously contacted the taxpayer regarding the same, the delinquent filings wouldn’t be handled under the standard OVDP process. Instead, the taxpayer was instructed to file the delinquent FBARs and information returns in accordance with their instructions and include a reasonable cause statement. The IRS indicated that no penalty would be imposed.
There was no discretion within the OVDP framework to negotiate a different penalty from that imposed by the FAQs or change the look-back period. The closure of an OVDP case resulted in a closing agreement on Form 906, which was used to resolve all tax issues. If a taxpayer disagreed with the penalty, he could always opt out of OVDP and have his case handled under the standard audit process. For some U.S. resident taxpayers, whose failures to disclose were non-willful, going through OVDP and opting out to negotiate a penalty lower than 27.5 percent was a strategy worth pursuing. This method was an alternative to pursuing a “quiet disclosure,” which the IRS indicated it would scrutinize more closely. A quiet disclosure involves filing amended returns with a reasonable cause statement for the years in which the statute of limitation remains open and hoping the returns are accepted as filed.
Streamlined
Streamlined went into effect on Sept. 1, 2012. The eligibility requirements included that the taxpayer: (1) resides outside the United States, (2) has never filed returns, and (3) presents a low compliance risk. To achieve tax compliance, such a taxpayer had to file three years of delinquent tax returns, including information returns, eight years of FBARs, pay all tax due with interest and complete a two-page questionnaire explaining why he presented a low compliance risk. An annual tax liability of $1,500 or less for each of the three years was considered indicative of low compliance risk; however, according to the IRS, the $1,500 was more of a marker and not a strict limit beyond which Streamlined wasn’t available. No penalties were issued under Streamlined, so long as the IRS accepted the filings, but unlike OVDP, there was no assurance that the IRS wouldn’t recommend criminal prosecution.
Program Changes for 2014
Because the reduced penalties under the 2012 OVDP applied to specific situations, and eligibility under Streamlined was predicated on residing outside the United States, among other factors, many U.S. taxpayers were deterred from coming forward. At the same time, the IRS was working closely with the U.S. Department of Justice to investigate foreign financial institutions that assisted U.S. taxpayers in avoiding their tax filing and payment obligations. To address these and other issues, the IRS expanded the availability of Streamlined, albeit while introducing a small 5 percent penalty for U.S. resident taxpayers. On the other hand, to penalize willfully evasive taxpayers who haven’t until now sought entry into OVDP, the IRS has increased the OVDP penalty to 50 percent in certain situations.
Streamlined changes. There are now two versions of Streamlined: one for U.S. resident taxpayers (Streamlined Domestic Offshore Procedures (SDOP)) and a second for U.S. taxpayers not residing in the United States. (Streamlined Foreign Offshore Procedures (SFOP)). Taxpayers availing themselves of either Streamlined procedure must still file or amend three years of tax returns, pay all tax and interest due and file or amend six years of FBARs. Neither SDOP nor SFOP is available to taxpayers already under an ongoing civil examination; however, taxpayers who have previously filed so-called “quiet disclosures” may still apply, although previous penalty assessments will not be abated. Also, the SDOP isn’t available to U.S. resident taxpayers who failed to file returns altogether; it’s available only to those amending returns that didn’t include income from foreign accounts or assets. Under the SDOP, these U.S. resident taxpayers have to pay a miscellaneous offshore penalty equaling 5 percent of the highest aggregate value of certain previously undisclosed foreign accounts and assets in any of the prior six years. This 5 percent penalty is applied on “foreign financial accounts” and “specified foreign financial assets”—which should have been reported on the FBAR and Form 8938, respectively. The IRS has clarified that only foreign financial assets in which the taxpayer had a financial interest are included in the 5 percent penalty base, as opposed to assets where the taxpayer had signature authority, but no financial interest. In contrast, the OVDP penalty base applies to a broader category of foreign assets, including financial accounts, tangible assets, such as real estate or art, and intangible assets, such as patents or stock or other interests in a U.S. or foreign business (that is, essentially, anything giving rise to unreported income or acquired with unreported proceeds).
Under the SFOP, there’s no penalty for U.S. non-resident taxpayers, and such taxpayers may file delinquent or amended returns. A “U.S. non-resident” for Streamlined purposes is either: (1) a U.S. citizen or green card holder who, in any of the prior three calendar years, has both lacked a U.S. “abode” within the meaning of Section 911 and been outside the United States for
330 or more days, or (2) a non-U.S. citizen or green card holder who, in any of the prior three calendar years, failed the substantial presence test of Internal Revenue Code Section 7701(b)(3). All others are U.S. residents and must apply under the SDOP.
Under the prior and new version of Streamlined, a taxpayer needs a Social Security number (SSN) or individual taxpayer identification number (ITIN) to apply. Many U.S. non-residents don’t have either an SSN or ITIN, and those who are citizens are ineligible to apply for an ITIN. They will now need to apply for an SSN at their local U.S. embassy or the Social Security Administration. The IRS acknowledges that it may take weeks—if not months—to obtain an SSN, which inevitably delays the Streamlined submission and could cause the taxpayer to become disqualified if he’s selected for audit or investigation.
Additional changes include:
• Elimination of the Streamlined questionnaire. The questionnaire inquired about matters such as assets outside of the taxpayer’s home country, tax
compliance in the taxpayer’s home country, U.S.-source income and the amount of unpaid U.S. income tax liability.
• Elimination of the $1,500 tax “threshold.”
• The taxpayer must now execute a “Certification” that: (1) breaks down the taxpayer’s yearly tax liability; (2) for U.S. resident taxpayers only, breaks down the yearly value of the taxpayer’s previously unreported assets for calculation of the 5 percent penalty; and (3) requests a narrative explaining why the prior failure to file and pay tax was “non-willful.” According to the IRS’ Streamlined website, “Non-willful conduct is 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.” Although originally a standardized model document available on the IRS’ website, the Certification now must be completed on IRS Form 14654 for SDOP and Form 14653 for SFOP. This replacement of the standardized document with an IRS form has created unnecessary problems, particularly an inability to provide notes, which must now be included on a separate statement.
• Because a taxpayer must now elect between OVDP and Streamlined, he must be certain that his failure to file was non-willful if he goes the Streamlined route. The IRS has refused to give concrete guidance on what constitutes non-willfulness, acknowledging that each case will turn on its individual facts and circumstances.
OVPD changes. For OVDP submissions made on or after July 1, 2014, there are many important changes:
• A pre-clearance request (confirming that the taxpayer isn’t already under investigation) must now include, in addition to the taxpayer’s identifying information, the identities of all foreign financial institutions or entities at or through which undisclosed assets were held.
• The Offshore Voluntary Disclosure Letter (now IRS Form 144557) and Attachment (now Form 14454)—still serving as the official OVDP application request and due 45 days after the IRS grants preclearance—now require a greater level of narrative detail.
• The offshore miscellaneous penalty is now due with the taxpayer’s other tax, accuracy-related penalty and interest payments and the returns and other documents reporting the same (90 days after the IRS accepts the Letter and Attachment), instead of being due with the closing agreement.
• The OVDP penalty is increased to 50 percent if both: (1) a taxpayer hasn’t requested preclearance by Aug. 4, 2014, and (2) there’s been a public announcement that any of the financial institutions holding the taxpayer’s foreign assets is under investigation or cooperating with the IRS. The IRS maintains a list of foreign financial institutions for whom an investigation or cooperation is public on its website.
• Previously, taxpayers were required to submit account documents only for large undisclosed accounts; now all account documents must be submitted but can be submitted electronically.
• The “Foreign Account and Asset Statement” and the “Penalty Computation Worksheet,” which used to be standardized but editable documents, are now IRS forms (Form 14452 and 14453, respectively). Especially with respect to the Penalty Computation Worksheet, this replacement of the standardized document with Form 14453 creates major and unnecessary problems in terms of showing accurate information. For example, there’s no way on this document to avoid double counting funds that were transferred from one account to another in the course of a year.
• FAQs #17 and #18, which granted automatic penalty relief for otherwise fully compliant taxpayers, have been eliminated and replaced by a separate procedure titled “Delinquent International Information Return Submission Procedures.” This change essentially provides the same procedure as before for a taxpayer to file delinquent FBARs and information returns without being subject to a penalty, provided that the taxpayer can establish reasonable cause. The IRS has said that taxpayers who aren’t otherwise fully compliant may still use this procedure, but they could still be subject to penalties for failure to establish reasonable cause. For delinquent information returns, the taxpayer is now required to provide an additional certification that the entity for which the information is being reported hasn’t engaged in tax evasion.
• Reduced penalties under FAQs #52 and #53 have been eliminated due to the expansion of Streamlined to a broader category of taxpayers.
OVDP “transitional treatment.” Because non-willfully evasive U.S. resident taxpayers had, prior to June 18, 2014, only OVDP to regularize their delinquencies, and because after July 1, 2014, those taxpayers would, presumably, opt for Streamlined, the IRS has decreased the penalty due under OVDP for any such taxpayers already participating in it. Subject to the IRS’ review and acceptance of a Streamlined Certification attesting to the taxpayer’s non-willful conduct, the taxpayer’s OVDP penalty will be reduced from 27.5 percent to 5 percent of the highest aggregate value of all previously unreported foreign financial accounts, Form 8938 “specified foreign financial assets” and/or assets for which income wasn’t previously reported.
There are some important notes, however, of which taxpayers and practitioners should be aware:
• To be eligible, a taxpayer must have already filed his Offshore Voluntary Disclosure Letter and Attachments by July 1, 2014. Merely requesting preclearance before that date is insufficient. The taxpayer also must not have closed his OVDP matter already by executing a Form 906.
• The taxpayer’s conduct must be non-willful pursuant to the definition of that term within Streamlined and with all the uncertainties surrounding that term as described above.
• Critically, even if a taxpayer is granted transitional treatment, this only reduces the OVDP penalty from 27.5 percent to 5 percent. It doesn’t change anything else about the OVDP requirements. The OVDP penalty still applies to eight years; the taxpayer must still pay eight years of tax, accuracy-related penalties and interest; and the taxpayer must still complete all of the remaining documentary requirements under OVDP. “Transitional treatment” doesn’t provide a transition to Streamlined; it provides only a reduced penalty.
End to Bank Secrecy Abuse?
By combining its efforts under OVDP and Streamlined with the recent effectiveness of FATCA and similar efforts to peel back layers of bank secrecy—such as the Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks5—the IRS, indeed, now might have the ability to, in the words of Deputy Attorney General James M. Cole and then-Assistant Attorney General of the Department of Justice’s Tax Division, Kathryn Keneally, “end the ability of U.S. taxpayers to use bank secrecy laws to hide their tax evasion and other crimes and to bring tax dollars back into the Treasury from around the globe.”6 With these changes to OVDP and Streamlined—making the programs more accessible and cheaper for taxpayers whose prior mistakes were “non-willful,” while nearly doubling the penalties on willfully delinquent taxpayers who should by now be aware that the banks holding their assets assisted in U.S. tax evasion—it’s even more incumbent on taxpayers to become compliant with their U.S. filings before these programs change again or are repealed altogether.
Endnotes
1. www.irs.gov/Individuals/
2. See Dina Kapur Sanna, “The HIRE Act,” Trusts & Estates (March 2012) at p. 42.
3. See Rachel J. Harris and Dina Kapur Sanna, “FATCA and Non-U.S. Trusts: An Overview,” Trusts & Estates (May 2013) at p. 26.
4. www.irs.gov/uac/Newsroom/IRS-
5. Under the Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks (the Program), Swiss banks that have reason to believe they’ve committed violations of U.S. tax laws and wish to cooperate and receive a non-prosecution agreement under the Program, known as Category 2 banks, must have submitted a letter of intent by Dec. 31, 2013 and met several requirements, which include agreeing to pay penalties based on the amount held in undeclared U.S. accounts. To mitigate their own penalties, Category 2 banks are asking their U.S. clients to confirm the accounts have been disclosed on U.S. tax and information returns.
6. James M. Cole and Kathryn Keneally, Joint Statement Before the Permanent Subcommittee on Investigations, Feb. 26, 2014.
