On June 18, 2014, the IRS announced sweeping changes to both the Streamlined and the OVDP programs. The effects are generally as follows:

Streamlined Program – Opening the Program Up

1. Expanded to include both U.S. citizens living abroad and U.S. citizens living in the United States;

2. Participants are not restricted to those who have less than $1,500 in tax;

3. There is no longer a “detailed questionnaire” to determine “low compliance risk”;

4. Taxpayers who live outside the United States (AKA “Americans living abroad”) can come into compliance WITHOUT PAYING ANY PENALTIES. In order to do so, they must certify that their lack of compliance was “non-willful”;

5. Taxpayers residing in the United States can come into compliance by paying a 5% penalty on the “offshore account” which was the reason for the non-compliance;

6. The new streamlined program can also be used for “amended returns”;

7. The new streamlined program is available to those who have made “quiet disclosures”;

8. Submissions may still be subject to a full examination;

9. Eligible taxpayers will not be subject to failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, or FBAR penalties, even if their returns are subsequently selected for audit;

10. Immunity from penalties, however, comes with a few exceptions. First, previous penalties assessed will NOT be abated. Second, to the extent that the IRS determines an additional tax deficiency for a return submitted under these procedures, it can assert additional tax and penalties relating to that additional deficiency. Finally, the IRS will unleash the full arsenal of penalties if the examination results in a determination that the original tax noncompliance was due to fraud and/or that the FBAR violation was willful.

Bottom line: U.S. citizens may enter the U.S. tax system without fear of penalties (or at least not more than a 5% penalty) provided that they certify their lack of compliance was “non-willful.”

OVDP (“Offshore Voluntary Disclosure Program”) – Making It Harder

The changes to the OVDP program are designed to make it attractive ONLY to those whose conduct has clearly been willful.

Changes to the OVDP program reflect that:

… the IRS is reshaping the terms for taxpayers to participate in the OVDP. “This is designed to cover those whose failure to comply with reporting requirements is considered willful in nature, and who therefore don’t qualify for the streamlined procedures,” Koskinen explained. “These changes will help focus this program on people seeking certainty and relief from criminal prosecution. From now on, people who want to participate in this program will have to provide more information than in the past, submit all account statements at the time they apply for the program, and in some cases pay more in penalties than they would have done had they entered this program earlier.”

The basic changes to the OVDP program include:

1. The reduced 12.5% and 5% penalties have been abolished. This reflects the changes to the Streamlined program.

2. Taxpayers must supply more information upfront and the offshore penalty is required at the point of entry into the program.

3. The penalty is 27.5% of the highest aggregate balance of all undisclosed foreign accounts during the disclosure period (eight years). However, beginning August 4, 2014, any taxpayer who has an undisclosed foreign financial account will be subject to a 50% offshore penalty if, at the time of submitting the preclearance letter to CI, any one of the following events has occurred:

a. The taxpayer’s foreign financial institution has become a target of investigation by the IRS or the Department of Justice; or

b. The taxpayer’s foreign financial institution is cooperating with the IRS or the Department of Justice to help them locate tax evaders; or

c. The taxpayer’s foreign financial institution has been identified in a court-approved summons seeking information about U.S. taxpayers who may hold financial accounts at that institution.

4. Note well: Once the IRS or DOJ obtains information under a John Doe summons, treaty request, or other similar action that provides evidence of a specific taxpayer’s noncompliance with the tax laws or Title 31 reporting requirements, that particular taxpayer will become ineligible for OVDP. For this reason, taxpayers concerned that their foreign financial institutions will disclose information about them to the IRS should apply to OVDP immediately, before it is too late.

Bottom line for the average American living abroad:

Non-compliant and non-willful Americans living abroad can come into compliance:

• Without the payment of penalties.
• But, they must still pay the back taxes for the three-year period covered by the Streamlined program and file delinquent FBARs for the past six years.

So, what does this all mean? 

For Americans living abroad, there is good news and bad news:

First, the good news:

The IRS will be more “compliance friendly,” making it easier for Americans living abroad to come into compliance and “clean up” past problems.

Now, the bad news:

Americans living abroad who come into compliance will still be subject to the incompatibility of U.S. tax laws. They will still have the problems which include (but are hardly limited to): PFIC, tax on principal residence, phantom capital gains, etc.

Conclusion

These expanded options for U.S. taxpayers underscore the IRS’s continued enforcement efforts aimed at U.S. taxpayers who have unreported foreign-source income. Taxpayers with unfiled foreign bank account reports or unreported income from offshore accounts would be wise to seek the advice of a tax attorney, who can evaluate the case, explain the options, and develop a defense strategy. Practitioners should be familiar with the new procedures so that they are prepared to help their clients navigate these choppy waters.