As a tax attorney specializing in OVDP, nary a day goes by that I don’t get a call from a person inquiring about the OVDP program.  The questions asked are relatively the same.  After a while, I began to make a list of the most frequently asked questions.  Below are my answers to them:

• Why should I make a voluntary disclosure?

Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties, and eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

• What are some of the civil penalties that apply if I don’t come in under the OVDP and the IRS examines me?

Depending upon a taxpayer’s individual case, the following penalties could apply:

(1) A penalty for failing to file the Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”). United States citizens, residents, and certain other persons must annually report their direct or indirect financial interest in, or signature authority over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign accounts exceeded $10,000 at any time during the year. Generally, the civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign account per violation. Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.

(2) Beginning with the 2011 tax year, a penalty for failing to file form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, and certain foreign securities and interests in foreign entities, as required by I.R.C. §6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.

(3) Fraud penalties. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that essentially amount to 75 percent of the unpaid tax.

(4) An accuracy-related penalty. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

• What are some of the criminal charges I might face if I don’t come in under OVDP and the IRS examines me?

Potential criminal charges include:

(1) Tax evasion: Tax evasion carries a prison term of up to five years and a fine of up to $250,000.

(2) Filing a false return: Filing a false return carries a prison term of up to three years and a fine of up to $ 250,000.

(3) Failure to file an income tax return: Failing to file an income tax return carries a prison term of up to one year and a fine of up to $ 100,000.

(4) Willfully failing to file an FBAR and willfully filing a false FBAR: Failing to file an FBAR carries a prison term of up to ten years and criminal penalties of up to $ 500,000.

• What kinds of assets does the 27.5% penalty apply to?

The offshore penalty applies to:

1. All assets directly owned by the taxpayer, including (i) financial accounts holding cash, securities or other custodial assets; (ii) tangible assets such as real estate or art; and (iii) intangible assets such as patents or stocks or other interests in a U.S. or foreign business.
2. Assets that are indirectly held or controlled by the taxpayer through an entity. The penalty may be applied to the taxpayer’s interest in the entity. But if the entity is an alter ego of the taxpayer, then the penalty may be applied to the taxpayer’s interest in the underlying assets.

Tax non-compliance includes not just the failure to report income from the assets but also the failure to pay U.S. tax that was due on funds used to acquire the asset.

• What years are included in the OVDP disclosure period?

1. For calendar-year taxpayers:

The voluntary disclosure period is the most recent eight tax years for which the due date has already passed.

Example: Assume that Kate submits a voluntary disclosure after April 15, 2014 but before April 15, 2015 (or other 2014 due date under extension).  The disclosure period includes each of the years 2006 through 2013 in which she had undisclosed foreign accounts and/or undisclosed foreign assets.

2. For Fiscal year taxpayers:

Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010.  For taxpayers who disclose after the due date (or extended due date) for 2011, the disclosure must include 2004 through 2011.

3. What about taxpayers who establish that they began filing timely, original, compliant returns that fully reported previously undisclosed offshore accounts (or assets) before making a voluntary disclosure?

The voluntary disclosure period will begin with the eighth year preceding the most recent year for which the return filing date has not yet passed. However, the compliant years will not be included.

Example: Willie Wonker has filed income tax returns omitting income from a securities account in Switzerland. He began reporting that income on his information reporting returns for 2009 and 2010 without making a voluntary disclosure. Willie subsequently filed a voluntary disclosure in January 2012.

Because January 2012 came after April 15, 2011 but before April 15, 2012, the most recent tax return that Willie had filed when he made his voluntary disclosure was 2010. Indeed, Willie’s 2010 tax return was due on or before April 15, 2011. His 2011 tax return was not due for another four and-a-half months. Therefore, 2011 is the most recent year for which the return filing date has not yet passed. And because 2010 is the year preceding 2011, 2010 is the year that is used to extrapolate the eight-year look back period. Because 2003 is the eighth year prior to 2010, the voluntary disclosure period began in 2003.

However, because Willie came into compliance beginning in tax year 2009, neither tax year 2009 nor 2010 would be included. Therefore, the voluntary disclosure period will only be from 2003 until 2008.

• How is the offshore penalty calculated?

The starting point is to sum up the values of all foreign accounts and foreign assets for each year. The corresponding penalty is calculated at 27.5% of the highest year’s aggregate value during the look-back period. If the taxpayer has multiple accounts or assets where the highest value of some accounts or assets is in different years, the values of accounts and other assets are summed up for each year and a single penalty is calculated at 27.5% of the highest year’s aggregate value.

An example will help illustrate this rule. Assume that Jack holds the amounts listed in the chart below in a foreign account over the period covered by his voluntary disclosure. He files a return but does not include the foreign account or the interest income on his return. Nor does he file a FBAR. Jack decides to apply to the voluntary disclosure program. Assume further (1) that Jack deposited the $ 500,000 in his account before 2003, properly reporting it; (2) that Jack’s voluntary disclosure is accepted by the IRS; and (3) that Jack is in the 35-percent tax bracket.

Year	Amount on Deposit	Interest Income	Account Balance
2003	$ 500,000	$ 25,000	$ 525,000
2004		$ 25,000	$ 550,000
2005		$ 25,000	$ 575,000
2006		$ 25,000	$ 600,000
2007		$ 25,000	$ 625,000
2008		$ 25,000	$ 650,000
2009		$ 25,000	$ 675,000
2010		$ 25,000	$ 700,000

 

Within the OVDP framework, Jack would pay $ 276,500. This includes:

• Tax of $ 70,000 (8 years at $ 8,750/year) plus interest;

 

• An accuracy-related penalty of $ 14,000 (i.e., $ 70,000 x 20%); and

 

• An offshore penalty, in lieu of the FBAR penalty, of $ 192,500 (i.e., $ 700,000 x 27.5%).

If Jack didn’t come forward and the IRS discovered his offshore activities, he would face up to $ 2,271,500 in tax, accuracy-related penalty, and FBAR penalty. He would also be liable for interest and possible additional penalties. And if this doomsday scenario comes to fruition, he could ultimately be prosecuted.

Outside of the offshore voluntary program, Jack’s civil liability includes:

• Tax, accuracy-related penalties, and, if applicable, the failure to file and failure to pay penalties, plus interest;

 

• FBAR penalties totaling up to $ 1,912,500 for the willful failure to file complete and correct FBARs:

1. 2005: $ 287,500 (.5 x $ 575,000),
2. 2006: $ 300,000 (.5 x $ 600,000),
3. 2007: $ 312,500 (.5 x $ 625,000),
4. 2008: $ 325,000 (.5 x $ 650,000),
5. 2009: $ 337,500 (.5 x $ 675,000),
6. 2010: $ 350,000 (.5 x $ 700,000).

• A potential fraud penalty of 75%; and

 

• The potential of substantial additional information return penalties if the foreign account or assets is held through a foreign entity such as a trust or corporation and required information returns were not filed.

Had the foreign activity started before 2003 and Jack decided not to enter the program, the IRS may even examine tax years prior to 2003.

• When determining the highest amount in each undisclosed foreign account for each year or the highest asset balance of all undisclosed foreign entities for each year, what exchange rate applies?

The foreign currency exchange rate at the end of the year, regardless of when during the year the highest account balance was reached.

• I have an interest in a PFIC (passive foreign investment company). What are my options?

Within OVDP, the IRS offers taxpayers an alternative to the statutory PFIC computation. The purpose of this alternative is to resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in I.R.C. § 1296 without requiring a complete reconstruction of historical data.

• I’m currently under examination. Can I still come in under voluntary disclosure?

No. If the IRS has already initiated a civil examination, then it’s too late. And that is true regardless of whether the examination relates specifically to undisclosed foreign accounts or undisclosed foreign entities. Similarly, taxpayers under criminal investigation by CI are also ineligible.

• I failed to file an FBAR disclosing an offshore bank account in my name and failed to report income from that same account on my tax return. I subsequently filed an amended return reporting all of my offshore income. Now I’m having second thoughts and want to apply to the OVDP. Am I still eligible?

The IRS is aware that some taxpayers have made “quiet” disclosures by filing amended returns and paying any related tax and interest for previously unreported offshore income.  Taxpayers who have already made “quiet” disclosures are eligible to take advantage of the penalty framework applicable to this program by submitting an application, along with copies of their previously filed returns – both original and amended – to the IRS’s voluntary disclosure coordinator.

Those taxpayers making “quiet” disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.

• I made a quiet disclosure by filing amended returns. Will the IRS audit me? If so, will I be eligible for OVDP?

The IRS is reviewing amended returns and could select any amended return for examination.  It has identified, and will continue to identify, amended tax returns reporting increases in income.

The IRS will closely review these returns to determine whether enforcement action is appropriate.  If a return is selected for examination, the taxpayer will no longer be eligible for OVDP.

• I have properly reported all of my taxable offshore income. I only recently learned that I should have been filing FBARs in prior years to report my personal foreign bank account. Must I come forward to disclose this?

The purpose of the voluntary disclosure program is to provide a way for taxpayers who did not report taxable income in the past to come forward voluntarily and resolve their tax matters.

To the extent that a taxpayer has reported and paid tax on all offshore income for prior years but did not file FBARs, he should file delinquent FBARs and include a statement explaining why they were filed late.

The IRS will not impose a penalty for failing to file FBARs so long as there was no underreported tax liability and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.

• I have two offshore accounts. No FBARs were filed. I reported all income from one account, but not the other. How do I report this?

The issue can be framed as follows: Must you report both accounts as a voluntary disclosure or should you separate them so that there is a delinquent FBAR filing for the reported account and a voluntary disclosure for the unreported account?

Because the annual FBAR requirement is to file a single report disclosing all foreign accounts meeting the reporting requirement, it is not possible to separate the corrected filing. Instead, you should make a voluntary disclosure for the omitted income and include the delinquent FBARs for both accounts.

The account with no tax deficiency is unrelated to your tax noncompliance. Therefore, no penalty will be imposed with respect to that account.

• If the amount of income that I underreported from my foreign bank account was de minimis, do I really need to enter the program?

According to the IRS, no amount of unreported income is considered de minimis for purposes of determining whether there has been tax non-compliance with respect to an account or asset.

• If the IRS has served a John Doe summons or made a treaty request seeking information that identifies me as the holder of an undisclosed foreign account or undisclosed foreign entity, does that disqualify me from making a voluntary disclosure under this program?

The mere fact that the IRS has served a John Doe summons, made a treaty request or has taken similar action does not automatically disqualify every member of the John Doe class or group identified in the treaty request from participating.

However, that comes with the following caveat.  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, that particular taxpayer will become ineligible for OVDP.

Another way in which taxpayers will become ineligible is if the IRS announces that certain taxpayer groups with bank accounts at specific foreign financial institutions will be ineligible.  Normally, this arises out of U.S. government action in connection with specific foreign financial institutions.

• If I enter OVDP, will my voluntary disclosure be subject to an examination?

Normally, no examination will be conducted once the taxpayer enters the offshore voluntary disclosure program.  However, the IRS reserves the right to conduct an examination.  The normal process is for the voluntary disclosure to be assigned to an examiner who will certify its’ accuracy and completeness.  The certification process is less formal than an examination and does not carry with it all the rights and legal consequences of an examination.

However, the examiner has the right to ask any relevant questions, request any relevant documents, and even make contact with third parties.  This is done to certify the accuracy of the amended returns.

• If I transferred funds from one unreported foreign account to another during the voluntary disclosure period, will I have to pay a 27.5 percent offshore penalty on both accounts?

No. If you can establish that funds were transferred from one account to another, you will only have to a 27.5 percent penalty on the highest balance in one account. However, the burden will be on you to establish the extent of the duplication.

• How can the IRS propose adjustments to tax for more than three years without either an agreement from the taxpayer or a statutory exception to the normal three-year statute of limitations for making those adjustments?

Agreeing to assessment of tax and penalties for all voluntary disclosure years is part of the resolution offered by the IRS for resolving offshore voluntary disclosures. The taxpayer must agree to assessment of the liabilities for those years in order to get the benefit of the reduced penalty framework. It is an all or nothing proposition.

• Must I complete and sign agreements to extend the period of time to assess tax – including tax penalties – and to assess FBAR penalties for any years that are set to expire while my application is being processed?

Yes. Agreements to extend the period of time to assess tax (including tax penalties) and to assess FBAR penalties must be submitted as part of the voluntary disclosure package.

• Does the examiner have any discretion to settle offshore voluntary disclosure cases for amounts less than the 27.5 percent offshore penalty?

No. Examiners nave no authority to negotiate a different offshore penalty. However, in limited situations, the offshore penalty can be reduced from 27.5 percent to 12.5 percent of the account value. To qualify for the reduced 12.5 percent offshore penalty, the highest aggregate balance in each of the years covered by the OVDP must be less than $ 75,000.

• What if, after making a voluntary disclosure, I disagree with the application of the offshore penalty? What can I do?

Remember that the penalty framework for offshore voluntary disclosure and the agreement to limit tax exposure to eight years are package terms. Mediation with appeals is not an option.

The only option is for the taxpayer to withdraw from or “opt out” of the program. An opt out is an election made by a taxpayer to have his case handled under the standard audit process. Once made, this decision is irrevocable. Therefore, if the taxpayer wakes up the following morning with buyer’s remorse, it is too late.

• If I opt out, will my case be referred for audit?

Yes, your case will be referred to the field for a complete examination of all issues. In that examination, the normal statute of limitations rules apply. If no exception to the normal three-year statute applies, the IRS will only be able to assess tax, penalties, and interest for three years.

However, if the period of limitations was open, then six years of liability may be assessed. Under what circumstances might the period of limitations remain open? One such scenario is if the IRS can prove a substantial omission of gross income. Similarly, if there was a failure to file certain information returns, such as Form 3520, Form 5471, or Form 8938, the statute of limitations will not have begun to run. And if the IRS can prove fraud, there is no statute of limitations for assessing tax.

Finally, the statute of limitations for asserting FBAR penalties is six years from the date of the violation, or the date that an unfiled FBAR was due to have been filed.

• Does my case remain within the Voluntary Disclosure Practice even after opting out?

Yes. Therefore, you must cooperate fully with the examiner by providing all requested information and records. In addition, you must pay, or make arrangements to pay, the tax, interest, and penalties that are ultimately assessed.

• If I opt out and the IRS discovers issues during a full scope examination that I did not previously disclose, can my case be referred back to Criminal Investigation?

Yes.

• If I opt out and the IRS conducts a full examination, may I appeal any tax and penalties imposed by the IRS? How about the IRS’s decision on the terms of the OVDP closing agreement?

After a full examination, any tax and penalties imposed by the IRS may be appealed. However, the IRS’s decision with respect to the terms of the OVDP closing agreement may not.