Internal Revenue Service reminds U.S. taxpayers with undisclosed offshore accounts that they should use existing paths to come into full compliance with their federal tax obligations.
Taxpayers that have undisclosed foreign financial accounts and assets, including those held through undisclosed foreign entities should consider using one of the IRS’ Offshore Voluntary Disclosure Programs to come into compliance. Each program offers advantages and disadvantages.
The ongoing efforts of the IRS and the Department of Justice to ensure compliance by those with U.S. tax obligations have raised awareness of U.S. tax and information reporting obligations with respect to non-U.S. investments. Because the circumstances of taxpayers with non-U.S. investments vary widely, the IRS offers the following options for addressing previous failures to comply with U.S. tax and foreign information return obligations with respect to those investments:
Present IRS Programs
- Offshore Voluntary Disclosure Program;
- Streamlined Filing Compliance Procedures;
- Delinquent FBAR Submission Procedures; and
- Delinquent International Information Return Submission Procedures.
Each of these options is explained below. The IRS encourages taxpayers to consult with professional tax or legal advisors in determining which option is the most appropriate for them.
Offshore Voluntary Disclosure Program
The Offshore Voluntary Disclosure Program (OVDP) is a voluntary disclosure program specifically designed for taxpayers with exposure to potential criminal liability and/or substantial civil penalties due to a willful failure to report foreign financial assets and pay all tax due in respect of those assets. OVDP is designed to provide to taxpayers with such exposure (1) protection from criminal liability and (2) terms for resolving their civil tax and penalty obligations.
The OVDP requires the taxpayer to pay all back taxes, interest and penalties for all the years in the disclosure period. In addition, the IRS also imposes an OVDP penalty that is generally 27.5% of the highest aggregate value of unreported OVDP assets for the years at issue (50% if it is public information that the foreign financial institution with the taxpayer’s assets is under investigation or is cooperating with the IRS or Department of Justice.)
The OVDP program is not available to taxpayers if the IRS has already initiated a civil examination or criminal investigation of the taxpayer.
Streamlined Filing Compliance Procedures
The streamlined filing compliance procedures described below are available to taxpayers certifying that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. The streamlined procedures are designed to provide to taxpayers in such situations with
- a streamlined procedure for filing amended or delinquent returns, and
- terms for resolving their tax and penalty procedure for filing amended or delinquent returns, and
- terms for resolving their tax and penalty obligations.
The streamlined filing compliance procedures are designed only for individual taxpayers, including estates of individual taxpayers. The streamlined procedures are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States.
The streamlined program requires the taxpayer to pay all back taxes, interest and penalties for all the years in the disclosure period. In addition, for taxpayers residing in the U.S., the IRS also imposes an offshore penalty that is generally 5% of the highest aggregate value of unreported OVDP assets for the years at issue.
Returns submitted under the Streamlined Filing Compliance Procedures will not be subject to IRS audit automatically, but they may be selected for audit under the existing audit selection processes applicable to any U. S. tax return. Unlike the OVDP, the Streamlined procedures do not provide a taxpayer with any civil or criminal protections. Therefore a taxpayer should feel comfortable with their ability to demonstrate that their failure to report income and file their foreign information returns was non-willful.
Taxpayers who do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:
- have not filed a required Report of Foreign Bank and Financial Accounts (FBAR) (FinCEN Form 114, previously Form TD F 90-22.1),
- are not under a civil examination or a criminal investigation by the IRS, and
- have not already been contacted by the IRS about the delinquent FBARs
should file the delinquent FBARs according to the FBAR instructions.
The IRS will not impose a penalty for the failure to file the delinquent FBARs if the taxpayer properly reported on his or her U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and they have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.
FBARs will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.
Delinquent International Information Return Submission Procedures
Taxpayers who do not need to use the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax, but who:
- have not filed one or more required foreign information returns,
- have reasonable cause for not timely filing the information returns,
- are not under a civil examination or a criminal investigation by the IRS, and
- have not already been contacted by the IRS about the delinquent information returns
should file the delinquent information returns with a statement of all facts establishing reasonable cause for the failure to file.
As part of the reasonable cause statement, taxpayers must also certify that any entity for which the information returns are being filed was not engaged in tax evasion. The submission must be signed under penalties of perjury.
Information returns filed with amended returns will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.
An alternative to any of the disclosure programs discussed above is a quiet disclosure. In a quiet disclosure, the taxpayer merely files their return or amended return, includes any required foreign information returns and pay any tax and associated interest due. There is no quiet disclosure that the IRS has sanctioned or approved. From the outset, the IRS's position on quiet disclosures has been that taxpayers who choose not to disclose through one of the options discussed above risk severe civil penalties and potential criminal prosecution.
Doing nothing is also a poor choice, as besides being exposed to the civil and criminal penalties discussed above, the normal three-year Statute of Limitations doesn’t run on filed tax returns with missing or incomplete foreign information reporting. This means the assessment period can be held open indefinitely, and will not start to run until the foreign information reporting is cured.
Given that the standard foreign information return penalty is $10,000 for each late-filed or unfiled foreign information return, taxpayers are advised to focus on any foreign accounts or assets they might have and make sure they are properly disclosed in their tax returns. Since the IRS maintains no threshold of unreported income is immaterial, the penalties can be harsh, especially in the case of taxpayers that failed to report de minimus amounts of foreign income and/or disclose foreign investments, however small or inactive, in their tax returns.
For the reasons discussed above, taxpayers are advised to discuss their specific tax situation with their tax advisor to make sure there will not be noncompliance, even inadvertent noncompliance with the tax law. There is no “one size fits all” solution to a taxpayer caught up with undeclared foreign assets or unfiled foreign information returns. In addition, some states, such as New York and New Jersey, also provide eligible taxpayers with a Voluntary Disclosure Program for their state filing tax obligations.
Concannon Miller Senior Manager E. Patrick Rush specializes in international taxes. Contact him with questions on this or other international tax laws at firstname.lastname@example.org or 610-433-5501.