Offshore Voluntary Disclosure Initiative (OVDI): Is The IRS Playing Fair?

This is an updated post.  The IRS has offered taxpayers with undisclosed foreign financial accounts the opportunity to “come clean” under its Offshore Voluntary Disclosure Initiative (OVDI) since 2009. According to the Internal Revenue Service, more than 38,000 United States taxpayers have entered the program. They have paid more than $5.5 billion to resolve issues, with an estimated $5 billion yet to come.

What is OVDI? It is a program of limited duration that offers significant benefits to taxpayers who may have engaged in conduct that could be viewed as criminal. Benefits include immunity from criminal prosecution and avoidance of the full brunt of civil penalties that otherwise could far exceed amounts concealed in offshore accounts. The OVDI program can end at any time. But considering its recent success, many practitioners expect it to continue well into the foreseeable future.

What are the eligibility requirements for OVDI? Officially, anyone can participate in the OVDI program unless they are under audit or criminal investigation, have received notice from the IRS regarding unreported foreign accounts or the IRS has already received their name from a cooperating bank. The first two exceptions are easy to understand: if you get a notice in the mail or a knock on the door from the IRS, then it’s too late to come into the program.

However, no one knows how or when the IRS will receive information from a cooperating bank. In some instances, the information could literally sit for months on the desk of an overworked IRS employee until contact is made. That is exactly the scenario that just recently played out.

An undisclosed number of taxpayers who were already accepted into the program received letters from the IRS informing them that they were no longer eligible. Their participation was terminated. What’s even more frightening is that some had been in the program for as long as six months before receiving the fateful letters.

While receiving a rejection letter isn’t the end of the world, it can be highly unnerving. For the poor, unfortunate soles that were recently rejected from the program, they are now subject to audit, possible criminal prosecution and draconian penalties.

Is the IRS playing fair? Of course not. However, they are playing within the rules — rules that they made. The message being sent by the IRS is crystal clear: the longer you wait, the higher the risks.

For those who have just recently become acquainted with OVDI, it is good to have some background information about the program. Before viewing OVDI as a panacea or a solve-all, it is important to know that there is a heavy price to pay in order to get the peace of mind that comes from a clear assurance that the government will not come after you with its guns blazing. An OVDI disclosure is made by doing the following:

(1) Filing both the original returns and amended returns for the prior eight years that report all income and disclose the foreign accounts;

(2) Filing all missing FBAR reports;

(3) Cooperating fully in the OVDI process;

(4) Signing agreements to extend the statutes of limitation; and

(5) Paying penalties.

Penalties can be quite substantial. For starters, there is a one-time FBAR penalty. The FBAR penalty is based on the highest aggregate balance in a taxpayer’s offshore account over the eight-year period. Typically, the penalty assessed is 27.5% of that amount, although a limited number of taxpayers may qualify for a 12.5% or 5% penalty rate.

While the FBAR penalty, alone, may appear to be punitive, it is not the only penalty. Taxpayers must also pay a 20% accuracy-related penalty based on the total underpayment for all eight years and failure-to-pay or failure-to-file penalties, if applicable.

Once the filing package is submitted to the IRS, the waiting game begins. The IRS will notify the taxpayer or his representative if additional information is required. If not, then the IRS will issue its proposal and request that the taxpayer agree.

The taxpayer has two options. The first is to agree with the IRS’s conclusions and pay the amount due. And the second is not to agree. If the taxpayer agrees, that will end the case once and for all with no further civil or criminal penalties being assessed on the foreign account. The one caveat to that is if the taxpayer fails to disclose all relevant information.

What if the taxpayer does not agree with the IRS’s conclusions? The taxpayer always has the option of “opting out” of the program. An opt out means that the taxpayer rejects the IRS penalty proposal. What are the consequences of opting out? The most significant consequence of an opt out is a withdrawal from the IRS of any assurances that it will forego prosecution. Another consequence of an opt out is that it is irrevocable, meaning that if the taxpayer wakes up the following morning and has buyer’s remorse, it’s too late.

The procedure following an opt out is relatively simple, but nothing short of nerve-racking. The IRS sends the taxpayer a letter requesting that he or she submit a proposed penalty, a counter-offer if you will, to the IRS’s penalty. If the IRS agrees to the proposal, the matter will be settled. If not, then it might as well be Armageddon for the taxpayer. In that case, the IRS will conduct a full audit of the taxpayer’s returns for the eight-year look back period.

Most troubling is what could happen in the event that the IRS discovers information during the audit that is inconsistent with prior OVDI submissions made by the taxpayer. First, criminal proceedings could be initiated. And second, civil FBAR penalties far in excess of OVDI penalties could be assessed.

To say that the OVDI has its share of critics would be an understatement. Indeed, many innocent taxpayers are being targeted and forced to pay large penalties for minor infractions in order to resolve their potential tax liability.

However, for taxpayers who have undisclosed foreign financial accounts, the OVDI program might be just what the doctor ordered. One need look no further than the criminal penalties to see why. Criminal penalties associated with failure to report a foreign financial account are a maximum fine of $250,000 and up to five years in prison.

Moreover, if the failure to file an FBAR is part of a pattern of illegal activity, the penalties double to a maximum $ 500,000 fine and up to ten years in prison. 31 U.S.C. § 5322. The penalty for a non-willful civil violation is up to a $10,000 fine. However, if the violation is deemed willful, then the penalty is the greater of $100,000 or 50% of the account balance at the time of the violation. 31 U.S.C. § 5321(a)(i).

Recent statistics show that this is no laughing matter. Since 2009, when UBS paid $780 million and turned over the names of more than four thousand account holders to avoid criminal charges, more than 120 U.S. taxpayers and advisers have been criminally charged in connection with offshore accounts, many of which were based in Switzerland.

Last August, a Zurich attorney pleaded guilty to helping clients evade U.S. taxes using Swiss bank accounts. And last October, Italian authorities arrested Raoul Weil, the former No. 3 official at UBS, based on an Interpol notice requested by U.S. authorities. Me. Weil was indicted in 2008 in connection with encouraging U.S. tax evasion.

While OVDI might make sense for many taxpayers who have undisclosed foreign bank accounts, it is not right for everyone. What class of taxpayers might it not be right for? Those with defenses or explanations. Why? Because OVDI is a one-size-fits-all “package” deal. Once the taxpayer enters the program, these tax, interest, and penalty assessments are automatically imposed. In other words, OVDI does not include the expectation of a full audit to determine a taxpayer’s correct tax liability and appropriate penalties. Very simply, a taxpayer is barred from offering mitigating evidence in support of a defense.

That can be particularly harsh, especially when the taxpayer has evidence that the prior failures to report were not willful but caused by inadvertence, negligence, or mistake. Indeed, the penalties assessed to a taxpayer who can show that the failure to disclose an offshore account was due to mere negligence or ignorance might actually be less than those in amnesty. Similarly, evidence such as reasonable cause and good-faith reliance on the advice of others will not be considered. Therefore, to the extent that the taxpayer has mitigating evidence, voluntary disclosure under OVDI is problematic.

Not surprisingly, many taxpayers are indecisive and apprehensive about making a voluntary disclosure. Some are willing to “take their chances” and avoid entering the OVDI. Before going down that road, it is important to understand the IRS’s enforcement initiatives.

The government has launched investigations of foreign banks believed to have helped U.S. taxpayers hide money abroad. In most cases, these banks are located in countries that have tax treaties with the United States. Notwithstanding the reputation that these countries have for solid bank secrecy laws, many banks in these countries have agreed to disclose account-holder information and to pay penalties based on the amount of assets they helped hide.

What would motivate a foreign bank to disclose such information? A guarantee of immunity from prosecution by the United States government. While it might be surprising to learn that these banks have turned a cold shoulder to the very same bank secrecy laws that have become enshrined in the culture of the countries in which they operate, there is something even more surprising. And that is that these banks have gone one step further and have begun prodding their account holders to disclose. Why? Because they could avoid owing penalties on undeclared assets if their account holders disclose.

The U.S. government has not stopped its investigation-gathering there. It also has at its disposal a major enforcement tool: the recently enacted Foreign Account Tax Compliance Act (FATCA). Signed into law in 2010, the FATCA allows for the exchange of information regarding foreign accounts between the U.S. and other countries. As of this writing, the U.S. has agreements with France, Spain, Germany, Italy, the United Kingdom, and Switzerland.

The foregoing government enforcement initiatives make it much more likely that the IRS will become aware of undeclared foreign accounts of U.S. taxpayers. And once they become aware, the OVDI is no longer an available option.

The takeaway is this: a taxpayer should give careful consideration before entering the OVDI. Most important, a determination should be made whether the underlying circumstances reflect past criminal behavior. Is there evidence that the taxpayer was aware of the duty to report the offshore accounts? Is there a pattern of misconduct extending over several years? Is there a significant unreported tax liability? Are there mitigating circumstances, including mistaken or negligent reliance on others? Because the IRS may view the circumstances as a criminal matter, this analysis should be made by an attorney, so that it remains privileged.

To the extent that you have an undisclosed foreign bank account and find the OVDI program to be a “good fit,” then you should get off the fence and do something now. Before it’s too late. Indeed, you don’t want to find yourself in the same position as the poor, unfortunate taxpayers who became the latest victims of the bureaucratic inefficiencies inherent within the IRS: initially accepted into the program only to find themselves later rejected. If history is any indication, further procrastination will only lead to disappointment.

In accordance with Circular 230 Disclosure

As a former public defender, Michael has defended the poor, the forgotten, and the damned against a gov. that has seemingly unlimited resources to investigate and prosecute crimes. He has spent the last six years cutting his teeth on some of the most serious felony cases, obtaining favorable results for his clients. He knows what it’s like to go toe to toe with the government. In an adversarial environment that is akin to trench warfare, Michael has developed a reputation as a fearless litigator.

Michael graduated from the Thomas M. Cooley Law School. He then earned his LLM in International Tax. Michael’s unique background in tax law puts him into an elite category of criminal defense attorneys who specialize in criminal tax defense. His extensive trial experience and solid grounding in all major areas of taxation make him uniquely qualified to handle any white-collar case.


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