On June 18, 2014, the IRS announced major changes in its offshore voluntary compliance programs. The changes include an expansion of the streamlined filing compliance procedures and key modifications to the 2012 Offshore Voluntary Disclosure Program (OVDP).

The expanded streamlined procedures are available to a wider population of U.S. taxpayers living outside the country and, for the first time, to certain U.S. taxpayers residing in the United States. The modifications to the existing OVDP program provide, in part, for an increased offshore penalty from 27.5% to 50% in certain circumstances.

Options for U.S. Taxpayers with Undisclosed Foreign Accounts

The IRS now offers taxpayers with undisclosed foreign financial assets the following options:

1. Offshore Voluntary Disclosure Program;
2. Streamlined Filing Compliance Procedures;
3. Delinquent FBAR and international information return submission procedures (otherwise known as a “qualified amended return”).

Necessity of Evaluating a Client’s Options Before Making a Recommendation

Due to the expanded availability of the streamlined procedures to a wider population of U.S. taxpayers, many tax practitioners are overlooking the delinquent FBAR submission procedures completely. But that is a mistake, especially in circumstances when the taxpayer’s failure to disclose foreign financial assets was nothing more than an oversight.

Given the costs and benefits associated with each option, practitioners have a duty to evaluate the viability of the delinquent FBAR submission procedures for any taxpayers whose failure to report their foreign financial assets was not willful. This blog discusses the benefits and potential risks associated with the streamlined program and the delinquent FBAR submission procedures.

Below is an overview of each option.

Offshore Voluntary Disclosure Program (OVDP)

The OVDP is specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report financial assets and pay all tax due in respect of those assets. The OVDP provides immunity from criminal prosecution and fixed terms for resolving civil tax and penalty obligations.

Streamlined Filing Compliance Procedures

The Streamlined Filing Compliance Procedures are available to taxpayers whose failure to report foreign financial assets was not the result of willful conduct. They are designed for individual taxpayers, including estates of individual taxpayers. The streamlined procedures are available to both U.S. taxpayers residing outside of the United States and U.S. taxpayers residing in the United States.

The streamlined procedures for taxpayers residing outside of the United States are called the Streamlined Foreign Offshore Procedures. The streamlined procedures for taxpayers residing in the United States are called the Streamlined Domestic Offshore Procedures.

Regardless of which streamlined program the taxpayer chooses, taxpayers must file three years of U.S. income tax returns together with all required international informational returns and six years of FBARs. In addition, taxpayers must certify that their failure to file FBARs or report foreign-source income was not the result of willful conduct. Non-willful conduct is defined 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.”

Penalties differ depending on which program the taxpayer elects. Within the Streamlined Foreign Offshore Procedures, there is no miscellaneous offshore penalty. However, within the Streamlined Domestic Offshore Procedures, there is a miscellaneous offshore penalty. And that penalty is equal to 5 percent of the highest aggregate value of the taxpayer’s foreign financial assets during the years in the covered tax return period and the covered FBAR period. This miscellaneous offshore penalty is in lieu of accuracy-related penalties, information return penalties, and FBAR penalties.

Tax returns submitted under either streamlined program will be processed like any other return. Returns submitted will not be subject to IRS audit automatically, but may be subject to IRS examination and even criminal investigation, if appropriate. To the extent that the IRS determines that the original returns were fraudulent or that the failure to file FBARs was willful, participants may be liable for additional penalties or be subject to criminal sanctions.

For this reason, taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns was due to willful conduct and who seek assurances that they will not be criminally prosecuted or assessed substantial civil penalties should consider participating in the OVDP. Because willfulness is a question of law, taxpayers are encouraged to consult with a criminal tax attorney before making the decision to participate in the streamlined program.

Once a taxpayer makes a submission under one of the streamlined programs, it is too late to participate in the OVDP. Similarly, taxpayers who submit OVDP voluntary disclosure letters on or after July 1, 2014 are ineligible to participate in the streamlined procedures.

Taxpayers who submit, or have submitted, voluntary disclosure letters under the OVDP prior to July 1, 2014, but who do not yet have a fully executed OVDP closing agreement, may request treatment under the streamlined procedure’s penalty terms. Such taxpayers need not opt out of OVDP, but must certify that the failure to report all income, pay all tax, and submit all required information returns – including FBARs – was not the result of willful conduct. The IRS will consider this request in light of all the facts and circumstances of the taxpayer’s case.

Shortcomings of the Streamlined Program

Despite the seemingly taxpayer-friendly incentives, the streamlined program has several shortcomings. The devil is in the details! First, participants are not guaranteed immunity from criminal prosecution. Second, with respect to the Streamlined Domestic Offshore Procedures, the five-percent penalty is imposed on a broader base of foreign assets – not just those relating to FBAR reporting.

Finally, to the extent that the IRS undertakes an examination of the taxpayer’s returns and finds that the taxpayer was willful, the taxpayer could be subject to any one of the following parade of horribles. First, and most obvious, the taxpayer will be barred from participating in the streamlined program. Second, not only could the IRS refer the matter to the Department of Justice for criminal prosecution on the FBAR front, but it could also recommend prosecution for perjury, on the grounds that the taxpayer submitted a false certification.

Taxpayers thinking that they can outsmart the fox by seeking shelter in the OVDP bunker in the event that a scenario like this one were to occur, are sorely mistaken. Why? Once a taxpayer makes a submission under the streamlined program, he is no longer eligible to apply to the OVDP. Therefore, when the smoke clears, the willful taxpayer who attempts to “sneak” into the streamlined compliance program under the guise that he wasn’t willful may end up paying a steeper price than the price of participating in the Offshore Voluntary Disclosure Program.

Filing Qualified Amended Returns

This program is designed for taxpayers who do not need to use the OVDP or the streamlined filing compliance procedures to come into compliance with their reporting obligations, but who have not filed a required FBAR. The purpose of the QAR procedure is to address civil violations of the Internal Revenue Code in such a way as to protect the taxpayer from accuracy-related penalties.

A QAR is an amended return filed after the due date of the return – or properly extended due date – but before any of the following events:

1. The date the IRS first contacts the taxpayer with news that it will be initiating a civil examination or a criminal investigation;

2. The date the IRS first contacts the taxpayer about his or her delinquent FBARs;

3. The date any person is contacted for a tax shelter promoter examination under Section 6700 with respect to any tax benefit claimed on the return;

4. The date the IRS issues a John Doe summons relating to the tax liability of a person, group, or class that includes the taxpayer;

5. The date the Commissioner announces a settlement initiative to compromise or waive penalties with respect to a listed transaction; and/or

6. The date a pass-through entity is first contacted by the IRS for an examination relating to the entity’s return.

Taxpayers are considered strong candidates for this program if they have properly reported their foreign financial accounts on their U.S. tax returns and paid all tax on the income relating to those accounts, notwithstanding the fact that they neglected to file FBARs. The IRS will not impose a penalty for the failure to file delinquent FBARs. In that case, the taxpayer need only file delinquent FBARs and include a statement explaining why the FBARs were filed late.

The QAR procedure is not just limited to the benign failure of filing an FBAR. That is but one example.

Under the QAR procedure, taxpayers may treat the amount of tax reported as the tax reported on the original return, the practical consequence of which is to eliminate the accuracy-related penalty. However, the taxpayer faces a doomsday scenario if the IRS determines that the failure to disclose had some sinister motive.

For example, to the extent that the failure to disclose was due to fraud, the taxpayer could face criminal prosecution. But even if the taxpayer avoids being ensnared in the coils of the criminal justice system, he faces an arsenal of civil penalties, not the least of which is the civil fraud penalty. As the 800-pound gorilla of civil penalties, the civil fraud penalty is equal to 75% of the underpayment of tax.

While the assertion of penalties might appear daunting, taxpayers do not have to just sit back and watch as the IRS assesses one penalty after another. The good news is that taxpayers who are left staring into the barrel of a gun that is loaded with IRS penalties can fight back by asserting a defense. One such defense is reasonable cause.

When submitting a qualified amended return that discloses previously unreported foreign financial assets, a distinction must be made between a reportable transaction and a listed transaction. Ownership of a foreign bank account is a reportable transaction, not a listed transaction. Why is that important?

The non-prosecution agreements between the Department of Justice and certain foreign financial institutions that facilitated U.S. taxpayer efforts to hide foreign assets do not involve listed transactions. In other words, they were not made pursuant to Section 6700. As a result, taxpayers who elect the QAR procedure stand a good chance of coming into compliance so long as they submit their amended returns prior to the occurrence of one of the events listed above. Failure to do so will result in the taxpayer being deemed ineligible to participate in the QAR procedure.

Shortcomings of QAR Procedure

In the same way that the streamlined program does not guarantee immunity from prosecution, neither does filing qualified amended returns. Although a taxpayer who files a qualified amended return is not liable for accuracy-related penalties, he may be nonetheless be liable for FBAR and other filing-related penalties if he cannot show that the failure to file was due to reasonable cause. However, most non-willful taxpayers will be able to overcome this obstacle without any difficulty.

What is the penalty amount? Assuming that the taxpayer can show that the failure to file FBARs was not negligent, the penalty for failure to file will not exceed $ 500. On the other hand, to the extent that the taxpayer is deemed to be non-willful, or willful, the penalties are much greater. In that case, the costs of making a qualified amended return are significantly greater than other compliance-driven initiatives, such as the streamlined program.

How do I check my eligibility for the compliance-driven initiatives and/or the offshore voluntary disclosure program?

Right about now, you might be wondering if there is anything that you can do to check your eligibility for the streamlined program and/or the offshore voluntary disclosure program. As a matter of fact, there is. Taxpayers can order account transcripts from the IRS. Taxpayers who elect the offshore voluntary disclosure program can submit a pre-clearance letter to the IRS, Criminal Investigation.

Conclusion

Allowing taxpayers to self-correct furthers the IRS’s mission of encouraging voluntary compliance and self-policing. If you remember nothing else from this blog, remember this: one size does not fit all. Practitioners and taxpayers alike should carefully weigh their options before deciding to enter one of the IRS’s compliance-driven initiatives or the offshore voluntary disclosure program.

Original Post By:  Michael DeBlis