Reporting Undisclosed Foreign Assets

Background

For decades, the IRS has had a voluntary disclosure policy, under which it would not refer for criminal prosecution taxpayers who voluntarily confessed their tax sins. Under the policy contained within the Internal Revenue Manual (IRM), a taxpayer must make a disclosure to the IRS prior to the IRS learning of the taxpayer’s noncompliance. To effect a successful voluntary disclosure, the taxpayer must provide a complete and truthful disclosure; cooperate with the IRS; and pay any tax, interest, and penalties that are due (or make good-faith arrangements for the payment of such). Finally, the disclosure must not relate to illegal-source funds; however, untaxed monies are not deemed illegal.

This longstanding policy is merely a criminal policy and has no impact on the IRS’s ability to seek civil penalties that would apply to a taxpayer’s noncompliance. Such civil penalties can include the familiar tax penalties, including the 75% fraud penalty, as well as penalties for failing to file a report of foreign bank and financial accounts (FBAR) or other International Information Returns, such as IRS Forms 5471, 3520, 3520-A, and others. Taxpayers who made disclosures pursuant to this policy did not know in advance which penalties would be applied by the IRS and what, if any, penalty mitigation they would receive.

As part of the IRS’s efforts to combat offshore tax evasion, the IRS announced its first OVDP in 2009. The 2009 OVDP built upon the IRS’s voluntary disclosure policy by adding a fixed civil penalty regime that would be applicable to those who came forward under the program. Thus, taxpayers could now avoid criminal prosecution by making a voluntary disclosure while also having certainty as to the financial price they would pay as part of the disclosure. This fixed and predictable penalty structure likely contributed to the OVDP’s success; as of March 2018, more than 56,000 taxpayers have come forward under the OVDP and have paid $11.1 billion in back taxes, interest, and penalties.

The Current Offshore Voluntary Disclosure Program

While the 2009 OVDP has since been replaced with the currently applicable 2014 OVDP, the overall structure has remained the same, albeit with an uptick in the penalty rate with each subsequent iteration. In its current form, the program generally requires taxpayers to file eight years of accurate amended (or original) tax returns reflecting any omitted income from the offshore assets and pay the tax due, plus an accuracy-related penalty equal to 20% of the additional tax due. In addition, in lieu of the FBAR penalty and all other information return penalties, participating taxpayers must pay a miscellaneous penalty equal to 27.5% or 50% of the highest aggregate balance of the previously unreported foreign assets during the eight-year look-back period. This penalty, referred to as the miscellaneous offshore penalty, applies to any offshore asset that is related to tax noncompliance, not just to foreign bank accounts.

For purposes of the OVDP, a foreign asset is related to tax noncompliance if the asset either generated unreported gross income or was funded or acquired with unreported income. The miscellaneous offshore penalty is increased from 27.5% to 50% for those taxpayers who held accounts at any foreign bank that has publicly been identified as either being under investigation, cooperating with the IRS, or the subject of a court-approved summons seeking information about U.S. taxpayers. A taxpayer who maintains even a single account at such a bank will be subject to the 50% penalty rate on all OVDP assets.

Closing the OVDP

In explaining its reasoning for closing the OVDP, the IRS noted that at the program’s peak in 2011 it attracted 18,000 taxpayers, while in 2017 only 600 taxpayers came forward. The IRS stressed, however, its continued focus on offshore enforcement and noted it would turn to other enforcement tools such as the Foreign Account Tax Compliance Act (FATCA), intergovernmental agreements between the United States and other countries, automatic third-party account reporting, John Doe summonses, and other “data-rich sources” to ensure compliance. The announcement also clarified that the IRS’s other offshore compliance programs would remain available after September 28, 2018, to those taxpayers who qualify under their terms. These include the following:

• Streamlined filing compliance procedures. Taxpayers whose tax and reporting noncompliance is not willful may be able to utilize this program to come into compliance by filing accurate tax returns for the past three tax years and FBARs for the past six years. For resident taxpayers, a penalty equal to 5% of the value of the noncompliant foreign financial assets is imposed; for nonresident taxpayers, no penalty is imposed. A taxpayer utilizing this program must certify under penalties of perjury that the non-compliance was not willful.
• Delinquent FBAR procedures. Taxpayers who are fully tax compliant, but who have not filed required FBARs, can use these procedures to come into compliance without the imposition of any penalties.
• Delinquent international information return procedures. Taxpayers who are fully tax compliant, but who have not filed required International Information Returns (such as Form 5471, 3520, or 3520-A), and who have reasonable cause for such failure, can use these procedures to come into compliance without the imposition of any penalties.

While a full review of these programs is beyond the scope of this article, it is important to note that these programs are narrowly tailored and are generally only available to those taxpayers whose conduct was not willful or nefarious. These programs do not provide any protection from criminal prosecution because the conduct they are intended to cure is not criminal. Taxpayers whose conduct was willful and who thus face the possibility of criminal prosecution are best served by making a voluntary disclosure.

The Future

Taxpayers have until September 28, 2018, to submit the OVDP Letter and Attachments and thus qualify for the terms of the current OVDP. Taxpayers who need to make a voluntary disclosure of offshore assets would therefore be best served to act quickly. Any subsequent program offered by the IRS is likely to come with even stiffer penalties, as evidenced by the increase in penalty rates between the original 2009 OVDP and the current OVDP.

For those taxpayers who need to make a voluntary disclosure of offshore matters after the deadline, the IRS’s general voluntary disclosure policy will continue to be available. Taxpayers proceeding in that manner will need to satisfy all of the requirements of making a voluntary disclosure noted above and should be mindful of two things in particular.

First, such taxpayers must make sure that they win the race by getting to the IRS before the IRS learns of their non-compliance. A taxpayer who comes forward after the IRS has learned of his conduct is not deemed to have made a timely voluntary disclosure. While the issuance of a summons to a third party seeking information about a class of people will not disqualify such taxpayers from making a voluntary disclosure under the IRS’s general voluntary disclosure policy, once the IRS has obtained the information from the third party that evidences a taxpayer’s non-compliance, that taxpayer is disqualified from making a voluntary disclosure; this is so even if the taxpayer is not aware that her information has been turned over to the IRS. As the IRS moves forward with its many sources of information, including its recent focus on unreported cryptocurrency-related income, taxpayers should come forward before their noncompliance comes to light.

Second, taxpayers and their advisors will need to grapple with the difficulty of making a voluntary disclosure without any certainty as to the financial cost of making such a voluntary disclosure. Voluntary disclosures made after the deadline will not be subject to any fixed penalty regime and will likely result in penalties that are even higher than the already steep 2014 OVDP penalty structure. This may lead some taxpayers to try to shoehorn their situation into one of the non-OVDP programs discussed above. Taxpayers struggling with this dilemma will need to be guided by competent professionals who can analyze the facts of their case and objectively determine whether their conduct was willful.