Federal Offshore Voluntary Disclosure

 

Table Of Contents

Introduction and Legal Disclaimer

Taxpayers that have undisclosed foreign accounts and assets, including accounts and assets held through undisclosed foreign entities, should consider using one of the IRS’ Offshore Voluntary Disclosure Program procedures to come into compliance with their tax reporting and foreign information return reporting requirements.  In addition, some states, such as New York and New Jersey, also provide eligible taxpayers with the option of using a Voluntary Disclosure Program to come into compliance with any corresponding state tax reporting obligations that flow from the federal voluntary disclosure.

For federal purposes, the IRS offers taxpayers with undisclosed foreign financial accounts and assets with several options to come into compliance with their income tax and foreign information return reporting obligations.   These options are as follows:

  • The Offshore Voluntary Disclosure Program (“OVDP”);
  • The Streamlined Filing Compliance Procedures;
  • Quiet Disclosure;
  • The Delinquent FBAR Submission Procedure; and
  • The Delinquent International Information Return Submission Procedures.

Each program or procedure offers non-compliant taxpayers with advantages and disadvantages. Which program is best for any individual taxpayer will vary with the unique set of facts and circumstances of his or her case.  When reviewing each program’s parameters, it is important to remember there is no “one size fits all” solution.  Consideration should be given to all possible alternatives.  Taxpayers with undeclared foreign assets that failed to file income tax or foreign information return reports should seek the advice of competent tax counsel, who can evaluate their case, explain their options, and develop a defense strategy.

This article is general and informational in nature and you should read the terms of our legal disclaimer regarding its use.

Back to Table of Contents

The OVDP

The OVDP (sometimes referred to as “noisy” disclosure) is specifically designed for taxpayers with exposure to potential criminal liability due to a willful failure to report foreign financial accounts and/or assets and pay all tax due in respect of those assets.   In addition, taxpayers that also have unreported income from domestic sources can utilize the OVDP so long as they are also reporting previously undisclosed foreign accounts or assets. Please note, taxpayers with unreported income from domestic sources only, should use the IRS Domestic Voluntary Disclosure Program.  A link to our discussion on the Domestic Voluntary Disclosure Program can be found here.

The OVDP allows a taxpayer to voluntarily contact the Internal Revenue Services’ Criminal Investigations (CI) Division in advance of filing tax returns to reduce the likelihood of criminal prosecution.   A formal voluntary disclosure creates no substantive or procedural rights for taxpayers and will not automatically guarantee immunity from prosecution.   However, in general, when a taxpayer truthfully, timely, and completely complies with all the provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.

In order to be eligible for the OVDP, a taxpayer must be reporting legal source income.   The Internal Revenue Manual does not define legal source income, but illegal source income would likely include money made from any unlawful dealings such as drug dealing or money laundering. In addition, the disclosure must be timely.”  In general, a disclosure is “timely” if made before you come to the attention of the IRS through independent means. According to the IRS, a disclosure is “timely” if it is received before:

  1. the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation;
  2. the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;
  3. the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or
  4. the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

In sum, if the IRS learns of a taxpayer’s liability through the news media, an informant, bank reporting, or by its own investigation, prior to the taxpayer coming forward, the taxpayer will not be eligible for the OVDP.

If the IRS accepts the disclosure, the IRS agrees to take the taxpayer’s disclosure into consideration when deciding whether to recommend prosecution by the Justice Department.   Once accepted, the taxpayer’s disclosure must be truthful and complete.  In addition, the taxpayer must demonstrate a willingness to cooperate (and, must in fact, cooperate) with the IRS in determining the correct tax liability.  The taxpayer must also make a good faith arrangement with the IRS to pay, in full, the tax, interest, and any related penalties that are associated with the filing of the returns.  A failure to be completely truthful may result in prosecution.  Therefore, it is important that taxpayers making OVDP submissions do not “shade” facts and are completely honest. Taxpayers and practitioners should also keep in mind that the full array of payment options that are generally available to delinquent taxpayers, are not available to taxpayers coming forward through the OVDP. For example, in the experience of this office, the IRS does not offer a taxpayer that came forward through the OVDP the option of using an Offer in Compromise to pay off the liabilities derived from an OVDP submission.

Taxpayers that agree to participate in the OVDP agree to file original and/or amended tax returns and delinquent foreign information returns for the previous eight years in which the due date for the filing of the taxpayer income tax returns has passed, with extensions (the “Disclosure Period”).   However, if the taxpayer was fully tax compliant for any of the eight years within the disclosure period, the taxpayer is exempt from submitting returns for the compliant year(s).  In addition, the account balances and asset values for the compliant year(s) will not be used to determine the OVDP penalty.   For example, if you timely and accurately filed your 2014 income tax and information returns, your disclosure period would be from 2014 to 2007, but no filings would be required for 2014, and only the balances in accounts from 2013 to 2007 would be considered in calculating the OVDP penalty.

The OVDP requires the taxpayer to pay all additional taxes due with applicable penalties and interest for the years within the disclosure period.  Penalties include the 20-percent accuracy related penalty on the full amount of the tax on the unreported foreign accounts or assets, as well as, the failure to timely file and/or pay penalties, if applicable.  In addition, the IRS also imposes an OVDP penalty that is either 27.5% or 50% of the highest aggregate value of any previously unreported OVDP assets for the years under the disclosure period.   Under the current iteration of the OVDP, the general OVDP penalty is 27.5%.  The OVDP Frequently Asked Questions (FAQs) makes clear however, that this amount is subject to change at any time.

In addition, the OVDP FAQs also provides for a 50% OVDP penalty in certain circumstances.  The OVDP penalty increases from 27.5 % to 50% if, prior to submitting the taxpayer’s pre-clearance request, it became public that a foreign financial institution (FFI) where the taxpayer held an offshore account or another party facilitating the offshore account was under investigation by, or cooperating with, the IRS or Department of Justice.   The increased 50% offshore penalty is further explained in the Frequently Asked Questions (FAQ) to the OVDP 2014 # 7.2 which provides that:

Beginning on August 4, 2014, any taxpayer who has an undisclosed foreign financial account will be subject to a 50-percent miscellaneous offshore penalty if, at the time of submitting the preclearance letter to IRS Criminal Investigation:  an event has already occurred that constitutes a public disclosure that either (a) the foreign financial institution where the account is held, or another facilitator who assisted in establishing or maintaining the taxpayer’s offshore arrangement, is or has been under investigation by the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person; (b) the foreign financial institution or other facilitator is cooperating with the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person or (c) the foreign financial institution or other facilitator has been identified in a court- approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a “John Doe summons”) at the foreign financial institution or have accounts established or maintained by the facilitator.

The current list of foreign financial institutions or facilitators that are considered “public” for purposes of the 50% penalty can be retrieved from the  IRS website. : . This list is, of course, subject to supplementation or modification.

In addition to the above criteria and requirements, there are other requirements participating taxpayer must comply with and documents they are required to provide, such as copies of all account statements for all financial accounts reflecting all account activity for each of the tax years included in the disclosure period, all relevant documents pertaining to the asset(s), and many other items to be discussed in detail with our legal professionals.

Once a taxpayer submits all the required documents, the IRS reviews the submission package, and if necessary, requests additional information regarding that submission.  If no additional information is necessary, or if all additionally submitted information is satisfactory, the IRS and the taxpayer will eventually enter into a formal closing agreement using Form 906, and the matter will be closed.

Back to Table of Contents

The Streamlined Filing Compliance Procedures

As an alternative to the OVDP, eligible taxpayers can report income derived from foreign financial assets and file delinquent foreign information returns through the Streamlined Offshore Procedure.  The IRS offers two different programs under the Streamlined Offshore Procedure for U.S. taxpayers, one for U.S. taxpayers residing inside the United States (Domestic Streamlined Procedure) and the other for those taxpayers residing outside of United States (Foreign Streamlined Procedure).  Under both programs, a Streamlined Procedure submission covers the most recent three (3) years of income tax returns and six (6) years for FBARs.

There are differences, however, in the eligibility requirements and the applicable penalties that as imposed under the different programs.  For example, the Domestic Streamlined Procedure provides for a reduced offshore penalty of 5% of the highest aggregate balance of the previously undisclosed “OVDP Assets” for the years covered by the Domestic Streamlined Procedure.   On the other hand, the Foreign Streamlined Procedure does not impose any offshore penalty.  Neither program imposes the accuracy related, failure to file or failure to pay penalties. The Streamlined Offshore Procedure, and the reduced penalty regime, is only available to taxpayers that are willing to certify that their failure to report income and foreign financial assets resulted from non-willful conduct.   The procedures are designed for only individual taxpayers, including estates of individual taxpayers.

Taxpayers using either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will also be required to certify that the failure to report all income, pay all tax and submit all required information returns, including FBARs, was due to non-willful conduct.   It is critically important to understand that the streamlined procedure is only available to non-willful taxpayers and provides no criminal or civil protections.  IRS’ guidance on the streamlined procedure defines non-willful conduct 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.” The IRS’s Internal Revenue Manual explains that “the mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish willfulness.”  Instead, willfulness is generally determined based on a reasonable inference from the facts.

Unlike the OVDP, the Streamlined Procedures do not provide a taxpayer with any promises of protection from a possible criminal prosecution referral, or from civil penalties.   This is why the streamlined procedure provides a reduced penalty.  After all, if the failures are non-willful, they would by definition be non-criminal.  A taxpayer should be comfortable with their ability to demonstrate that their failure to report their income and file their foreign information returns was non-willful.  If a taxpayer is concerned that a trier of fact might find their conduct to be willful then they will get no protection from the streamlined process, and will be subject to draconian civil and criminal penalties and/or prosecution. Therefore, if the taxpayer has any significant doubts as to their ability to demonstrate that their failures were non-willful, using the regular OVDP program could be the safer alternative.

A taxpayer must choose between the Streamlined Procedure and the OVDP –they cannot do both.

Streamlined Domestic Offshore Procedure

In order to be eligible for the streamlined domestic offshore procedure, the taxpayer must satisfy the following requirements:

  • The residency requirement as further detailed below;
  • Previously filed Form 1040, U.S. individual Income Tax Return, for each of the most recent 3 years for which the due date (including properly applied for extensions) with regard to such income tax returns has passed;
  • Failed to report income and pay taxes from foreign financial assets or foreign financial accounts or file information returns for foreign financial assets;
  • The IRS must not have initiated a civil examination or criminal investigation of your returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets and
  • Such failures to report and/or pay taxes or file information returns were the result of non-willful conduct.

Residency Requirement:

In order to satisfy the residency requirement, a taxpayer must either be a U.S. citizen, a U.S. lawful permanent resident, or satisfy the substantial presence test.  In addition, for the three most recent years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the taxpayer must have had (1) a U.S. abode or (2) was physically present in the United States for at least 35 full days.  If the taxpayer fails to meet these requirements, the taxpayer can still use the Streamlined Procedure, but must use the Foreign Streamlined Procedure.

Back to Table of Contents

Quiet Disclosure

An alternative to a formal voluntary disclosure is a quiet disclosure.  In a quiet disclosure, the taxpayer simply files their income tax returns, and pay any associated tax and interest due, and files any foreign information returns, without contacting the IRS beforehand.  A taxpayer may find this choice appealing because it can minimize the financial impact and limit the arduous process that the OVDP submits them to.  Essentially, the taxpayer takes all of the steps required within the OVDP, without agreeing to pay the miscellaneous OVDP penalty.  If the IRS accepts the amended returns and appropriate forms as filed, this could be the end of the taxpayer’s case.  However, there are significant risks associated with this approach.

A taxpayer who submits a quiet disclosure cannot take advantage of any of the guarantees that come with participation in the OVDP.   The IRS does not consider a quiet disclosure to be an adequate voluntary disclosure for the purposes of triggering the benefits of the voluntary disclosure program.   Additionally, when the taxpayer chooses to proceed with a quiet disclosure, the threat of a referral to CI still exists and the probability of severe civil penalties increases.   In fact, the IRS has specifically advised taxpayers of the increased scrutiny and dangers of a quiet disclosure, since they do not give even the limited protections afforded to taxpayers by an accepted formal voluntary disclosure.   After all, if taxpayers are able to come into compliance using the quiet disclosure process, there is no deterrence for those taxpayers to correct future behaviors.  Taxpayers may try to use new and innovative tax concealment techniques because they have the fail-safe of quiet disclosure available to them.  While there may be potential benefits in a quiet disclosure, they should carefully be weighed against the potential pitfalls.

Back to Table of Contents

Which Disclosure is “Better”?

Here are some issues that we believe you should consider, before deciding which type of disclosure you want to pursue.

Criminal Protection

The greatest concern for a taxpayer in making the decision to disclose is the fact that the statements made in any disclosure are treated as admissions that may be used against the taxpayer in other civil or criminal proceedings. Unless the taxpayer is disqualified from the OVDP, the formal or “noisy” disclosure gives the taxpayer some expectation that there will be no criminal prosecution.

Taxpayers with undisclosed foreign accounts or interests in foreign entities should consider entering into the OVDP because it enables them to become compliant, avoid substantial civil penalties and generally eliminates the risk of criminal prosecution. Those taxpayers who do not submit a voluntary disclosure risk discovery by the IRS and the imposition of substantial penalties; including the fraud penalty, foreign information return penalties, and an increased risk of criminal prosecution.

The OVDP is good choice if you have significant undeclared foreign income.  The OVDP is also a good idea if the facts of your case might give rise to a criminal tax fraud prosecution.  For example, if a taxpayer established a foreign trust or foundation to hide the true ownership of the foreign account, or if the taxpayer diverted taxable domestic income to a foreign account.

The OVDP is also a good choice if the IRS can prove that the taxpayer willfully failed to report foreign assets or accounts. In determining the applicability of a fraud charge, taxpayers should be aware that the IRS will consider whether the taxpayer is financially sophisticated, whether they controlled the undisclosed foreign or domestic accounts/investments, whether they made frequent deposits to or withdrawals from the undisclosed foreign accounts, or whether they can demonstrate that the taxpayer knew or should have known of their disclosure obligations and they disregarded those obligations.

However, the OVDP is not appropriate for all taxpayers with unreported foreign accounts and assets. For example, the OVDP may not be the best course of action if:

  1. The taxpayer only had signature authority or power of attorney over an account, but never had beneficial ownership of the funds in the account (i.e., those funds were not yours).  For example, when a parent adds a child to an account for convenience or for estate planning purposes.  In such a case, the child associated with the account can often come into compliance by filing the delinquent FBARs through the Delinquent FBAR submission procedure, as further discussed below, disclosing the nature of their relationship to the foreign account without making a formal voluntary disclosure
  2. The unreported income was minimal, offset by losses, offset by unclaimed tax credits, or there was no tax loss to the IRS.  If there was no tax loss to the IRS, then the taxpayer may want to consider using an alternative method for coming into compliance. Taxpayers should be careful, however, since the IRS FAQ # 33 makes clear that there is no de minimis unreported income exception relating to tax noncompliance and that “[e]ven one dollar of unreported gross income from an OVDP asset will bring it into the offshore penalty base.”
  3. Foreign Assets Not Subject to Tax Non-Compliance: the OVDP FAQs provide an example of a taxpayer that owns valuable land and artwork located in foreign country, and asks whether the taxpayer is required to report the foreign assets.  According to the IRS, the answer depends on whether the assets were acquired with funds related to tax-noncompliance and if the assets produced income that was not reported during the disclosure period.  As a starting point, any assets purchased with funds that were subject to U.S. tax but on which no such tax was paid, must be reported using the OVDP, whether or not such assets produced income during the disclosure period.  As for assets acquired using after-tax funds or funds that were not subject to U.S., such assets only need to be reported if the assets produced income that was subject to U.S. tax during the disclosure period which was not reported.

In contrast, the quiet disclosure and the Streamlined Procedure do not result in the IRS giving any affirmative assurance of protection from criminal prosecution. By making a “quiet” disclosure or Streamlined Procedure submission, you run a greater risk of being audited and potentially criminally prosecuted for all applicable years.  The risk of criminal prosecution may be more likely if you fail to fully disclose all income. Some possible criminal charges include tax evasion and filing a false return.  After a taxpayer makes a quiet disclosure or Streamlined Procedure submission, the IRS has six years to audit the return(s).  There will remain uncertainty as to whether the IRS will audit or criminally prosecute you until the respective statutes of limitation for the particular filing have passed. However, you may still be eligible for the OVDP if an IRS examination has not been started.  This is important as some taxpayers may want the predictability that the OVDP provides after initially proceeding with a “quiet disclosure.” So long as an examination has not been started, that predictability, even though it means being subjected to harsher penalties, is available in the OVDP.

Cost

The noisy disclosure and the streamlined procedure are more expensive than the quiet disclosure. Noisy disclosures and streamlined submissions require additional legal fees to cover the very careful preparation of the initial overture to CI and thereafter careful and intricate interaction with CI in order to obtain the greatest possible assurance of non-prosecution (or, more precisely, non-referral to DOJ Tax).  As for quiet disclosures, there are minimal upfront legal fees. On the other hand, you may give the IRS a roadmap to charge you criminally, and if you are caught, you are likely to be subject to harsh civil penalties and the possibility of criminal charges.

Under the Streamlined Offshore Procedures, eligible taxpayers will only have to pay the miscellaneous offshore penalty of 5%, as compared to 27.5% or 50% under the noisy disclosure and will not be subject to accuracy-related penalties, information return penalties, or FBAR penalties.

With all the risks and benefits in mind, the ultimate decision is up to the taxpayer on what amount of risk they wish to absorb.  But with IRS examiners more aggressive lately in an attempt to send the message that the voluntary disclosure program is a better option, the quiet disclosure is as dangerous an option as ever.

 Pre-Clearance Procedure

A taxpayer that decides to use either the OVDP or the Streamlined Procedure, should submit a pre-clearance letter to the IRS in advance of their submission.  The purpose of the pre-clearance letter is to ask the IRS if the taxpayer has already been identified in a criminal prosecution, selected for audit or is otherwise ineligible for the voluntary disclosure program.

Under the current OVDP regime, a pre-clearance letter discloses the taxpayer’s name, tax identification number, home address and certain identifying information related to the undisclosed foreign accounts or assets, without disclosing any of the underlying facts of the taxpayer’s particular case.   With regard to the undisclosed foreign accounts or assets, the information disclosed in the pre-clearance letter includes all foreign and domestic financial institutions the taxpayer had accounts with, and all foreign and domestic entities through which the taxpayer owned accounts or other foreign and domestic undisclosed assets.

The submission of the preclearance letter does not guarantee a taxpayer acceptance into the OVDP. If and when the taxpayer receives a pre-clearance, the taxpayer will then have forty-five (45) days from that date to decide whether they want to go forward with an OVDP submission or withdraw their pre-clearance and submit through the Streamlined Procedure.

While the OVDP FAQs specifically provides for submitting a pre-clearance letter in the context of the OVDP, the FAQs are silent as to whether a taxpayer can and should submit a pre-clearance letter in the context of a Streamlined Procedure.  However, since the risk of providing the IRS with a taxpayer’s returns which can be used as a road map to the taxpayer’s noncompliance is the same in both the context of the OVDP and the Streamlined Procedure, it is our general practice to submit a pre-clearance letter even if the taxpayer intends to ultimately submit through the Streamlined Procedure.

If the taxpayer intends to move forward through the OVDP, the taxpayer must then provide the IRS with Form 14457, Offshore Voluntary Disclosure Letter, and Form(s) 14454, Attachment to Offshore Voluntary Disclosure Letter(s), as applicable.  The Disclosure Letter requires the taxpayer to provide the IRS with considerable information regarding the taxpayer and the previously undisclosed foreign financial account(s). The Disclosure attachments must be filed for each foreign financial account that the taxpayer is disclosing and requesting information regarding the account, persons associated with the account and the taxpayer’s advisers.

Back to Table of Contents

Opt-Out Procedure

In certain situations, a taxpayer may want to consider opting out of the one-size fits all civil penalty regime of the OVDP and instead, have their case examined under the regular IRS audit procedures.   An “opt out” is an irrevocable election to have your case handled under the standard audit process rather than the civil settlement structure of the OVDP.   Under an opt-out, a taxpayer is still afforded the same criminal protection that was available to them under the OVDP, but they are no longer subject to the OVDP civil penalty regime.

With regard to criminal protection under an opt-out, according to the OVDP Frequently Asked Questions # 51 and 51.3, under an opt-out, a taxpayer’s case is examined under the IRS’ Criminal Investigation’s Voluntary Disclosure Practice that provides a recommendation to the Department of Justice against prosecutions of tax violations up to the date of the taxpayer’s disclosure if the taxpayer fully cooperates with the IRS by providing all requested information and records and pays or make arrangements to pay the tax, interest, and penalties that are ultimately determined to be due.  As with the OVDP, if the taxpayer fails to cooperate and make payment arrangements, or if after examination, issues exist that were not disclosed prior to the opt-out, their case would likely be referred back to the Criminal Investigation Division and they would then potentially be subject to criminal prosecution for all tax and FBAR violations.  Therefore, assuming that the taxpayer was truthful and honest in their tax and information return filings, they would receive the same criminal protection from the IRS whether they remained in the OVDP or decide to opt-out.

With regard civil penalties, upon opting out, the IRS will open an examination of the tax returns subject to the disclosure and can assert any civil penalty that applies under the Internal Revenue Code or the Bank Secrecy Act (BSA).  The BSA requires certain taxpayers to file FBARs and report their interests or signature authority over foreign bank accounts and imposes civil penalties for those individuals that negligently fail to do so, which penalties are increased to draconian levels when  the failure was willful.   In addition, the IRS has the discretion to perform a civil examination over a period including more than the eight tax years covered by the OVDP if they pursue the fraud penalty, but could not assert a tax unless they can demonstrate that a return that is barred by the ordinary statutes of limitations was fraudulent.

The following civil penalties may apply to your case:

  • A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). The civil penalty for willfully failing to file an FBAR is the greater of $100,000 or 50 percent of the total balance of the foreign account per violation. See 31 U.S.C. § 5321 (a) (5).  On the other hand, non-willful negligent violations that the IRS determines were not due to reasonable cause are subject to a $10,000 maximum penalty per violation.  Finally, if a taxpayer can demonstrate reasonable cause for the omission, no penalty is imposed.
  • Civil fraud penalties imposed under IRC §§ 6651 (f) or 6663 are 75 percent of the unpaid tax due to fraud. While there is a substantial burden on the IRS to prove fraud even in a civil matter, the standard of proof is less than that required for a conviction on criminal fraud. However, it would require more than the mere fact of these omissions.  There would need to be some evidence that there was willful failure.

Therefore, the decision whether to opt-out really turns on whether the taxpayer believes that their conduct was such that the IRS could carry its burden of showing that the taxpayer was willful in their alleged failures to report all income and/or foreign assets, as well as, pay any corresponding tax related to such income and/or assets.  While each failure should be carefully reviewed as the taxpayer decides whether an opt-out is appropriate in the present circumstance or if they should continue with the OVDP, practitioners should consider that the IRS will look at the case as a whole to determine whether such actions were willful or if there was a pattern of willfulness.  Taxpayers should keep in mind that if they opt-out, they will need to provide the IRS with a reasonable cause letter that details why they are opting-out and their grounds for reasonable cause.

At the present time, there are only two published cases in which the IRS imposed the willful FBAR penalty, and the taxpayer litigated the imposition. They are United States v. Williams, No. 10-2230 (4th Cir. 2012) and United States v. McBride, No. 2:09-cv-00378 (D. Utah 2012). In each of these two cases, the IRS won. Note, however, these were not opt-out cases, and we could therefore find no opt-out case in which the penalty was imposed.  Nor do we know how many times the penalty was imposed and the taxpayer reached an accommodation with the IRS without litigation. However, given that there were likely to have been a significant number of FBAR violations dealt with by the IRS, and the fact that the IRS typically only chooses its best cases to go forward, one must be careful not to read too much into either the fact that there have been only two such cases, or that both were decided in favor of the IRS.  Although the underlying facts in each case were certainly not the best, the courts might not lightly view those with considerable financial resources who fail to inquire about their potential reporting requirements associated with various interests in foreign financial accounts.

Back to Table of Contents

The Delinquent FBAR Submission Procedure

Not all taxpayers that failed to report foreign financial accounts should use the OVDP or the Streamlined Procedure.  For example, a taxpayer that previously reported and paid all income associated with unreported foreign financial accounts, should consider the delinquent FBAR submission procedure.  Under this procedure, the IRS will not impose a penalty for the failure to file the delinquent FBARs if the taxpayer properly reported all of their income, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs.  In addition, in order to be eligible for this program, the taxpayer must not have been previously contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.  Keep in mind that if the taxpayer reported all income but failed to file information returns other than FBARs, they should also consider the delinquent information return procedure.

In order to utilize the Delinquent FBAR Submission Procedures, the taxpayer must file all outstanding FBARs electronically through the FinCEN website, and include a statement explaining why the taxpayer failed to timely file the FBARs.

Thus, if a taxpayer owes no income tax on his foreign accounts, and he is not under civil audit or criminal investigation by the IRS, and he has not already been contacted by the IRS concerning delinquent FBARs, he should not make a submission to the IRS under the OVDP or the Streamlined Procedures.  All he needs do to comply with the law is file his delinquent FBARs.

How Many Years Are Included

The IRS is silent as to how many years a taxpayer must go back if filing FBARs through the Delinquent FBAR Submission Procedure.  With that being said, the statute of limitations for imposing a penalty for failure to file an FBAR is six years, which begins to run on the filing due date of the FBAR, or June 30, of the succeeding the calendar year in which the FBAR ownership and monetary thresholds are satisfied.  The statute of limitations begins to run whether or not the FBAR is ever filed.  Therefore, since the statute of limitations is only six years, it would appear that a taxpayer need only go back six years.  In a telephone conversation with the IRS civil hotline on this very issue, the IRS confirmed this analysis with this office.

Note that the due date for FBARs was recently changed to April 15 starting with the 2016 tax year. Therefore, the 2015 FBAR would still be due under the old due date requirement of June 30.

Streamlined Procedure or Delinquent FBAR Submission Procedure?

In determining which procedure a taxpayer should use, a key issue is whether the taxpayer had unreported income derived from the previously undisclosed foreign assets. If the taxpayer reported all of its income but simply failed to file the FBARs, the FBAR delinquent procedure would appear to be the proper program for the taxpayer to use to come into compliance with its foreign reporting obligations.  However, if the taxpayer did not report all of its income related to undisclosed foreign financial accounts or assets, the taxpayer should use the Streamlined Procedure.

What if the taxpayer failed to report income during the six year look-back period, but the failure to report the income occurred in years 4 through 6.  Under the Streamlined Procedure, the taxpayer is required to only amend the three most recent income tax returns, of which the due date to file has passed.  Since the failure to report occurred in years 4 through 6, is the taxpayer eligible for the Delinquent FBAR Submission Procedure, or must he file through the Streamlined Procedure.

The Streamlined Filing Compliance Procedures for U.S. Taxpayers Residing in the United States Frequently Asked Questions and Answers (Streamlined FAQs) Number 7 appears to answer this question.  According to Streamlined FAQ Number 7, the taxpayer may make a streamlined submission.  Taxpayers should still file Form 1040X’s with a zero change in tax and explain in the Streamlined Certification as well as, on the 1040X, that the Streamlined Submission is made due to failures to report income in prior years.

Taxpayers that would be eligible for the Foreign Streamlined Procedure do not have as clear an answer for this issue.  The Foreign Streamlined Procedure FAQs do not address this issue.

Back to Table of Contents

Delinquent International Information Return Submission Procedures

The Delinquent International Information Return Submission Procedures is a new alternative to the OVDP and Streamline Procedures for those taxpayers that failed to file required foreign information returns.  The Delinquent International Information Return Submission Procedures should be filed by those taxpayers who do not need to file delinquent or amended tax returns to report and pay additional tax, and who:

  • have not filed one or more required international 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.

 

Included in the Delinquent International Information Return Submission Procedures package is 1) an amended tax return with all delinquent foreign information returns attaches (except Forms 3520 and 3520A, which are separately filed), and 2) a statement establishing reasonable cause for the failure to file.   As part of this 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 benefits of using the Delinquent International Information Return Submission Procedures are, assuming that the IRS accepts the reasonable cause argument, there is hope to believe there will be zero penalties assessed on the late-filed foreign information returns, which can be as high as $10,000 per year, per return.

 

However, there are no assurances that the failure to file delinquent international returns will be permitted without the imposition of penalties if the IRS examines the submission, even where all tax liabilities have been reported.   Further, if the taxpayer is under an IRS examination, civil or criminal, or if the IRS finds that the entities were used for tax evasion, the taxpayer will not qualify for the zero penalty assessment.   So, the taxpayer should not file under the Delinquent International Information Return Submission Procedures without being certain they qualify.  To limit these risks, the reasonable cause statement must be enclosed, the filing must be timely, there must not be any indication of tax evasion, and the submission must otherwise qualify under the Delinquent International Information Return Submission Procedures program.

Taxpayers who are not certain whether they will qualify under the Delinquent International Information Return Submission Procedures should consider filing pursuant to the OVDP or the Streamlined Procedures.

Back to Table of Contents

New York Voluntary Disclosure

In general, when a taxpayer files original or amended returns through one of the IRS’ voluntary disclosure programs, the taxpayer should also consider the collateral effect such submission will have at the State level.  For those taxpayers filing federal amended returns, pursuant to NY Tax Law §659, taxpayers are required to file amended New York returns within ninety days of such federal change.  Upon filing those returns however, New York will automatically impose the failure to timely pay penalty on the amounts due, and may also impose other civil or criminal penalties if applicable.

In order to ameliorate the potential penalties that can be imposed, an eligible taxpayer can submit such returns and pay such taxes through the New York State’s Voluntary Disclosure and Compliance program.  Under the New York State’s Voluntary Disclosure and Compliance program eligible taxpayers that owe back taxes and have not filed related returns can avoid monetary penalties and possible criminal charges by filing such returns through the voluntary disclosure program.

The New York State Voluntary Disclosure webpage, at its online application, states that a taxpayer is eligible to participate in the New York State voluntary disclosure program if all of the following criteria are met:

  1. The taxpayer is not currently under audit by the Tax Department for the tax type and tax year(s) that are being disclosing;
  2. The taxpayer must not have received a bill for the past due taxes that they are disclosing;
  3. The taxpayer is not currently a party to any criminal investigation being conducted by a New York State agency or political subdivision of the state; and
  4. The taxpayer is not seeking to disclose participation in a tax avoidance transaction that is a federal or New York State reportable or listed transaction.

A  general discussion of New York’s voluntary disclosure relief program can be found here.

Back to Table of Contents