Amid heavy pressure from tax professionals and taxpayers alike, the IRS has finally made changes to the Offshore Voluntary Disclosure Program (OVDP). The pressure to change the program came from the clear impression by many that the former programs were too severe for taxpayers who were not attempting to evade taxes or hide assets offshore. Therefore, the unintended consequences were that non-willful offenders were sometimes left with the choice of entering the program and paying a very high penalty, or risking the unknown by making a quiet disclosure. While the new program offers additional disclosure options for the non-willful offender, the IRS has increased the penalties on taxpayers they catch before the taxpayer makes a voluntary disclosure and broadened the definition of what this means. Further complicating the matter are new procedures for making a disclosure as well as transitional rules for participants already involved in the program.
The Good News:
Taxpayers whose failure to file a foreign financial report was non-willful, and who meet certain other requirements, have a new streamlined process to make a disclosure. For people qualifying under this new streamlined procedure the penalty will only be 5% of the highest aggregate balance of offshore accounts for taxpayers falling under the resident category, and the penalty will be waived in its entirety for participants falling under the non-resident category. This is in heavy contrast to the prior OVDP standard penalty of 27.5%. The previous OVDP did allow for reduced penalty amounts of 5% – 12.5% but these options came with heavy restrictions and requirements that ruled out many taxpayers. The streamlined process also does not include the other penalties included in the OVDP such as the accuracy related penalty, and for non-resident filers also the failure to file penalty and failure to pay penalty. Other than the residency requirement and applicable penalty of 5%, the other major difference between the resident and non-resident procedures is that residents must have filed tax returns for the three previous years. Furthermore, in addition to the lesser penalty, the reporting required under the streamlined process, including returns, forms and documents, is much less onerous than the standard OVDP. Before entering the new streamlined process taxpayers should have a tax professional analyze their specific facts and circumstances to determine if they qualify for this process.
The Bad News:
For taxpayers that were already planning to make a standard disclosure under the previous terms of the OVDP, the changes are less drastic. The major items to note are that the pre-clearance submission now requires additional information and the penalty payment and bank statements relating to the disclosure are due at the time of filing regardless of the size of the accounts. The big hammer comes in the form of an increased penalty on the aggregate account balances to 50% if the taxpayer enters the program after “either a foreign financial institution at which the taxpayer has or had an account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement has been publicly identified as being under investigation or as cooperating with a government investigation.” The program goes into some detail about what this means but of most concern is the inclusion of banks that are cooperating with the IRS to give information about U.S. account holders. As FATCA compliance becomes more widespread, many taxpayers are getting letters from foreign financial institutions stating that they are in the process of or preparing to submit the taxpayer’s information to the IRS. It is not completely clear if this means the threshold has been hit to push a taxpayer’s penalty into the 50% threshold; however, if the taxpayer has decided to make a disclosure the best option is to enter the program immediately to give the best chance of being considered under the original penalty structure of 27.5%. The IRS does not want taxpayers waiting until they are forced into the program, they are asking for voluntary disclosure now.
Quiet disclosure is an option some taxpayers had previously made when faced with the options before these recent changes. A typical quiet disclosure is where a taxpayer files all late forms and amended returns outside of the OVDP and hope they are processed without further inquiry. The IRS has previously stated that they do not want taxpayers to make quiet disclosures and with the new streamlined process for taxpayers that unintentionally violated IRS filing requirements; we expect the IRS will not view any quiet disclosures favorably and will likely assess all potential penalties against those that are caught attempting quiet disclosure. Furthermore, with the electronic filing of the foreign financial account statements (previous FBAR) it will also be easier for the IRS to identify those attempting quiet disclosure.
Additionally, the IRS has given further insight into their position on quiet disclosure by stating in the most recent FAQ to the updated OVDP that they encourage anyone who has made a quiet disclosure to enter the new streamlined process. As you can imagine, in order for this recommendation to carry any weight, the IRS will have to be vigilant in assessing penalties against quiet disclosures. Could this be the end of quiet disclosure? Possibly.
The new OVDP also may be the end of opting out for many taxpayers. Under the prior OVDP, at the end of the process the taxpayer had the option to opt out of the program if they felt the penalty was not appropriate for the facts and circumstances of their case. In most cases, this only made sense if the taxpayer was a non-willful violator. Now, a non-willful violator should use the streamlined approach to pay the lesser penalty or no penalty if they qualify as a non-resident and therefore will essentially eliminate the benefit of opting out of the OVDP for most taxpayers. Of course for those taxpayers that are non-willful, but ineligible for the streamlined process (e.g. a resident who has not filed their last 3 years of tax returns) they may still choose to enter the OVDP and consider opting out.
Any taxpayer with unreported foreign financial accounts or earnings needs to have a comprehensive analysis done of the new procedures and processes versus their particular facts. This is true whether the taxpayer is considering making a disclosure or in the middle of one already. For taxpayers who have not yet made a disclosure, delaying the process could result in severe consequences if the matter is not addressed soon. The IRS appears to be making it clear that they are working towards a fair and reasonable resolution for the people that voluntarily come forward and will be relentless in pursuing those who choose not to disclose.
If you have any questions about your foreign accounts, assets, or earnings, contact us at Hone Maxwell LLP today for a full analysis of your case. At Hone Maxwell LLP we have experience to guide you through the web of disclosure options, potential penalties, and filing requirements. Whether you choose us or another representative, make sure you choose someone with experience, technical skills, knowledge of the various programs and the customer service you need to make your experience as comfortable, efficient and effective as possible.