The IRS’s streamlined filing procedures for offshore assets were announced in 2012 for non-U.S. residents and extended to U.S. residents in 2014. The streamlined procedures are open to taxpayers whose failure to report foreign financial assets “did not result from willful conduct.” Under the streamlined procedures, the taxpayer must submit three years of amended tax returns and six years of Reports of Foreign Bank and Financial Accounts (FBAR), pay all of the tax and interest due, and, for U.S. residents, pay a one-time miscellaneous offshore penalty in the amount of 5% of the highest year-end value of the assets subject to the penalty. While submissions made under the streamlined procedures are not subject to the same scrutiny as under the offshore voluntary disclosure program (OVDP), they are also not provided the same insulation from criminal prosecution and willful penalties. The IRS has informed taxpayers that submissions “may be selected for audit under the existing audit processes applicable to any U.S. tax return,” meaning that only some of the submissions will be audited.

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Although the streamlined procedures have been in place for years, audits of streamlined filings have only just begun. These audits require careful preparation and sensitivity, given the fact that criminal prosecution or willful penalties are not off the table if the IRS determines that the taxpayer’s conduct was willful.

The Streamlined Filing Procedures and Pre-audit Considerations

Arguably, the most important aspect of the streamlined procedures is the narrative certifying the taxpayer’s nonwillfulness in failing to previously report offshore assets. Whether a U.S. resident submitting an IRS Form 14654, Certification of U.S. Person Residing in the United States, or a nonresident submitting an IRS Form 14653, Certification of U.S. Person Residing Outside of the United States, the taxpayer is required to “provide specific reasons for [the taxpayer’s] failure to report all income, pay all tax, and submit all required information returns, including FBARs.” The taxpayer must describe all of the facts (favorable and unfavorable), give a description of his background, lay out the source of the funds or assets, and describe contacts with the account or asset.

Although preparation of the streamlined narrative occurs well before the taxpayer knows whether the submission will be chosen for audit, the taxpayer and her advisors should draft the narrative with a potential audit in mind for several reasons. First, it may be that the taxpayer can avoid triggering an audit through the streamlined narrative by satisfying the reviewing agent that her conduct was consistent with nonwillfulness. Second, if the submission is audited, the certification is a critical component for the IRS in assessing the taxpayer’s willfulness. Finally, the taxpayer is required to sign the narrative under penalties of perjury, providing the IRS with an independent vehicle for attack against the taxpayer if any of the information provided in the streamlined narrative is later proven to be false.

For all of these reasons, the determination to make a streamlined submission as opposed to proceeding through the OVDP should be made with careful consideration of all of the relevant facts and circumstances. For a full discussion of the various factors that a taxpayer and his advisors should take into consideration prior to making a streamlined submission, see the July 2017 installment of this column (Sharon L. McCarthy, “The Pitfalls of Streamlined Foreign Account Disclosures,” http://bit.ly/2Lm4Xjr). The taxpayer and his advisors should be confident that the taxpayer can provide a strong narrative statement that will stand up under audit.

Audit Initiation

A streamlined audit is initiated with a notice of examination, in the same way as any other audit. Experience indicates that it will likely be years after the streamlined package is submitted before the IRS initiates an audit. Due to the passage of time, the taxpayer may have thought she was done with the process; therefore, it is important to inform the taxpayer at the outset of the possibility of an audit being initiated years later.

Upon receipt of a notice of examination, it is a good idea for the taxpayer, the taxpayer’s counsel, and the taxpayer’s accountant to review the amended returns and the streamlined certification in order to refamiliarize themselves with the information that the IRS has in its possession.

The streamlined filing procedures state that any streamlined submission “may be selected for audit under the existing audit processes applicable to any U.S. tax return.” Other than that language, the IRS has not issued any guidance regarding what may trigger an audit of a streamlined submission. As more streamlined submissions are chosen for audit, practitioners may be able to determine factors that are likely to trigger an audit, but at this stage, it is unclear whether audits will be initiated on anything other than a random basis.

Requests for Documents

Unlike the OVDP, the streamlined procedures require the taxpayer to submit only amended tax returns and the streamlined certification. Therefore, when an audit is initiated, the taxpayer should expect requests for documents, perhaps even at the same time they receive the notice of examination. Initially, such document requests will be made through the use of a Form 4564 Information Document Request (IDR); however, summonses are possible during the course of the audit, especially if the taxpayer fails to respond to the IDR. For this reason, it is in everyone’s best interest to establish a good relationship with the revenue agent and to request additional time to respond to an IDR if necessary.

Almost undoubtedly, the IRS will request bank statements for all offshore accounts, as well as documentation relating to the accounts, including account opening statements, correspondence with the bank, and signature cards. The IRS will also likely request the six years of FBARs and copies of foreign tax returns, if any were filed. Because these documents will have been used in the preparation of the amended tax returns, they should be maintained and readily accessible in the event of an audit.

Other documents the IRS is likely to request include documents related to any other foreign assets divulged on the amended tax returns. For example, if the taxpayer’s amended returns disclosed an interest in a foreign entity, the IRS may request documentation or information regarding the taxpayer’s interest in that entity, including when the taxpayer acquired his interest, what business that entity conducts, the identity of any other owners, and whether the taxpayer derived any income from that entity. If, instead, the taxpayer’s amended returns disclosed rental income from a property located abroad, the IRS may request documentation of that income, as well as evidence to support any expenses associated with the property.

The IRS may also ask the taxpayer to produce documentation with respect to non–bank account assets that were included in the taxpayer’s computation of the miscellaneous penalty. This is another important consideration. The taxpayer should be able to back up any estimated values of assets included in the penalty computation.

Audit Interviews

Taxpayer interview.

At some point during the audit, the IRS will request to interview the taxpayer. The audit interview is the most sensitive and potentially the most advantageous aspect of the audit. The purpose of the taxpayer interview is to confirm the taxpayer’s submission for correctness, as well as to satisfy the examiner that the taxpayer’s conduct was, in fact, nonwillful.

The interview will be conducted by the agent conducting the audit, but will also include a representative from the IRS Chief Counsel’s office and potentially a manager. There will also be a court reporter taking down the taxpayer’s testimony. If the streamlined submission was made jointly by spouses, the IRS will interview each taxpayer separately. In preparing the taxpayer for such an interview, the taxpayer should be made aware of these facts so that she is not caught off guard on the day of the interview.

It is important during this preparation to give the taxpayer an idea of the questions he may face, including the routine questions that the IRS asks no matter the individual circumstances. It is also important to anticipate how the taxpayer may react to a stressful situation. An important aspect of the interview is making sure the IRS has a good impression of the taxpayer and finds him to be credible. The more comfortable the taxpayer is, the more likely he will be able to convey his credibility.

The taxpayer’s interview will begin with a thorough rundown of the taxpayer’s background and education. The taxpayer is also likely to face general questions regarding what is done to prepare tax returns on a yearly basis. If the taxpayer used a tax return preparer, the IRS will want to know about any documents the taxpayer provided to, and conversations the taxpayer had with, the return preparer. In addition, the revenue agent will likely ask the taxpayer whether the returns are reviewed before signing.

It is important to remember that the purpose of the IRS’s audit is to confirm the taxpayer’s assertion of nonwillfulness. Therefore, when preparing a taxpayer for an audit interview, special attention should be paid to the facts and circumstances surrounding the basis for nonwillfulness. The taxpayer should be comfortable responding to questions such as why she has offshore assets, why she did not tell the tax return preparer about offshore accounts and assets, and why she did not believe that foreign-sourced income should be reported on her U.S. tax return. The responses to these questions will have to be addressed based on individual circumstances.

The taxpayer should also be made aware that he could face questions that may trigger the attorney-client privilege. Counsel should be present during the interview, but it is beneficial for the taxpayer to be aware of what questions counsel may object to. For streamlined audits, a sensitive topic will be the taxpayer’s decision to use the streamlined procedures instead of entering the OVDP. Where this decision was made with counsel, as it should be, any response to such inquiry will be subject to the attorney-client privilege.

As long as the taxpayer and her advisors were careful in preparing the streamlined submission and there are few or no indications of willfulness, the interview should proceed smoothly. If there are grey areas or sticky facts, however, the taxpayer should be fully prepared for the IRS to question those circumstances thoroughly.

Return preparer interview.

The IRS may also request a formal interview of the taxpayer’s return preparer. The return preparer should be prepared for this eventuality, particularly in cases where the same return preparer prepared the taxpayer’s original returns and the amended returns submitted through the streamlined procedures.

As with the taxpayer, the return preparer should expect to face questions about his background. The IRS will also likely inquire into the return preparer’s procedures for preparing a tax return for a client. In addition, questions about the return preparer’s relationship with the taxpayer, as well as their general communications and interactions with the taxpayer, should be expected.

The return preparer should be familiar with the taxpayer’s nonwillful narrative. It is critical that the return preparer has the same understanding of the facts as the taxpayer. If, for example, the taxpayer asserts that her return preparer never asked her about the existence of offshore assets, the return preparer should be able to testify to the same. Along the same lines, a preparer is likely to face questions about why he did not ask the taxpayer if she had any offshore assets, especially if the taxpayer has dual citizenship or spends time abroad.

Another question that the return preparer is likely to face is whether the taxpayer ever received a questionnaire, and if so, whether that questionnaire asked about foreign assets. If the taxpayer did receive a questionnaire and failed to disclose the existence of any foreign assets to the return preparer, that is something that should be discussed with counsel prior to deciding upon a streamlined submission.

Don’t Panic

When a taxpayer receives a streamlined audit notice, the initial reaction may be dread. With careful planning and preparation, however, the process can go smoothly. The taxpayer and his advisors should always keep in mind that the basis of making a streamlined submission is nonwillfulness and be prepared for the IRS to request information and documents to satisfy itself that the taxpayer did not act willfully.

Cassandra Vogel, JD is a former associate at Kostelanetz & Fink LLP, New York, N.Y.