IRS OFFSHORE VOLUNTARY DISCLOSURE PROGRAM (OVDP) HAS NEW STING FOR SOME BANKS’ CUSTOMERS
By: PETER REISS, ESQ
The IRS has given taxpayers who innocently or flagrantly ignore US reporting and filing requirements in two basic filing areas – on Forms 1040 and FBARs (Foreign Bank Account Reports) – three chances to come into full compliance with Offshore Account Reporting requirements. The current 2014 OVDP is a continuation of a program introduced in 2012, and, if used properly, allows taxpayers complete forgiveness of existing criminal exposure for noncompliance.
According to IRS, the objective of the OVDP is to bring into compliance with the U.S. tax laws taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax. Additionally, the information gathered from taxpayers making voluntary disclosures under OVDP will be used to further IRS’s understanding of how foreign accounts and foreign entities are promoted to US taxpayers as ways to avoid tax.
The incentive for taxpayers with undisclosed foreign accounts or entities to make voluntary disclosures is that it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate with a reasonable degree of certainty the total cost of resolving all offshore tax issues. Taxpayers who do not submit voluntary disclosures run the risk of detection by IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution.
It is important to note that if the IRS has initiated a civil examination for any year, regardless of whether it relates to undisclosed OVDP assets, the taxpayer is not eligible to participate in the OVDP. The government’s increased ramping up of the implementation of the Foreign Account Tax Compliance Act (FATCA) regulations has resulted in increased IRS awareness of the players (foreign banks and US taxpayers) and increases the possibility that IRS will become aware of noncompliant taxpayers and initiate proceedings against those taxpayers, and, increasingly, the offshore institutions, which will render the taxpayers ineligible for the program, or, even if eligible, increase the applicable penalty rate from 27.5% to 50%.
Generally, taxpayers who successfully participate in the OVDP pay a “miscellaneous” offshore penalty equal to 27.5% of the highest aggregate value of OVDP assets during the 8-year voluntary disclosure period. Previous iterations of this program provided for penalties of 20% and 25%. This penalty is in lieu of a plethora of penalties that may otherwise apply to the undisclosed foreign assets, accounts and entities, which penalties when aggregated could easily far exceed the value of the undisclosed accounts.
The penalty rate, and, in some cases, actual eligibility for participating in OVDP, is determined by the date on which the taxpayer makes an initial submission via a “Request for Pre-Clearance.” While this initial submission is not a prerequisite for participation in the program, it is, in this writer’s opinion, recommended, because it establishes an earlier date than would be established if all of the (considerable) required disclosures and documents are assembled for submission under the program.
With its increased efforts to implement FATCA, IRS, as part of the 2014 OVDP, is raising the stakes for some taxpayers who have not previously come forward and who have or had accounts with foreign institutions, or through facilitators who helped the taxpayer establish or maintain an offshore arrangement, which institution or facilitator has been publicly identified as being under investigation or as cooperating with a government investigation. 2014 OVPD has established a new 50% offshore penalty for disclosures involving these entities. Under a newly-released list, the 50% penalty (instead of the 27.5% penalty) would apply if, at the time of making the initial submission to IRS to participate in the OVDP, the taxpayer had an account at any of a number of institutions including UBS AG; Credit Suisse AG; Butterfield Bank; HSBC India; CIBC First Caribbean; Bank Leumi (Israel, Luxembourg or US) and others identified on the IRS website. See http://www.irs.gov/Businesses/International-Businesses/Foreign-Financial-Institutions-or-Facilitators.
Notes re new “Streamlined Program” with 5% penalty: The relatively new streamlined program offers some taxpayers a chance to address inadvertent noncompliance through a relatively quick and painless process with a substantially reduced 5% penalty. This streamlined disclosure program (“SDP”) was designed for taxpayers who can certify that their failure to report foreign financial assets and pay all tax due with respect to those assets did not result from willful conduct. Before the 2014 program changes, the SDP was available only to non-US residents and those with small amounts of unpaid taxes due for each year. The 2014 OVDP expanded the availability of the program to US residents and those with more than $1,500 per year (the previous threshold) of unpaid tax per year.
There are risks, though, in applying for consideration under the SDP. IRS has stated that returns submitted under SDP may be subject to IRS examination, additional civil penalties and possible criminal prosecution “if appropriate.” In this writer’s opinion, this eliminates much of the certainty that comes with participation in the traditional OVDP protocol. The most troublesome aspect in this program is the requirement that the taxpayer who wishes to participate in this program must have acted non-willfully in his/her noncompliance and must certify under penalties of perjury that the taxpayer acted non-willfully (without intent to violate the law). The problem is that there is very little official guidance as to what the IRS considers willful, and therefore there is what some might consider an unacceptable element of uncertainty as to how the SDP will be applied. IRS has stated that “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.” There is an excellent article in Forbes magazine illustrating the problems and complexities associated with applying under the SDP. See http://www.forbes.com/sites/irswatch/2014/07/07/irs-ovdp-vs-streamlined-what-to-do/.
Unfortunately, the taxpayer cannot apply for both OVDP and SDP, except in the case of unclosed OVDP cases. The taxpayer must elect at the outset which program to use. A taxpayer who elects SPD and is rejected cannot then enter OVDP. What happens to such a taxpayer is unclear. A taxpayer with an unclosed OVDP case who elects to transition to SPD in order to qualify for the lower penalty rate faces heightened scrutiny and uncertainty, as is pointed out in the Forbes article.
What is clear is that as time passes, the situation will become increasingly difficult for taxpayers who have ignored three chances to come into full compliance with the offshore account reporting requirements. Through its implementation of FATCA and increased entry into intergovernmental agreements, IRS is becoming increasingly aware of foreign account holdings. As this initiative progresses, it becomes increasingly likely that taxpayers voluntarily entering OVDP will be subject to a 50% penalty instead of the 27.5% penalty. And, of course, taxpayers who continue to ignore their obligations, perhaps because their foreign institution is not yet “on the list”, could find themselves in the situation of having to pay cumulative penalties that actually exceed the value of their holdings. IRS is quite clear on its website that “the terms of this program could change at any time. For example, the IRS may 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.”
This article is not legal advice and is provided for informational purposes only. Actual legal advice can only be provided after consultation by an attorney licensed in your jurisdiction.