On Wednesday, June 18, 2014, the IRS overhauled the Offshore Voluntary Disclosure Program while expanding and modifying the streamlined filing procedures in order to accommodate a broader group of U.S. taxpayers.  Major changes to the streamlined procedures include the following: (1) extension of eligibility to U.S. taxpayers residing in the U.S., (2) elimination of the $ 1,500 tax threshold, and (3) elimination of the risk assessment process associated with the 2012 streamlined filing compliance procedures.

These changes are expected to ease the financial and legal pain for almost six million expatriate Americans who live and work abroad, many of whom had no clue that they had to pay U.S. taxes on their foreign income.

U.S. taxpayers living abroad who disclose their foreign accounts and settle their U.S. tax bills under the Streamlined Foreign Offshore Procedures won’t be charged any penalties.  Instead, they will simply owe back taxes and interest.  Previously, they would have owed a 27.5% penalty, computed as a percentage of each undisclosed foreign account.  Also eliminated was the requirement that the unpaid tax be $ 1,500 or less a year – a low ceiling that most people exceeded.  There will now be no limit.

At the same time, the IRS extended an olive-branch to Americans living in the U.S. with undisclosed foreign accounts, effectively validating the “I didn’t know” argument as a viable defense for this class of taxpayers.  Such persons who come forward now will owe back taxes, interest, and a reduced “miscellaneous offshore penalty” equal to five percent of their undisclosed foreign financial assets.  Previously, they would have faced a 27.5 percent penalty.

These changes come as overseas financial institutions brace for new reporting requirements beginning July 1, 2014.  That is when thousands of foreign financial institutions will be required to report to the IRS the foreign accounts of “U.S. persons” under the Foreign Accounts Tax Compliance Act, or FATCA for short.

This blog focuses on the streamlined Filing Compliance Procedures.  Eligibility for the streamlined filing compliance procedures is conditioned upon the taxpayer certifying that his failure to disclose his foreign financial assets and pay his taxes (with respect to those assets) was not willful.  The procedures are designed to provide taxpayers with (1) a streamlined procedure for filing amended or delinquent returns and (2) terms for resolving their tax and penalty obligations.  They take effect on July 1, 2014 and are available indefinitely or until otherwise announced.

General Eligibility for the Streamlined Procedures

The modified streamlined filing compliance procedures are designed specifically for individual taxpayers, including estates of individual taxpayers.  They are available to both U.S. taxpayers living outside the United States and U.S. taxpayers living in the United States.  With respect to non-U.S. residents, the procedures are referred to as the “Streamlined Foreign Offshore Procedures.”  And with respect to U.S. residents, the procedures are referred to as the “Streamlined Domestic Offshore Procedures.”

Taxpayers using either the foreign or domestic offshore procedures must certify that the failure to report all income, pay all tax, and submit all required information returns – including FBARs – was not willful.

To the extent that the IRS has initiated a civil examination of a taxpayer’s returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets, the taxpayer will be ineligible for the streamlined procedures.  Similarly, taxpayers under criminal investigation by IRS Criminal Investigation are also ineligible to use the streamlined procedures.

Taxpayers eligible to use the streamlined procedures who have previously filed delinquent or amended returns in an attempt to come into compliance with their foreign reporting obligations – through so-called “quiet disclosures” – may still use the streamlined procedures.  However, any penalty assessment previously made with respect to those filings will not be mitigated.

General Treatment under the Streamlined Procedures

Tax returns submitted under either the foreign or domestic offshore procedures will be processed no different than any other returns submitted to the IRS.  In other words, do not expect confirmation from the IRS for receipt of the returns.  Even more important, the streamlined filing process will not culminate in the signing of a closing agreement with the IRS.

Returns submitted under either the foreign or domestic offshore procedures will not automatically be selected for audit.  However, they may be selected for audit under the existing audit selection processes applicable to any U.S. tax return and may also be subject to verification procedures.  The purpose of the verification procedures is to ensure accuracy and completeness of submissions by cross-checking the submission against information received from banks, financial advisors, and other sources.  The bottom line is that returns submitted under the streamlined procedures may be subject to examination, civil penalties, and even criminal liability.

To the extent that your failure to report income, pay tax, and submit required information returns was due to willful conduct and you demand assurances that you will not be prosecuted and/or be the target of onerous monetary penalties, then you should consider participating in the OVDP.

Coordination with Treatment under OVDP

If you take nothing else from this blog, remember this: Once you make a submission under the streamlined procedures, it is too late to participate in the OVDP.  Similarly, if you submit an OVDP voluntary disclosure letter on or after July 1, 2014, you are ineligible to participate in the streamlined procedures.  So just like the eminent archaeologist Indiana Jones who had to choose between the real grail and the fake grail with the latter resulting in a gruesome death (i.e., decaying into dust), you must choose wisely!

What about taxpayers who are eligible for treatment under the streamlined procedures but who have submitted a voluntary disclosure letter under the OVDP prior to July 1, 2014?  Must they opt out of OVDP in order to obtain the favorable penalty terms available under the streamlined procedures?  No, they may request treatment under the favorable terms of the streamlined procedures without having to opt out.

However, there are a few caveats.  First, an OVDP closing agreement must not yet have been executed.  Second, they must certify that the failure to report all income, pay all tax, and submit all required information returns – including FBARs – was not due to willful conduct.  The IRS will consider this request in light of all the facts and circumstances of the taxpayer’s individual case.  Then and only then will it decide whether or not to incorporate the streamlined penalty terms in the OVDP closing agreement.

As parting words, in a time where federal tax laws and penalties are changing so quickly, Michael DeBlis recommends that anyone concerned with offshore disclosure consult a qualified professional immediately.