March 15, 2012
Following two initiatives in 2009 and 2011, the Internal Revenue Service (IRS) has announced a third offshore voluntary disclosure program (OVDP) for foreign financial accounts – this one with an indefinite deadline to apply. In this connection, the IRS noted that, collectively, the two previous programs have generated more than $4.4 billion in tax revenue. This new program is similarly designed to help motivate U.S. taxpayers with undisclosed accounts to comply with required U.S. tax reporting.
- The new OVDP comes at a time when the U.S. has stepped up its focus on international tax compliance and its negotiations with several foreign banks to obtain the release of account information of U.S. customers.
- In addition, new reporting applicable to such foreign financial accounts and other foreign financial assets commences with 2011 income tax returns. The statute of limitations for omission of gross income which is derived from a reportable offshore asset is extended to six years if such income is in excess of $5,000.
- Moreover, under the Foreign Account Tax Compliance Act provisions, foreign financial and nonfinancial institutions will be required to disclose U.S. persons’ accounts beginning in 2014.
The terms of this OVDP could change in the future with the possibility of increased penalties for all or defined classes of taxpayers, or could be ended completely at any moment. Thus, this OVDP seems an opportunity for taxpayers with undisclosed foreign financial accounts to come into U.S. tax compliance without fear of criminal prosecution and with a clear understanding of what penalties will be imposed.
The overall penalty structure for this new program generally remains unchanged from the predecessor 2011 program, with one principal exception: The basic penalty has increased from 25% to 27.5% of the highest aggregate balance in unreported accounts during the eight full tax years prior to disclosure.
As noted above, and similarly to the first two programs, the new OVDP applies to the last eight full tax years before the year of participation – e.g., 2004-2011 during the current year 2012.
Certain key provisions of the 2011 program – which is described in our Alerts dated February 14, 2011 and August 2, 2011 – remain in effect under the 2012 program, including the following:
- Taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year will continue to qualify for a lower penalty of 12.5% during the disclosure period.
- Taxpayers meeting all of the following four conditions qualify for a reduced penalty of 5% if the taxpayer:
- Did not open or cause the account to be opened (and permitting such an account opening if the financial institution required that a new account be opened, rather than allowing a change in ownership of an existing account, upon the death of the previous owner);
- Has exercised minimal, infrequent contact with the account;
- Has not withdrawn more than $1,000 from the account in any year of the eight years of the program, except for a withdrawal closing the account and transferring the funds to an account in the U.S.; and
- Can establish that all applicable U.S. taxes have been paid on funds deposited in the account.
Observation: For purposes of the last requirement above, if funds were deposited before 1991 but no information is available to establish that the funds were appropriately taxed, it is presumed that they have been so taxed – this date also applied to the previous program and apparently has not been moved forward to a later date.
Taxpayers who reside abroad and who were unaware of their U.S. citizenship also may qualify for the 5% penalty without having to meet the four qualifications above.
Observation: The IRS recently issued Fact Sheet FS 2011-13 – described in our Alert dated January 10, 2012 – to provide guidance to, inter alia, dual citizens who reside outside the U.S. It is not clear how the Fact Sheet and its guidance reconcile with the new OVDP’s penalty structure – e.g., under the Fact Sheet the IRS will consider reasonable cause to minimize or eliminate penalties for certain taxpayers.
- The IRS continues to provide in the new OVDP an alternative mark-to-market computation for Passive Foreign Investment Companies held by participating taxpayers, as described in our Alert dated November 23, 2010 .
- For those who have reported and paid tax on income from foreign financial accounts, but did not file Foreign Bank Account Reports (FBARs), this is another opportunity to file delinquent FBARs without penalty assessment, provided that a statement explaining the cause for the filing delay is contained within the filing. Similarly, those with signature authority – but no ownership interest – in foreign financial accounts should file delinquent FBARs under the same procedures.
- No penalties will apply for the failure to file certain other information returns with respect to foreign income – including but not limited to Form 5471 and Form 3520 – if there are no underreported tax liabilities and the information returns are filed with an amended tax return accompanied by a statement explaining the reason for the delinquency.
Observation: In general, the statute of limitations does not run on information returns such as Form 5471 or Form 3520 if they are not filed.
- A taxpayer whose noncompliance has already been learned by the IRS will not be able to participate in the new OVDP, nor will participation be permitted where the foreign financial account includes property derived from illegal activities.
Observation: Taxpayers who have previously come forward since the closing of the last 2011 program will be treated under the provisions of the new program.
- It should be noted that the National Taxpayer Advocacy Office recently invoked an administrative tool to force changes in IRS audit procedures with respect to the first 2009 program. At issue is whether the IRS must revoke a March 1, 2011, memo directing examiners to stop accepting less than the 20% offshore penalty under that program (as apparently permitted in the IRS’s own FAQ 35 under the program) and instead instruct examiners to assume a violation was not willful unless they can prove otherwise.
Observation: This challenge may ultimately impact terms of the new OVDP.
- Taxpayers participating in the new OVDP must file with the IRS all original and amended tax returns for the 8-year period covered and pay – in addition to the penalty amounts referred to further above based on highest foreign account balances – the balances of any income taxes owed for the covered period, interest on the balances, a 20% accuracy related penalty, and late payment or filing penalties, if applicable.