Citing a strong response to two previous disclosure programs, the IRS has just announced a third offshore voluntary disclosure program (OVDP). These disclosure programs are designed to seek taxpayers who are “hiding” offshore accounts that produce unreported taxable income, and bring them back within the U.S. tax system. The lure is the offer to achieve a controlled disclosure of these assets through the imposition of penalties that, while significant, still are less than the potential civil and criminal penalties that can only be described as draconian. The stepped-up efforts of IRS to both pursue significant prosecutions of taxpayers holding such accounts, and to force more and more foreign financial institutions to divulge the identities of such taxpayers, have led to a heightened awareness by taxpayers that they need to “come forward and come clean” before IRS catches them.
The basic premise of this problem is that the tax law of the United States, unlike most other countries, requires taxpayers to report and pay taxes on all income, including income earned outside of the United States. Even though that foreign income is reported to another country and taxes are paid there, that income also must be reported on the U.S. tax return. In most cases, the double tax is offset or reduced by a foreign tax credit. If the aggregate value of all foreign bank and investment accounts exceeds $10,000 at any time during the year, a Report of Foreign Bank and Financial Accounts (FBAR) must be filed (even if there is no tax due from those accounts). Failure to file this form carries a minimum penalty of $10,000 per year, which can increase if the taxpayer “wilfully” failed to file the form, and criminal penalties can apply as well. Many taxpayers could unknowingly be caught up in this difficulty. For example, an immigrant to the United States who still owns real estate or has bank or investment accounts in the original country would be subject to the disclosure requirements.
According to the IRS, some 33,000 taxpayers have responded to the previous disclosure programs, initiated in 2009 and 2011. Approximately $3.4 billion has been collected through the 2009 program, which is mostly completed, and another $1 billion of “up front” payments have been received so far in the 2011 program, which is only beginning to be processed. IRS reported that since the 2011 program closed in September, many individuals and tax advisors continue to express interest in the disclosure program.
The details of the new OVDP are still sketchy. It appears that the parameters and penalty framework will be similar to the 2011 program, except that the applicable disclosure penalty (which is in addition to other penalties such as underpayment of tax and a 20% accuracy-based penalty) will be 27.5% of the value of the foreign accounts and assets, up from 25% under the 2011 program. This still may be preferable to the potential penalties if the taxpayer holds out and is discovered by IRS. IRS is aggressively pursuing disclosure by offshore financial institutions in many countries, forcing an increasing number of “tax havens” to sidestep bank secrecy laws and divulge information on foreign accounts and income that previously was not taxed by IRS.
Given the increasing chance of being caught, taxpayers and their advisors are giving more consideration to voluntary disclosure. The penalties can be significant, but the alternative is having to constantly live under the shadow of potential discovery by IRS, which could result in extremely severe penalties and expenses, as well as criminal prosecution.
It should be noted, though, that this voluntary disclosure is not the remedy for everyone. For instance, the penalties under OVDP apply to the value of all foreign-based assets resulting in “tax noncompliance”, i.e., unreported income or unpaid tax. This can include foreign assets that do not have to be disclosed on the FBAR (the original basis for OVDP), such as income-producing real estate or valuable artwork sold at a profit. The value of such assets can significantly increase the amount of OVDP penalties. There is a procedure to “opt out” of the disclosure program, once accepted into it, if the penalties under the program are too severe and unwarranted under the facts, such as no unreported income or a lack of “wilfulness” in failing to report the foreign accounts.
We have dealt with these disclosures for our clients. If you or someone you know is in this situation, please give us a call so that we can help.