Recent Changes To Offshore Voluntary Disclosure Program Raises Stakes For Some And Expands Opportunities For Others
Kelley Drye Client Advisory
On June 18, 2014, the Internal Revenue Service announced major changes to its Offshore Voluntary Disclosure Program (OVDP) and Streamlined Filing Compliance Procedures (SFCP) for taxpayers with unreported foreign financial assets and income. The changes to the OVDP impose stricter requirements and potentially higher penalties for taxpayers participating in the program, while the changes to the SFCP expand the class of taxpayers eligible to participate in the program and ease the requirements for participation.
Evolution of and Changes to the OVDPThe changes to the OVDP announced on June 18th are the latest evolution of the offshore voluntary disclosure program first offered by the IRS in 2009 and modified in 2011 and again in 2012. The purpose of the program is and has been to give taxpayers with unreported foreign financial assets and income and unpaid tax an opportunity to declare those assets and income to the IRS in exchange for a prescribed set of penalties and protection against possible criminal tax liability. (The protection against criminal prosecution is not and never has been an absolute guarantee against criminal prosecution. However, acceptance into and compliance with the program generally results in the IRS recommending against criminal prosecution to the U.S. Justice Department.)
As modified, the OVDP continues to impose a prescribed set of penalties, including an accuracy-related penalty equal to 20% of the tax on any unreported income and an “offshore” penalty generally equal to 27.5% of the highest aggregate value of undisclosed foreign financial assets (plus certain other foreign assets that either generated or were acquired with undisclosed amounts) during the period covered by the voluntary disclosure. It also continues to generally provide protection against potential criminal prosecution.
The major changes to the OVDP announced on June 18th are effective July 1, 2014 and include the following:
- Increase in the 27.5% offshore penalty to 50% if the foreign financial institution at which the taxpayer held or holds an unreported financial account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement has been publicly identified as being under investigation or as cooperating with a U.S. government investigation;
- Elimination of the substitute 5% offshore penalty (in lieu of the 27.5% offshore penalty) in cases previously considered by the IRS not to warrant imposition of the higher penalty based on specified taxpayer conduct; and
- Requirement to deliver (potentially incriminating) information about foreign financial institutions as part of the OVDP pre-clearance process.
Participation in the OVDP is not open to taxpayers who are the subject of a civil examination (regardless of whether the taxpayer has received notice that the IRS has initiated an examination and whether the examination relates to an unreported foreign financial asset or income) or who are under criminal tax investigation. The 2012 OVDP established a procedure pursuant to which a taxpayer (or more typically, a taxpayer’s attorney) could obtain pre-clearance from the IRS that the taxpayer was eligible for the program by submitting the taxpayer’s name, date of birth, social security number and address, which the IRS would use to confirm the taxpayer was not the subject to a civil examination or criminal investigation. Once accepted into the program, a taxpayer would provide potentially incriminating evidence, including the names of foreign financial institutions where unreported accounts were maintained, generally without fear that the disclosed information would be used in a criminal prosecution against him.
Under the modified OVDP announced on June 18, 2014, however, the pre-clearance process will require taxpayers to submit not only their unique identifying information noted above, but also the identity of the financial institutions where they maintained accounts or assets. This additional pre-clearance disclosure requirement places taxpayers at a significant disadvantage should the IRS deny their acceptance into the program since at that point the IRS would have information linking the specific taxpayer to a specific foreign financial institution, which information could be used in a subsequent civil or criminal investigation.
Evolution and Changes to the SFCPThe SFCP was first introduced on June 26, 2012 as a way to encourage individual non-resident U.S. taxpayers (i.e., U.S. taxpayers residing outside the United States) with relatively modest U.S. tax compliance failures relating to foreign financial assets and income to remediate those failures through a process less complicated and burdensome than the OVDP and which allowed them to avoid any tax penalties for those failures. To qualify, a U.S. taxpayer had to (i) reside outside the United States since January 1, 2009, (ii) fail to have filed U.S. tax returns since that time (filing U.S. tax returns disqualified a taxpayer from the SFCP), (iii) have less than $1,500 in tax due in each year, and (iv) demonstrate through the completion of a short questionnaire a low risk of tax non-compliance. Under the SFCP, a taxpayer would file delinquent U.S. tax returns for the most recent three years, pay any U.S. tax resulting therefrom, along with statutory interest, submit copies of or file delinquent FBARs for the last six years and submit a questionnaire designed to establish whether the taxpayer represented a high or low risk of tax non-compliance. As noted above, a taxpayer meeting the requirements of the SFCP could avoid tax penalties.
The modified SFCP announced on June 18, 2014 makes several important, and generally taxpayer-friendly, changes to the 2012 SFCP. It eliminates the requirements that the taxpayer (i) have less than $1,500 in tax due in each year covered by the program, (ii) fail to have filed U.S. tax returns for the same years, and (iii) demonstrate a low risk assessment of tax non-compliance. In addition, the program has been expanded to cover U.S. taxpayers who reside in the United States. Separate procedures apply for U.S. residents and U.S. non-residents, although in both cases, taxpayers will have to certify that that their failure to report their foreign financial assets and income and the failure to pay tax thereon was due to “non-willful conduct.” U.S. residents participating in the SFCP will generally be required to pay a penalty equal to 5% of the highest aggregate balance or value of undisclosed foreign financial assets during a six-year look-back period. The IRS announced on June 20, 2014 that it plans to review all taxpayer certifications of non-willful conduct that it receives through the new SFCP.
As in the case of the OVDP, a taxpayer that is under civil examination or criminal investigation is not eligible for the SFCP.
Coordination between OVDP and SFCPOnce a taxpayer makes a submission under the SFCP, the taxpayer is not eligible to participate in the OVDP. Likewise, a taxpayer who submits a voluntary disclosure letter to the IRS (to formally enroll in the OVDP) on or after July 1, 2014 cannot participate in the SFCP. Taxpayers who have enrolled in the OVDP prior to July 1, 2014 but who do not yet have a fully executed OVDP closing agreement as of that date may request the penalty treatment under the SFCP without formally opting out of the OVDP, provided the taxpayer certifies that the failure to report his or her foreign financial assets and income and failure to pay tax thereon was due to non-willful conduct.
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 Foreign financial assets that consist of foreign financial accounts are required to be reported independently of a taxpayer’s U.S. income tax return (IRS Form 1040) if the aggregate value of all such accounts exceeds $10,000 at any time during the calendar year. Reporting is made on FinCEN Form 114 (Report of Foreign Bank and Financial Accounts (FBAR)) (formerly FinCEN Form TD F 90-22.1) and is due by June 30th of the succeeding calendar year. Additionally, taxpayers must file Form 8938 (Statement of Specified Foreign Financial Assets) with their U.S. tax return to report specified foreign financial assets if certain value thresholds are met.