Federal Offshore Voluntary Disclosure
Table Of Contents
- Introduction and Legal Disclaimer
- The Voluntary Disclosure Program
- The Streamlined Filing Compliance Procedures
- Quiet Disclosure
- Which Disclosure is “Better”?
- The Delinquent FBAR Submission Procedure
- Streamlined Procedure or Delinquent FBAR Submission Procedure?
- The Delinquent International Information Return Submission Procedures
- New York Voluntary Disclosure
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’ 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 Voluntary Disclosure Program
- The Streamlined Filing Compliance Procedures
- Quiet Disclosure
- The Delinquent FBAR Submission Procedure
- 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.
The Voluntary Disclosure Program
The IRS previously offered two types of Voluntary Disclosure Programs. The Offshore Voluntary Disclosure Program (OVDP) was used 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. All other types of Voluntary Disclosures were processed through the Domestic Voluntary Disclosure Program.
The IRS closed the Offshore Voluntary Disclosure Program (“OVDP”) effective September 28, 2018. However, OVDP voluntary disclosures commenced prior to September 28, 2018 will still be processed under the former OVDP procedures.
On November 20, 2018, the IRS released a memorandum addressing the updated procedures for all voluntary disclosures both domestic and offshore. The updated procedures apply to all voluntary disclosures filed after September 28, 2018.
In order to participate in a voluntary disclosure under the updated procedures, the IRS will now require all taxpayers to submit a preclearance request to the IRS using a forthcoming revision of Form 14457. As of January 10, 2019, the IRS has yet to release the revised Form 14457. For all cases where the IRS grants preclearance, the taxpayer must then provide the IRS with all required voluntary disclosure documents using the forthcoming revision of Form 14457. This form will require information related to taxpayer’s noncompliance, including a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance.
All voluntary disclosures under the updated procedures will be forwarded to the appropriate Business Operating Division and Exam function for civil examination. All voluntary disclosures handled by examination will follow standard examination procedures. This includes, the right to request an appeal with the IRS’ Office of Appeals to contest the determination of tax or imposition of penalties as further discussed below.
Under the updated procedures, taxpayers that agree to participate in the voluntary disclosure program, will generally be required to file original and/or amended tax returns and delinquent foreign information returns for the previous six 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 last six years within the disclosure period, the taxpayer is exempt from submitting returns for the compliant year(s). In certain instances, the IRS has reserved the right to expand the disclosure period. Those instances include (1) when the taxpayer has not agreed to resolve all tax and tax related noncompliance through an agreement with the IRS or (2) cooperative taxpayers may be allowed to expand the disclosure period if it would assist the taxpayer with, among other things, correcting tax issues with other government agencies that require additional tax periods.
The updated voluntary disclosure procedures requires the taxpayer to pay all additional taxes due with applicable penalties and interest for the years within the disclosure period. Penalties will be asserted as follows:
- In general, the civil fraud penalty will apply to the one tax year with the highest tax liability in the disclosure period. In limited circumstances, examiners may apply the civil fraud penalty to more than one year in the disclosure period if, for example, the taxpayer fails to cooperate and resolve the examination by agreement.
- Willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17.
- A taxpayer may request that the accuracy related penalties under I.R.C. § 6662 be imposed rather than the civil fraud penalty or that the non-willful FBAR penalties be imposed instead of the willful penalty. The IRS has stated that granting requests for the imposition of lesser penalties is expected to be exceptional.
- Penalties for the failure to file information returns will not be automatically imposed. Examiner discretion will take into account the application of other penalties (such as civil fraud penalty and willful FBAR penalty) and resolve the examination by agreement.
- Penalties relating to excise taxes, employment taxes, estate and gift tax, etc. will be handled based upon the facts and circumstances with examiners coordinating with appropriate subject matter experts.
The Streamlined Filing Compliance Procedures
As an alternative to the voluntary disclosure program, eligible taxpayers can report income derived from foreign financial assets and file delinquent foreign information returns through the Streamlined Filing Compliance Procedures.
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 foreign 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 voluntary disclosure program, 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 voluntary disclosure program could be the safer alternative.
Streamlined Domestic Offshore Procedure
In order to be eligible for the streamlined domestic offshore procedure, you 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.
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.
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 voluntary disclosure program submits them to. Essentially, the taxpayer takes all of the steps required within the voluntary disclosure program, without agreeing to the penalty structure imposed under the updated voluntary disclosure procedures. 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 voluntary disclosure program. 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.
Which Disclosure is “Better”?
Here are some issues that we believe you should consider, before deciding which type of disclosure you want to pursue.
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 voluntary disclosure program, 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 voluntary disclosure program 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 voluntary disclosure program is good choice if you have significant undeclared foreign income. The voluntary disclosure program 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 voluntary disclosure program 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 voluntary disclosure program is not appropriate for all taxpayers with unreported foreign accounts and assets. For example, the voluntary disclosure program may not be the best course of action if:
- 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 submission.
- 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.
- Foreign Assets Not Subject to Tax Non-Compliance including foreign real estate held individual name, gold bars, and artwork located overseas.
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 voluntary disclosure program if an IRS examination has not been started. This is important as some taxpayers may want the predictability that the voluntary disclosure program 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 voluntary disclosure program.
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 the possibility of the civil fraud penalty and FBAR penalties which appears to be the starting point for the under the updated procedures under the voluntary disclosure program.
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.
A taxpayer that decides to use the voluntary disclosure program is required to 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 updated procedures for the voluntary disclosure program, all taxpayers wishing to utilize the voluntary disclosure program will now be required to submit a preclearance request to the IRS using a forthcoming revision of Form 14457. As of January 10, 2019, the IRS has yet to release the revised Form 14457.
The Delinquent FBAR Submission Procedure
Not all taxpayers that failed to report foreign financial accounts should use the voluntary disclosure program 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 voluntary disclosure program 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.
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.
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 voluntary disclosure program or the Streamlined Procedures.
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:
- The taxpayer is not currently under audit by the Tax Department for the tax type and tax year(s) that are being disclosing;
- The taxpayer must not have received a bill for the past due taxes that they are disclosing;
- 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
- 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.