The IRS recently launched a second offshore voluntary disclosure initiative (OVDI). The 2011 OVDI is very similar to one offered in 2009, which, according to the IRS, resulted in more than 15,000 taxpayers voluntarily disclosing previously unreported foreign accounts. The IRS is predicting that the second disclosure initiative will be as successful if not more successful than the first one. The 2011 OVDI is a complex and lengthy process. This letter highlights some of the key elements of the initiative.
Reporting requirements. United States persons who have a financial interest in or signature authority or other authority over any financial account in a foreign country, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year, must report these accounts to the IRS. These disclosures are made on a special U.S. government form, Report of Foreign Bank and Financial Accounts (known as the “FBAR”).
Taxpayers who do not disclose their foreign accounts, if required, risk many penalties. Depending on the taxpayer’s facts and circumstances, some of the penalties include, but are not limited to, penalties for failing to file certain returns, fraud penalties, and an accuracy-related penalty on underpayment of tax. The IRS can also seek criminal sanctions against a taxpayer.
Voluntary disclosures. In recent years, the IRS has used a carrot and stick approach to encourage taxpayers with unreported foreign accounts to make voluntary disclosures. In 2009, the IRS offered taxpayers a reduced penalty framework in exchange for full disclosure. At that time, IRS officials said the program was one-time only. However, interest in the program remained strong after it ended and in January 2011, the IRS announced a second offshore disclosure initiative.
The 2011 OVDI also offers taxpayers a reduced penalty framework in exchange for full disclosure of unreported foreign accounts. The penalty framework for the 2011 OVDI is less generous than the penalty for the 2009 program. The IRS did this intentionally so as not to reward taxpayers who did not come forward in 2009.
At the same time, the IRS recognizes that not every taxpayer with a foreign bank account is a tax evader. In some cases, funds were deposited long ago in a foreign bank and the children or grandchildren of the depositor may be unaware of the account or their obligation to report it. In other cases, individuals deposited money in a foreign bank to escape persecution in their home country and after they became U.S. citizens they failed to report the account. The 2011 OVDI includes reduced penalties that may apply in these and similar situations.
Penalty framework. In most cases, the 2011 OVDI penalty is 25 percent of the amount in the foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period. Some taxpayers may be eligible for five or 12.5 percent penalties. Participants also must pay back-taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.
The 12.5 percent penalty applies to taxpayers with smaller offshore accounts. The IRS has explained that these generally are taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year covered by the 2011 OVDI. The five percent rate may apply if the taxpayer can show that the foreign account was not used to hide income and the taxpayer did not have withdrawals of more than $1,000 in any year, unless transferred to an account in the U.S. The five percent penalty may also apply in the case of a foreign resident who was unaware that he or she was a U.S. citizen.
The penalty is intended to apply to all of the taxpayer’s offshore holdings that are related in any way to noncompliance with U.S. tax laws. The penalty applies regardless of the form of the taxpayer’s ownership or the character of the asset. If the assets are assets are indirectly held or controlled by the taxpayer through an entity, the penalty may be applied to the taxpayer’s interest in the entity or to the taxpayer. The IRS has also emphasized that its agents and managers have no discretion or authority to negotiate a different penalty for taxpayers who request to participate in the initiative.
Steps. On its web site and in other materials, the IRS has described the steps taxpayers must take to request to participate in the 2011 OVDI. The IRS first instructs taxpayers to request pre-clearance into the program. If approved, the IRS will notify the taxpayer that he or she has been cleared to make a voluntary disclosure. The IRS has developed a package of materials for taxpayers to use to make voluntary disclosures. The package must be provided to the IRS no later than August 31, 2011.
Quiet disclosures. Some taxpayers tried to avoid the penalty in the 2009 initiative by making so-called “quiet disclosures.” They filed amended returns and paid any tax due on previously unreported offshore income without participating in the disclosure program. The IRS is encouraging taxpayers who made quiet disclosures to come forward under the 2011 OVDI. The IRS has reported it is examining quiet disclosures and will impose penalties to the fullest extent allowed.
More reporting. The IRS will soon have more tools to discover funds in foreign accounts and other assets outside the U.S. In 2010, Congress passed legislation (the Hiring Incentives to Restore Employment (HIRE) Act) requiring taxpayers to attach a disclosure statement to their income tax return if the aggregate value of all specified foreign financial assets exceeds $50,000. Taxpayers will make these disclosures with their 2011 tax returns filed in 2012. The HIRE Act also imposes new disclosure and reporting requirements on foreign banks and financial institutions.
The 2011 OVDI is not an amnesty program, despite frequently being referred to as one in the general media. There are serious financial consequences. Taxpayers need to consult with tax professionals before contacting the IRS. Because all disclosures must be made before August 31, 2011, taxpayers have only a short window in which to act. If you have any questions about the 2011 OVDI, please do not hesitate to contact our office.