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IRS Offshore Voluntary Disclosure Representation

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Since the 2009 calendar year, the Department of Justice and the IRS have been aggressively waging war on taxpayers who hold undisclosed offshore assets. Through a variety of methods, the Department of Justice and the IRS have obtained volumes of information about the holders of offshore financial accounts and their assets abroad. Some of this information has been made public; other information has not been made public.

There are two categories of international penalties. The first set of international penalties can be found in the Internal Revenue Code. Chapter 61 of the Internal Revenue Code contains countless reporting requirements regarding foreign information filing obligations. Many of the sections under Chapter 61 impose significant penalties for the failure to comply with the reporting requirements. The more well known reporting requirements and penalties are found in Chapter 61 and are as follows:

The Internal Revenue Code requires certain persons to provide the Internal Revenue Service or IRS with information regarding foreign corporations on a Form 5471. Form 5471 is used by certain U.S. persons who are officers, directors, or shareholders in respect of certain foreign entities that are classified as corporations for U.S. tax purposes. The Form 5471 and schedules are used to satisfy the reporting requirements of the Internal Revenue Code. The Form 5471 is ordinarily attached to a U.S. person’s federal income tax return. The penalty for failure to file, or for delinquent, incomplete or materially incorrect filing is a reduction of foreign tax credits by ten percent and a penalty of $10,000, as well as a reduction in the taxpayer’s foreign tax credit. An additional $10,000 continuation penalty may be assessed for each 30 day period that noncompliance continues up to $60,000 per return, per year.

Similarly, Internal Revenue Code Section 6038A requires 25 percent foreign-owned domestic corporations and limited liability companies to report specified information as an attachment to a corporate tax return. This is done on Form 5471, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. In filing a Form 5472, the filer must provide information regarding its foreign shareholders, certain other related parties, and the dollar amounts of transactions that it entered into during the taxable year with foreign related parties. A separate Form 5472 is filed for each foreign or domestic related party with which the reporting entity engaged in reportable transactions during the year. Any reporting corporation or limited liability company that fails to file Form 5472 may be subject to a penalty of $25,000. If the failure continues for more than 90 days after notification by the IRS, there is an additional penalty of $25,000 for each 30 day period or fraction. There is no upper limit on this penalty.

Another well known provision in Chapter 61 is Section 6039F. Section 1905 of the 1996 Tax Act created new reporting requirements under Section 6039F for U.S. persons (other than certain exempt organizations) that receive large gifts (including bequests) from foreign persons. The information reporting provisions require U.S. donees to provide information concerning the receipt of large amounts that the donees treat as foreign gifts, giving the IRS an opportunity to review the characterization of these payments and determine whether they are properly treated as gifts. Donees are currently required to report certain information about such foreign gifts on Part IV of Form 3520.

Section 6039F(b) generally defines the term foreign gift as any amount received from a person other than a U.S. person that the recipient treats as a gift or bequest. However, a foreign gift does not include a qualified transfer (within the meaning of Section 2503(e)(2)) or any distribution from a foreign trust. A distribution from a foreign trust must be reported as a distribution under Section 6048(c)(discussed below) and not as a gift under Section 6039F.

Section 6039F(c) provides that if a U.S. person fails, without reasonable cause, to report a foreign gift as required by Section 6039F, then (i) the tax consequences of the receipt of the gift will be determined by the Secretary and ii) the U.S. person will be subject to a penalty equal to 5 percent of the amount for the gift for each month the failure to report the foreign gift continues, with the total penalty not to exceed 25 percent of such amount. Under Sections 6039F(a) and (b), reporting is required for aggregate foreign gifts in excess of $100,000 during a taxable year. Once the $100,000 threshold has been met, the U.S. donee is required to file a Form 3520 with the IRS.

Under Section 6048 of the Internal Revenue Code, U.S. owners of a foreign trust must ensure that the foreign trust files a Form 3520-A with the IRS. Under Section 6677 of the Internal Revenue Code, the penalty for failure to file Form 3520-A is the greater of $10,000 or 5% of the gross value of the portion of the trust’s assets treated as owned by the U.S. person at the close of that taxable year. If the IRS issues a continuation letter, and the Form 3520-A is not filed, the IRS may assess an additional penalty of $10,000 for each 30-day period until the 3520-A is filed.

Form 8938 is used to report interests in specific foreign financial assets. Specific foreign financial assets include: (1) financial accounts maintained by a foreign financial institution; (2) stock or securities issued by someone that is not a U.S. person; (3) any interest in a foreign entity; and (4) any financial instrument or contract that has an issuer or counterparty that is not a U.S. person.

Originally, penalties associated with Form 5471, Form 5472, Form 3520, Form 3520-A, and Form 8938 (hereinafter “international penalties”) were assessed manually on individuals and entities whose missing filings were discovered during an audit. The IRS is still assessing international penalties during audits. Several years ago the IRS began a systemic assessment of international penalties associated with the late filing of these returns. The systemic assessment of international penalties is controversial. Many taxpayers are unaware of their international reporting obligations and learn of their filing obligations after the due date of the filing obligation has already passed. Many of these same taxpayers often try to comply with their international filing obligations by filing an international informational return (i.e. Form 5471, Form 5472, and Form 3520) late. The IRS typically rewards these same taxpayers “trying to do the right thing” by automatically assessing international penalties against them. These penalties can range from a minimum of $10,000 to several million dollars.

The second category of international penalties can be found in Title 31 of the United States Code. Title 31 of the United States Code requires U.S. persons that have a “financial interest” in or “signature authority” over, or “other authority” over one or more “financial accounts” located in a “foreign country” with an aggregate value of such account(s) exceeding $10,000 at any time during the calendar year to file a FinCen Form 114 (“FBAR”) with FinCEN.

A U.S. person has a financial interest in a foreign financial account for which he or she is the owner of record or holder of legal title, regardless of whether the account is maintained for the benefit of the U.S. person or for the benefit of another person. A U.S. person has a “financial interest” in each account where the title holder or owner of the account falls into one of the following six categories: (i) the U.S. person’s agent, agent, nominee, or attorney, (ii) a corporation whose shares are owned, directly or indirectly, more than 50 percent by the person, (iii) a partnership in which the person owns greater than a 50 percent profits interest, (iv) a trust of which a U.S. person is the trust grantor and has an ownership interest in the trust for United States tax purposes, (v) a trust from which the person derives in excess of 50 percent of the current income or in which the person has a present beneficial interest in more than 50 percent of the assets, or (vi) any other entity in which the U.S. person owns directly or indirectly more than 50 percent of the voting power.

A person has “signature authority” over an account if the person can control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.

The definition of “financial account” located in a “foreign country” can be difficult to understand. A financial account includes securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution. A financial account also includes a commodity future or option account, an insurance policy with a cash value (such as a whole life policy), an annuity policy with a cash value, and shares in a mutual fund or similar pooled fund.

Failure to timely disclose foreign financial accounts on an FBAR can result in significant penalties. The IRS can either assess non-willful FBAR penalties in the amount of $10,000 per violation or willful penalties in the amount of $100,000 or 50 percent of the balance of the account(s) at the time of the violation.

Statute of Limitations for Assessment of Tax and Civil Penalties on Undisclosed Foreign Source Income

The statute of limitations on civil penalties associated with the non-disclosure of foreign financial accounts or assets vary by the specific penalty involved, but the most serious of the civil penalties either have a six year, or no statute of limitations.

U.S. taxpayers are required to report and pay tax on their worldwide income. When a U.S. taxpayer fails to disclose income on a U.S. federal tax return, generally, the IRS may audit and impose tax on a U.S. taxpayer for up to three years from the date a tax return was filed. This three-year statute of limitations is extended to six years when a taxpayer omits 25 percent or more of his or her gross income on a federal tax return.

On March 18, 2010, the Hiring Incentives to Restore Employment Act (Pub. L. No. 111-14)(“The HIRE Act”) was signed into effect. The HIRE Act dramatically expanded the statute of limitations to assess tax liability on undisclosed foreign income. In the case of unreported foreign income and the assessment of civil penalties, the statute of limitations on the period in which the IRS can assess tax liabilities and penalties have been extended under the HIRE Act as follows:

  1. The HIRE Act has extended the statute of limitations to six years from three years when a taxpayer omits more than $5,000 of income attributable to one or more assets required to be reported under Internal Revenue Code Section 6038D (i.e., foreign financial assets with an aggregate value exceeding $50,000).
  2. The statute of limitations on a tax return for purposes of income tax and penalty assessments will not begin to run until the information required to be reported under Internal Revenue Code Sections 6038, 6038A, 6038B, 6046, 6046A, and 6048 have been furnished to the IRS.
  3. The relevant forms for the above-cited Internal Revenue Code sections are: i) Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation;” ii) Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts;” iii) Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner;” iv) Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations;” v) Form 5472, “Information Return of a 25-percent Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business;” vi) Form 8621, “Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund;” vii) Form 8858, “Information Return of U.S. Persons With Respect to Foreign Disregarded Entities;” viii) Form 8865, “Return of U.S. Persons With REspect to Certain Foreign Partnerships.”
  4. If a U.S. taxpayer has income which should have been disclosed on any of the aforementioned information returns, the statute of limitations on the assessment of additional taxes does not begin to run until the appropriate information return is filed with the IRS and the income associated with the information return is disclosed to the IRS. The statute of limitations for the assessment of penalties for not timely filing an information return with the IRS does not begin to run until the information return is filed with the IRS. In addition, FATCA amended Internal Revenue Code Section 6662 to permit the IRS to impose a 40 percent penalty on any portion of an underpayment of tax attributable to a transaction involving an undisclosed financial asset that should have been reported under Internal Revenue Code Sections 6038, 6038B, 6046A, or 6048. The statute of limitations on the Section 6662 penalty does not begin to run until the appropriate returns are filed with the IRS.
  5. The civil statute of limitations for FBAR penalties is six years from the due date of the FinCEN 114 not the date the return was filed with FinCEN.

Statute of Limitations on Criminal Offense

In addition to civil penalties, the failure to disclose foreign source income on a U.S. tax return or the failure to report foreign financial assets on an information return result in criminal penalties. In the criminal context, a taxpayer with undisclosed foreign financial accounts could be charged not only with the failing to disclose a foreign financial account on an FBAR, the taxpayer could be charged with a number of tax crimes such as tax evasion or the filing of false tax returns. The statute of limitations vary by the specific criminal violation involved.

The statute of limitations for criminal willful failure to disclose a foreign financial account on an FBAR is five years from the due date of the information return. Typically, the statute of limitations for tax crimes such as tax evasion or the filing of false tax returns is six years from the date a tax return was filed or when the return or payment of the tax due, whichever is later.

There are a number of rules that extend the statute of limitations for criminal purposes involving foreign income and foreign information returns. Below, please find a provisions in the Internal Revenue Code and the U.S. Code that extend the statute of limitations for criminal prosecution purposes:

  1. Internal Revenue Code Section 6531: This Internal Revenue Code Section extends the statute of limitations in criminal cases while a U.S. taxpayer is outside of the United States.
  2. Internal Revenue Code Section 7609(e)(1): This Internal Revenue Code Section extends the statute of limitations in criminal tax cases where certain summons enforcement proceedings have commenced.
  3. 18 U.S.C. Section 3292: This United States Code Section extends the statute of limitations in criminal cases to permit the government to obtain foreign evidence if the government files an application indicating that evidence of an offense is in a foreign country and proving by a preponderance of the evidence that an official request has been made for such evidence and that it reasonably appears, or reasonably appeared at the time the request was made, that such evidence is, or was, in such foreign country.
  4. Internal Revenue Code Section 6531(8): This Internal Revenue Code Section is a conspiracy statute. This statute can be used as a vehicle for extending the statute of limitations for criminal prosecution. Federal prosecutors have successfully argued, however, that a conspiracy to defraud the United States for tax crimes well after the date of the filing of a tax return.

Voluntary Disclosures

U.S. taxpayers with undisclosed foreign financial accounts must understand that they have exposure to serious criminal and civil penalties that may not only threaten financial ruin, but also a very real risk of a lengthy prison sentence. Many individuals with current or previously undisclosed foreign financial assets can utilize the voluntary disclosure process to avoid criminal sanctions and to mitigate civil penalties associated with the failure to report the existence of, and income on, a foreign financial asset on tax returns, as well as for the non-filing of an international information return. Individuals who have previously failed to disclose foreign financial assets and/or foreign income may avoid serious liability by initiating a disclosure before the IRS or any other U.S. government agency discovers the undisclosed financial asset or foreign income. The manner and means of a voluntary disclosure along with the reporting positions should be determined with great care.

IRS Voluntary Disclosure Policy

On November 20, 2018, the Internal Revenue Service (“IRS”) issued a Memorandum discussing the rules for all voluntary disclosures (foreign and domestic) after the expiration of the final Offshore Voluntary Disclosure Program (“OVDP”). The Memorandum is broken down into multiple parts: background and overview, IRS Criminal Investigation (“CI”) procedures; civil processing, case development, and civil resolution framework, each of which are discussed in detail below. This article will also discuss the significant hazards of making a voluntary disclosure to the IRS.

Background

In 2009, the IRS opened the initial OVDP to provide a uniform mechanism to U.S. citizens and tax residents who had not otherwise disclosed foreign bank accounts, foreign situs assets and income that was used to pay for such assets. After the expiration of the 2009 OVDP, the IRS created the 2011 OVDP Initiative. After the expiration of the 2011 OVDP, the IRS opened another version of the program, the 2012 OVDP, which was significantly modified in July of 2014. The OVDP programs ended on September 28, 2018; however, the IRS voluntary disclosure program continues. On November 20, 2018, the IRS issued a Memorandum discussing new procedures for voluntary disclosures. According to the IRS Memorandum issued on November 20, 2018, contrary to the previous “one size fits all” application of OVDP programs of the past, “examiner discretion” based on all relevant facts and circumstances will be utilized for purposes of penalty mitigation. Finally, unlike previous OVDPs, offshore and domestic voluntary disclosures will be handled in the same manner.

Making a Voluntary Disclosure- Buyer Beware

The Memorandum states that the intent of the new voluntary disclosure program is to address either potential criminal liability or substantial civil penalty exposure due to a willful failure to report foreign financial assets and pay appropriate income tax thereon. Under current practice, a participant who failed to file a tax return or declare his full income and pay tax due can potentially escape criminal prosecution through voluntary disclosure of the deficiency, so long as the voluntary disclosure is made before an investigation has started. A disclosure must also be truthful, complete, and the participant must cooperate with IRS personnel in determining the correct tax liability. (Cooperation includes making good faith arrangements to pay unpaid taxes and penalties to the extent of the participant’s actual ability to pay). Unfortunately, even if a participant makes a timely disclosure and cooperates with the IRS, for reasons discussed below, a voluntary disclosure is far from a “sure thing.”

A voluntary disclosure will not in and of itself guarantee immunity from prosecution. Examples of this are illustrated in United States v. Tenzer, 127 F.3d 222,226 (2d. Cir. 1997) and Crystal Pools v. United States, 172 F.3d 1141, 1146 (9th Cir. 1999). In Tenzer, a taxpayer attempted to negotiate an installment payment plan with the IRS and filed amended tax returns pursuant of a voluntary disclosure. The IRS unilaterally determined the taxpayer did not qualify for the voluntary disclosure program because his offer to settle his back tax liabilities was inadequate. The IRS unilaterally determined the taxpayer did not qualify for the voluntary disclosure program because his offer to settle his back liabilities was inadequate. The taxpayer was charged with four counts of failing to file tax returns.

The taxpayer moved to dismiss the charge on the ground that the IRS had violated his due process rights by prosecuting him in violation of the voluntary disclosure program. The district court found that the taxpayer had complied with the voluntary disclosure policy and that the IRS was constitutionally required to comply with its own published policies; therefore, the charges against the taxpayer had to be dismissed. The Second Circuit Court of appeals reversed the district court’s decision, stating that the taxpayer’s due process rights had not been violated because the taxpayer had not paid his taxes or made arrangements to pay his taxes. The Second Circuit Court of Appeals also held that the IRS is not constitutionally required to comply with its own published policies.

In Crystal, the taxpayers, through their attorney, initiated contact with the IRS of Los Angeles for a voluntary disclosure. The attorney was told that voluntary disclosures were generally handled by the taxpayers’ local IRS district office. The attorney contacted the CID office for southern California, who confirmed that the IRS still had a voluntary disclosure program permitting taxpayers to amend past tax returns without the threat of criminal prosecution. Upon further discussion, the IRS told the attorney that the taxpayers’ profiles fit the program’s requirements and that there was no prior IRS investigation underway that would disqualify them. In the meantime, the taxpayers’ attorney faxed the IRS a confirmation letter of voluntary disclosure concerning the taxpayers’ unreported income. The Los Angeles office thereafter initiated a full investigation of the taxpayers. When the taxpayer argued that they had been misled in making disclosures to the IRS, and that the IRS acted in bad faith, the district court found their voluntary disclosure did not foreclose investigations. In addition, the misrepresentation upon which the taxpayers relief could not be imputed to the IRS. The Ninth Circuit Court of Appeals affirmed the case.

A review of case law and the Internal Revenue Manual (“IRM”) points out that regardless of whether a participant actually benefits or suffers detriment from voluntarily disclosing and rectifying faulty tax returns, that disclosure itself does not formally insulate the participant from prosecution. Anyone considering making a voluntary disclosure to the IRS must understand making such a disclosure is a calculated risk. In deciding whether or not an individual should avail him or herself of the voluntary disclosure program, the individual must weigh competing probabilities. A factor that would tend to discourage submitting to the voluntary disclosure program could be in cases where an individual is providing evidence that could be used against him or her that may not otherwise be unobtainable by the IRS. The factor that would tend to encourage participation in the voluntary disclosure program is when it may not be in the best interest of the government to criminally prosecute, or even attempt to impose the civil fraud on the taxpayer who availed himself of the voluntary disclosure program.

In any event, anyone considering making a voluntary disclosure to the IRS should carefully weigh their options before proceeding. The rule of caveat emptor definitely applies to anyone considering making a voluntary disclosure to the IRS.

The Procedures Governing a Voluntary Disclosure

Pre-Clearance Process

After an individual carefully considers his or her options and elects to make a disclosure to the IRS, an initial disclosure must be made to the IRS. The purpose of this initial disclosure is to determine if the individual can qualify to make a disclosure to the IRS. If the IRS has already begun to investigate an individual, that individual will not qualify to make a voluntary disclosure to the IRS. An initial voluntary disclosure may be done by a fax to the IRS CI Lead Development Center. The following must be included in the disclosure:

  1. Applicant identifying information including complete names, dates of birth (if applicable), tax identification numbers, addresses, and telephone numbers;
  2. Identifying information of all financial institutions at which undisclosed assets were held. Identification of undisclosed financial accounts.
  3. Identification of all foreign and domestic entities through which undisclosed assets were held by the individual seeking to make a voluntary disclosure.

IRS CI will notify the participants via fax whether or not they have been cleared to make a voluntary disclosure. Acceptance will be made by letter and simultaneously IRS CI will forward the voluntary disclosure with all attachments to the Large Business and International (“LB&I”) Austin unit for case preparation before examination.

Processing

Upon receipt of the relevant information from IRS CI, LB&I Austin, Texas will “route” the case as appropriate. Austin in effect will assign the case to an IRS examiner. In order to mitigate interest exposure, Austin will accept payment prior to case assignment for those taxpayers wishing to make prompt payment. All distributed disclosures from Austin handled by the IRS exam will follow standard IRS audit procedures. With that said, unlike the earlier “take it or leave it” or “one size fits all” offshore voluntary disclosures, examiners are directed to develop cases by using appropriate information gathering tools to determine proper tax liabilities and applicable penalties. The IRS expects that all disclosures made under the practice will be resolved by a closing agreement with full payment of taxes, interest, and penalties for the relevant disclosure period. Failure to cooperate with civil examination could result in the IRS examiner requesting IRS CI to revoke the preliminary acceptance. The Memorandum relies on the IRM for the purpose of providing guidance on the meaning of cooperation, which includes assisting the IRS in determining the correct tax liability for the tax returns being audited.

The New Civil Resolution Framework

The Memorandum introduces a new “Civil Resolution Framework” and grants the IRS discretion to extend this framework to non-offshore (i.e., domestic voluntary disclosures that have not been resolved). The Civil Resolution Framework calls for a six-year disclosure period (down from eight years in the 2014 OVDP) and will apply to all voluntary disclosures. However, while this is a general rule to apply to the most recent six tax years, disclosures and examinations periods may vary for voluntary disclosures not resolved by agreement- discretion is delegated to the examiner to expand the scope of the years at issue (i.e., beyond six years) to include the full duration of the non-compliance and may also assert maximum penalties under the law with approval of IRS management.

Accordingly, anyone making a voluntary disclosure to the IRS needs to consider the statute of limitations on assessments. As discussed above, the HIRE Act dramatically expanded the statute of limitations to assess tax liability on undisclosed foreign income. Anyone with undisclosed offshore income beyond applicable “open” tax years of the new program could find themselves being assessed significant taxes going back to at least the 2003 tax years. This is a major hazard that must be considered by any taxpayer with undisclosed offshore income.

Under the “Civil Resolution Framework,” individuals making a voluntary disclosure must submit all required returns and documents requested for the disclosure period (However, as discussed above, the standard six year disclosure period may be expanded). At the conclusion of the IRS examination of all relevant information, an IRS examiner will determine the applicable tax, interest, and penalties. In regards to the penalties that may be assessed, the Memorandum provides the following guidance:

The civil fraud penalty set forth in Section 6663 will apply to the one year with the highest tax liability. A civil fraud penalty equal to 75 percent of the underpayment of tax attributed to fraudulent conduct. Alternatively, the civil penalty under Section 6651(f) for the fraudulent failure to file tax returns can apply. (Under Internal Revenue Code Section 6651(f), the failure to timely file a penalty can be punished by a civil fraud penalty). In “limited circumstances” IRS examiners may apply the civil fraud penalty (whether based on Section 6663 or Section 6651) to more than one year within the circumstances of the case. In the event a participant fails to cooperate and resolve the examination by agreement, examiners are authorized to potentially apply the civil fraud penalty beyond the six-year disclosure period.

In cases of undisclosed foreign bank accounts, willful FBAR penalties (The willful penalty equals to a penalty of $100,000 or 50 percent of the value of the undisclosed foreign financial account(s)) will be asserted in accordance with existing IRS penalty guidance under IRM 4.26.16 and 4.26.17 (i.e., for one year during the disclosure timeframe). Participants may request the imposition of accuracy-related penalties under Section 6662 (The Internal Revenue Code imposes an additional tax of 20 percent on the portion of an underpayment of tax attributed to “negligence for rules and regulations) in lieu of civil penalties discussed above and/or non willful FBAR penalties (In cases of non willful violations, the IRS may assess a penalty up to $10,000 per violation) instead of willful penalties. However, the Memorandum warns that given the “objectives of the voluntary disclosure practice” granting such requests for lesser penalties “is expected to be exceptional.” No examples are given; however, the taxpayer must provide convincing evidence to justify why the civil fraud and willful FBAR penalties should not be imposed where the facts and law supports such penalties. Anyone considering making a disclosure to the IRS should carefully consider defenses to the civil fraud penalties and FBAR before entering into the program.

Taxpayers with undisclosed international informational returns, such as Forms 5471 and 3521, may under certain circumstances utilize the new voluntary disclosure program to reduce their exposure to international penalties. The penalty for late-filing a Form 3520 is $10,000 and the penalty for not timely filing a Form 3520 can be much greater. These penalties are not subject to administrative waivers. See IRM 20.1.1.3.3.2.1 (11-21-2017). Under the new voluntary disclosure procedures, penalties for failure to file international information returns will not be automatically applied. Instead, IRS examiners are granted discretion to take into account the application of other penalties such as the civil fraud penalty and the willful FBAR penalty and resolve the examination by agreement. The Memorandum specifically indicates these penalties will be addressed by IRS examiners based on the facts and circumstances, and examiners are directed to coordinate with appropriate subject matter experts. In certain cases, the voluntary disclosure program may offer relief to those facing significant offshore penalties.

Streamlined Compliance Procedures

Individuals who did not willfully fail to disclose their foreign financial assets and/or foreign income to the IRS, should consider disclosing their previously undisclosed foreign financial assets and/or foreign income to the IRS through the Streamlined Compliance Procedures. Unlike the targeted offshore voluntary disclosure programs, where each submission was reviewed by the IRS, under the Streamlined Procedures, the IRS applied its regular audit selection process. With that said, individuals considering entering into the Streamlined Compliance Procedures should understand that it is not an official program offered by the IRS. Instead, the Streamlined Compliance Procedures is merely a filing position. And, as such, the IRS is free to audit a Streamlined Compliance Procedures submission and in appropriate circumstances recommend criminal prosecution and/or additional civil penalties.

Under the Streamlined Compliance Procedures, participants are subject to a 5 percent penalty on the highest aggregate undisclosed foreign account(s) balance for the last three years of non-compliance.

As discussed above, tax returns submitted under the Streamlined Compliance Procedures are subject to selection for an IRS audit. In other words, there is no assurance that the IRS will accept a submission. As a matter of fact, the IRS’ own website provides the following words of caution:

“Returns submitted under the Streamlined Procedures will not be subject to IRS audit automatically, but they may be selected for audit under the existing audit selection process applicable to any U.S. tax return and may also be subject to verification procedures in the accuracy and completeness of submissions may be checked against information received from banks, financial advisors, and other sources. Thus, returns submitted under the streamlined procedures may be subject to IRS examination, additional civil penalties, and even criminal liability, if appropriate. Taxpayers who are concerned that their failure to report income, pay tax and submit required information returns was due to willful conduct and who therefore seek assurances that they will not be subject to criminal liability and/or substantial monetary penalties should consider participating in the OVDP.”

The Procedure for Making a Streamlined Compliance Disclosure

Any individual participating in the Streamlined Compliance Procedures must submit a certificate to the IRS. The Certificate must include the following:

  1. Participants must certify that they failed to report income from one or more foreign financial assets during one or more of the three prior years;
  2. Participants must certify that their failure to report and pay taxes with respect to offshore financial assets was “non-willful.” Participants are required to certify the following statement:

“My failure to report all income, pay all taxes, and submit all required information returns, including FBARs, was due to non-willful conduct. I understand 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.”

The Certificate form goes on to ask participants to “provide specific reasons for your failure to report all income, pay all taxes, and submit all required information returns, including FBARs. If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice.”

In addition, the following acknowledgment must be provided:

“I recognize that if the Internal Revenue Service receives or discovers evidence of willfulness, fraud, or criminal conduct, it may open an examination or investigation that could lead to civil fraud penalties, FBAR penalties, information return penalties, or even referral to Criminal Investigation.”

FBAR Returns That Must be Submitted with a Streamlined Submission

Anyone making a Streamlined submission must file FBAR informational returns for the last six years. If an individual failed to timely file correct or complete FBARs for any of the last six years, the participant must certify that he or she now filed correct FBARs, and must include a statement explaining that the FBARs are being filed as part of the Streamlined Compliance Procedures.

Income Tax Liabilities

Any participant of the Streamlined Compliance Procedures must pay additional income taxes plus interest attributable to omitted offshore income for the prior three years of the financial noncompliance. It is important to note that individuals participating in the Streamlined Procedures must have previously filed income tax returns for the period covered under the program.

Conclusion

The IRS currently has a number of programs aimed at encouraging taxpayers to come forward with voluntary disclosures to disclose previously undeclared foreign financial assets or foreign income. An individual considering disclosing their previously undisclosed foreign financial assets and/or foreign income should have an international tax attorney provide them with a careful analysis of his or her facts to determine how to best proceed. The tax attorneys at Diosdi & Liu, LLP have significant experience assisting clients avoiding or penalties associated with failing to disclose foreign assets and foreign income on U.S. tax returns.

Anthony Diosdi

Written By Anthony Diosdi

Partner

Anthony Diosdi focuses his practice on international inbound and outbound tax planning for high net worth individuals, multinational companies, and a number of Fortune 500 companies.

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