Introduction to the Offshore Voluntary Disclosure Program (OVDP)
For many years, a large number of U.S. taxpayers have placed and continue to place large sums of money in foreign financial accounts. Many of these individuals, knowingly or unknowingly, violate federal law by not disclosing these foreign accounts to the Internal Revenue Service (“IRS”). In an effort to step-up enforcement of disclosing foreign financial accounts to the IRS, the United States Department of Justice has successfully pierced previously secret banking in foreign countries. As a result, the IRS has been gaining access to information regarding undisclosed foreign financial accounts. This left many individuals scrambling to make a voluntary disclosure to the IRS to avoid criminal prosecution and serious civil penalties some of which are discussed in detail below.
Potential Penalties for Failure to File OVDP
Federal law provides that if a U.S. taxpayer has a financial interest in, or signature or other authority over, any financial accounts in a foreign country, including bank accounts, securities, or other type of financial accounts, and if the aggregate value of these accounts exceed $10,000 at any time during the calendar year, that individual must disclose that account on a FinCen 114 (also known as “FBAR”) with the IRS. The IRS can levy a failure to file penalty of up to $10,000 per year. However, the failure to file penalty may increase to $100,000 per year if it is determined that the violation was willful. The Government may even assess a criminal penalty of up to $500,000 and ten years in prison for such a violation. The IRS can assess significant penalties for not disclosing foreign financial accounts on a number of informational returns. In the past, many U.S. taxpayers who did not timely disclose foreign financial accounts to the IRS through either the 2009, 2011, 2012, or 2014 Voluntary Disclosure Programs (“OVDP”).
Under the terms of the OVDP programs, taxpayers were required to amend their tax returns for up to eight years to include any previously unreported foreign source income. Participants were also required to file all previously omitted offshore informational returns such as FinCEN 114a. Additionally, participants were required to pay all delinquent taxes, interest, and penalties. In exchange for participating in an OVDP, the IRS stated that they “may decide not to recommend a criminal prosecution.” For the most part, individuals that elected to participate in the OVDP were not criminally prosecuted by the Government for failing to disclose foreign financial accounts or tax related crimes. Depending on the OVDP program, the participants paid either a 20, 25, 27.5, or 50 percent penalty on the greatest aggregate amount of all undeclared foreign assets. The participant also promised to fully cooperate with the IRS in determining the correct amount of tax, interest, and penalties owed. The OVDP programs assisted thousands of individuals in disclosing undisclosed foreign financial accounts to the IRS. However, individuals looking to disclose previously undisclosed foreign financial accounts to the IRS after September 28, 2018 will no longer be able to utilize be able to utilize a traditional OVDP. The next section of this article will discuss the state of the OVDP after September 28, 2018.
The State of the OVDP After September 28, 2018
Now since the IRS will no longer be supporting the OVDP, can an individual with undisclosed foreign assets safely disclose those previously undisclosed assets to the IRS without the fear of a criminal referral to the Department of Justice? Unfortunately, there is no easy answer to this question. With that said, even though the IRS will no longer have an OVDP program after September 28, 2018, the spirit of the OVDP will likely continue as long as the taxpayer making the disclosure makes a true voluntary disclosure.
Under current practice, the IRS now considers a true “voluntary disclosure” along with other factors in determining whether or not to recommend prosecution to the Department of Justice. A voluntary disclosure occurs when the communication is truthful, timely, complete, and when the taxpayer cooperates with the IRS in determining the correct tax liability, so long as the disclosure is received before the IRS has initiated an inquiry that is likely to lead to the taxpayer and to which the taxpayer is thought to be aware of, and the taxpayer does not know of some event that is likely to cause an audit.
A disclosure of a foreign financial account or asset for voluntary disclosure purposes must be made before the IRS discovers the undisclosed account and/or income. A disclosure within this meaning of the practice also means a communication that is truthful and complete, and the individual making the disclosure must cooperate with IRS personal in determining the correct tax liability. With that said, a voluntary disclosure will not of itself formally immunize the participant from criminal investigation or criminal prosecution. In deciding whether or not to disclose an undisclosed foreign financial account, foreign asset, and/or foreign source income, a taxpayer must weigh competing probabilities. A factor that would tend to encourage making a voluntary disclosure to the IRS could be that a taxpayer may provide evidence that could be used against him that may otherwise be unobtainable by the government. The factor that would tend to encourage a voluntary disclosure is that it may not be in the best interest of the Government to criminally prosecute taxpayers who has disclosed a foreign financial asset.
At first glance it appears that disclosing a previous undisclosed foreign financial account or asset to the IRS post September 28th will be far more risky. Despite the fact that making a voluntary disclosure of a foreign financial account to the IRS appears more risky, Government will always try to encourage people to engage in certain behavior. Encouraging taxpayers to disclose foreign financial accounts and income is in the best interest of the Government. Prosecuting individuals who make a voluntary disclosure of a previous undisclosed foreign financial account and/or foreign source income will likely dissuade others from making voluntary disclosures to the IRS. Consequently, it is unlikely taxpayer (who has timely made a disclosure, acts truthfully, and cooperates with the IRS) disclosing foreign source income, source financial accounts, or foreign financial assets will face a greater risk of prosecution after September 28, 2018.
What About the Civil Penalty Under OVDP Programs? There’s good news.
Under previous OVDP programs, participating taxpayers were subject to a set penalty based on the highest aggregate undeclared foreign assets during a certain period. The IRS Revenue Officer assigned to the participants case did not have discretion to deviate from the set penalty which in some cases could be as high as 50 percent of the aggregate value of undeclared foreign assets. A participant did not agree with the uniform OVDP penalty structure, the taxpayer’s only option was take his or her chances and opt out of the OVDP program and risk a greater liability. Over the years the inflexible OVDP penalty structure frustrated by participants and IRS Revenue Officers. The good news in a post September 28th world is that there are no minimum penalties on the aggregate amount of previously undeclared foreign assets. This means that IRS Revenue Officers reviewing voluntary disclosures will no longer be bound to assess an automatic penalty. The fact that the IRS will no longer assesses a minimum penalty on offshore voluntary disclosures is good news for taxpayers who did not willfully or recklessly in failing to disclose foreign financial accounts or assets. It is possible participants disclosing foreign source accounts to the IRS will pay significantly less penalties compared to the taxpayers who availed themselves to the OVDP programs of the past. It is also possible that many individuals making voluntary disclosures in a post September 28th world will not be assessed any civil penalties. Obviously, the determination the amount of civil penalties will be determined on a case by case basis. But, given the fact that the IRS will no longer have a minimum penalty structure on offshore voluntary disclosures will certainly be welcome.
How Many Years of Tax Returns Should Be Amended by Individuals Making a Voluntary Disclosure?
Under the terms of the 2012 and 2014 OVDP programs, taxpayers were required to amend their tax returns to disclose foreign financial accounts for up to eight years. Should an individual making a voluntary disclosure in a post September 28th world amend tax returns for eight years? The answer is absolutely yes and in certain cases, additional amendments should considered. Individuals with undisclosed foreign financial accounts and assets must understand that they are not only required by law from file FinCen 114s, but in many cases, these individuals must disclose foreign assets and transactions on IRS informational forms 926, 5471, 8865, 8938, 8861, 8858, 3520, or 3520-A. Failure to file these informational returns can trigger a penalty of up to $60,000 per year for each unfiled informational return. The IRS also assesses interest on these penalties. With this in mind, the IRS statute of limitations on auditing a tax return with a missing informational return stays open the foreign transaction is properly disclosed on an IRS informational returns. In other words, if a taxpayer fails to file a required informational return, the IRS may not only audit the tax return at issue, the IRS may assess additional tax liabilities and penalties until the foreign asset is properly disclosed on the required IRS informational return. The fact that an individual makes a voluntary disclosure to the IRS does not prevent the IRS assessing additional taxes and penalties against an individual who did not properly disclose a foreign asset or transaction on an IRS informational return. Anyone contemplating making a voluntary disclosure to the IRS should make sure that they are fully compliant with all IRS informational return requires for previous years and amend as many returns as necessary. This will reduce the possibility of a devastating audit in the future.
If You’re Considering OVDP, You Need to Carefully Asses Your Situation
Anyone considering making a voluntary disclosure of foreign financial assets to the IRS in a post September 28th world must carefully analyze the undisclosed financial assets and previously filed tax returns. Although making a voluntary disclosure in a post September 28th world may present an opportunity for some, if not done correctly the first time, an individual making a voluntary disclosure in a post September 28th world may find themselves facing a number of future audits with a hefty price tag.