Accounting for “double counting” is not child’s play. Your tax attorney will need the following information in order to complete his or her review of your double counting issue. These steps must be repeated for every year in which you believe that there is a double counting issue.
For each transfer, you should provide the following:
(a) The highest balance of the account from which the transfer(s) was made for the tax year in question;
(b) The highest balance of the account into which the transfer(s) was made for the tax year in question;
(c) The exact amount of the transfer in foreign currency along with a reference to the account statement that verifies this particular transfer;
(d) The account number from which the transfer was made;
(e) The account into which the transfer was made (i.e., its “final resting place”);
(f) The date of the transfer;
(g) The balance in the account (from which the money was transferred) immediately before the transfer was made along with a reference to the account statement that verifies this transfer;
(h) The balance in the account (into which the money was transferred) after the transfer was complete along with a reference to the account statement that verifies this transfer;
(i) A list of any and all accounts that were closed during the tax year, with special emphasis on whether the accounts from which the transfer was made or the accounts into which the transfers were sent were closed at any point during the calendar year;
(j) Assuming any such accounts were closed, identify the account and provide the date on which the account was closed along with the closing balance.
Below is an example:
Tax year: 2008
Account from which transfer was made: account ending in “1234”
Highest balance in the account ending in “1234” for tax year 2008: 400,000
Amount of transfer: 50,000 (see account statement for ABC account ending in “1234” dated March 2008)
Balance in account ending in “1234” immediately before 50,000 transfer was made: 350,000 (see account statement for ABC account ending in “1234” dated March 2008)
Date of transfer: 3/1/2008
Account into which $ 50,000 was transferred: account ending in “7890”
Balance in account ending in “7890” after the transfer was complete: 550,000 (see account statement for XYZ account ending in “7890” dated March 2008)
Was the account ending in “1234” or in “7890” closed at any point during 2008? No.
Let’s round out this blog with a comprehensive hypothetical to drive home this concept of “double counting.” Suppose that the taxpayer’s highest aggregate balance during the eight-year disclosure period falls in 2012, where it is $ 2,500,000 (USD) (without taking into consideration double counting). For those new to the concept of “maximum aggregate balance,” it is determined by adding up the highest balances of each one of a taxpayer’s foreign accounts during the tax year in question. This is the amount that must be reflected on the taxpayer’s FBAR. For purposes of this example, the taxpayer’s FBAR must reflect a maximum aggregate balance of $ 2,500,000 (USD).
However, just because the taxpayer reports $ 2.5 million as the maximum aggregate balance for 2012 does not necessarily mean that it is the amount used to determine his offshore penalty. As provided for in the OVDP Q &A, a taxpayer is entitled to eliminate any amounts that were “double counted.” By double counted, what I am referring to are amounts that were transferred between accounts.
Let’s assume that the taxpayer in the above example claims that $ 1,000,000 was double counted in 2012. The practical consequence of this is that before the offshore penalty is calculated, the maximum aggregate balance must be adjusted to reflect the “true” maximum aggregate balance. Here, the true maximum aggregate balance, after taking into consideration double counting, would be $ 1,500,000 (i.e, $ 2.5 million (-) $ 1.0 million). Thus, the offshore penalty would be calculated by multiplying 27.5% times $ 1,500,000, not $ 2,500,000 (USD). For those whose minds work quick than mine, that means that the offshore penalty would be $ 412,500, not $ 687,500.
While this might be music to the ears of a cash-strapped taxpayer, be aware of the following. First, the adjusted maximum aggregate balance might be just as much a curse as it is a blessing. Why? Because while it might have drastically reduced the “inflated” maximum aggregate balance, the adjusted maximum aggregate balance may no longer represent the highest aggregate balance during the disclosure period. Instead, it might now represent the second or third highest aggregate balance during the disclosure period. For example, in the hypothetical above, suppose that the second highest aggregate balance during the disclosure period was in 2013, where it was $ 2.0 million (USD).
In that case, although double counting may have reduced the taxpayer’s maximum aggregate balance in tax year 2012 by almost fifty percent from $ 2.5 million to $ 1.5 million, it is no longer the highest aggregate balance. Instead, the $ 2.0 million aggregate balance in tax year 2013 now has that distinction. Therefore, the base for applying the offshore penalty would be $ 2.0 million (USD), and not $ 1.5 million (USD).
The offshore penalty would thus be $ 550,000 and not $ 412,500 since it would be calculated by multiplying 27.5% times $ 2.0 million, not $ 1.5 million.
This is why I cannot emphasize enough the importance of accounting for double counting in every year during the disclosure period, and not just limiting it to the lone year that represents the highest maximum aggregate balance.
Even if $ 1.5 million continues to be the highest aggregate balance in the disclosure period for the above taxpayer, he should not be so quick to pop the cork off the bottle of champaign and start celebrating. Why? He must be able to account for every penny of the amount transferred when he itemizes his transfers. In other words, after the “smoke clears” and all of the transfers for 2012 have been aggregated, the sum total should be $ 1,000,000 and not a penny less.
The IRS will expect the taxpayer to produce account statements that verify that the sum total of all of his transfers for 2012 was $ 1,000,000. Anything less will not suffice. Very simply, the IRS wants a “roadmap” that will allow them to follow the money trail. If you don’t prepare one for them, they will prepare their own. And when that happens, batten down the hatches because nothing good can ever come from that. At best, it will lead to a torrent of follow-up questions. At worst, it could trigger an audit that is more painful than a root canal.