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Overview of the IRS 2011 Offshore Voluntary Disclosure Initiative [i]
and
Circular 230 Warning to Tax Return Preparers
By: Attorney Morris N. Robinson, CPA, LL.M.; Matthew A. Morris, Esq., LL.M.; Timothy R. Weeks, Esq., LL.M.
Introduction
On February 8, 2011, the Internal Revenue Service (“IRS”) announced a second offshore voluntary disclosure initiative with an August 31, 2011 deadline (“2011 OVDI”).Eligibility to Participate in the 2011 OVDI
Taxpayers who have not complied with their United States income tax obligations regarding “undisclosed offshore accounts or assets”[ii] are eligible to participate in the 2011 OVDI. Taxpayers who are under civil examination or criminal investigation by the IRS, however, are not eligible to participate – whether or not the examination or investigation is related to the failure of the taxpayer to disclose foreign accounts.[iii]
Pre-Clearance for Participation in the 2011 OVDI
Taxpayers will want to obtain pre-clearance from the IRS before submitting their information since the submission of information acts as an admission against interest in any possible criminal trial. A taxpayer may request pre-clearance from the IRS by submitting by facsimile his or her name, date of birth, social security number, and address to the IRS Criminal Investigation Lead Development Center at the facsimile number listed in FAQ 23. There, the taxpayer’s identification will be compared against multiple databases maintained at the Center. A taxpayer’s representative must also submit an executed power of attorney if seeking pre-clearance for a client. Criminal Investigation will then inform the taxpayer whether or not he or she is cleared to make an offshore voluntary disclosure. The FAQs do not provide a deadline for an IRS response. Once the taxpayer is cleared, however, he or she must provide an Offshore Voluntary Disclosure Letter within 30 days of acceptance;[iv] and must provide the entire package of disclosure materials by the August 31, 2011 deadline.[v] Notably, pre-clearance does not guarantee a taxpayer’s acceptance into the 2011 OVDI; in order to be accepted, the taxpayer must “truthfully, timely, and completely comply with all provisions of the offshore voluntary disclosure program.”[vi]
Requirements for Participation in the 2011 OVDI
Once pre-clearance has occurred, taxpayers must submit the following information for tax years 2003 through 2010 (the “tax years covered by the voluntary disclosure”) as part of their voluntary disclosure package to the IRS by August 31, 2011: [vii]1. Copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for all tax years covered by the voluntary disclosure.
2. Complete and accurate amended federal income tax returns for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account or entity.
3. Accurate and complete Forms TD 90-22.1: Reports of Foreign Banks and Financial Accounts (“FBARs”), and other applicable Title 26 offshore-related information returns (e.g. Form 3520: Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) for all tax years covered by the voluntary disclosure.
4. A Foreign Account or Asset Statement for each previously undisclosed foreign account or asset during the voluntary disclosure period. The Foreign Account or Asset statement requires, inter alia, information regarding the name of the financial institution, the date the account was opened, and the source of funds in the account.
- Applicants disclosing offshore financial accounts with an aggregate highest account balance in any year of $1 million or more must submit a Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer had undisclosed accounts or transactions during the voluntary disclosure period.
5. A properly completed and signed Taxpayer Account Summary with Penalty Calculations.
6. A check for the total amount of tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties, for the voluntary disclosure period.
- If a taxpayer cannot pay the amount owed, he or she can propose an alternate payment arrangement after submitting a Form 433-A Collection Information Statement (or Form 433-B, if the taxpayer is a business). However, the taxpayer must complete arrangements satisfactory to the IRS for the payment of tax, penalties, and interest by the August 31, 2011, deadline.[viii]
8. Properly completed and signed agreements to extend the period of time to assess tax (including tax penalties) and to assess FBAR penalties.
A full and complete submission is required for acceptance into the 2011 OVDI.[ix]
Amnesty from Criminal Prosecution for 2011 OVDI Participants
As long as the taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice as described above, the IRS will not recommend taxpayers participating in the 2011 OVDI to the United States Department of Justice (“DOJ”) for criminal prosecution for tax evasion.[x],[xi]Civil Penalty Structure for 2011 OVDI Participants
The IRS created a complex civil penalty structure for taxpayers who complete all requirements for participation in the 2011 OVDI. Essentially, taxpayers must compare different sets of civil penalties for the years 2003 through 2010 and then determine which produces the lowest penalty amount. According to the 2011 OVDI, “[u]nder no circumstances will taxpayers be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes.”[xii]Within the OVDI, the taxpayer will be penalized with either the “standard” OVDI penalty or the “adjusted” OVDI penalty, both of which are described below. Issues of willfulness regarding the taxpayer’s non-compliance will not be considered within the OVDI. Because penalties within the 2011 OVDI cannot be settled or appealed, the taxpayer may consider “opting out” of the program. A taxpayer should consider “opting out” if he believes that he would receive a lesser penalty under standard IRS audit procedures. However, in order to establish that he is entitled to a lesser penalty, the taxpayer must prove that his failure to comply with United States reporting obligations was non-willful. If the taxpayer can establish a lack of willfulness, the penalty associated with his non-compliance is calculated under the applicable Internal Revenue Code and U.S. Bank Secrecy Act[xiii] statutes. By statute, a non-willful failure to file an FBAR has a maximum penalty of $10,000 per year and if the failure to file was with reasonable cause, the penalty is zero. The taxpayer should be aware that if he chooses to “opt out,” his election is irrevocable but he does “remain within the Criminal Investigation’s Voluntary Disclosure Practice.”[xiv] This means that the taxpayer essentially keeps his or her criminal immunity but must cooperate fully with the IRS or risk being referred back to Criminal Investigation for possible prosecution.[xv]
The applicable FBAR civil penalties are summarized as follows:
The “Standard” 2011 OVDI Penalty. This is the sum of the following four penalties:
a) The accuracy -elated penalty under IRC § 6662(a) at a rate of 20 percent on the “full amount of the underpayment”;[xvi]
b) The maximum failure-to-file penalty, without considering mitigating factors, under IRC § 6651(a)(1), if applicable;[xvii]
c) The maximum failure-to-pay penalty, without considering mitigating factors, under IRC § 6651(a)(2), if applicable;[xviii] and
d) A “miscellaneous” offshore account penalty equal to either 25 percent, 12.5 percent, or 5 percent of the highest aggregate balance in foreign bank accounts (or assets[xix]) during the period covered by the voluntary disclosure. This offshore account penalty is imposed in lieu of any other penalties that may apply, including the 50 percent per year FBAR penalty, civil fraud penalty, and any Title 26 offshore-related information return penalties.[xx]
The “Adjusted” OVDI Penalty. This is the sum of all existing statutory penalties without taking into account reasonable cause, lack of willfulness and other mitigating factors.[xxi] This penalty is used by the IRS if it produces a lesser penalty than the standard penalty.[xxii]
The “Opt Out” Penalty. This is the sum of all statutory penalties after taking into account reasonable cause, lack of willfulness, other mitigating factors, and the possibility of penalty reduction if the penalty is appealed.
The benefits of the 2011 OVDI penalty structure are not available to taxpayers who fail to complete all requirements for participation by the August 31, 2011 deadline.[xxiii]
The Applicable “Miscellaneous” Offshore Account Penalty
The 25 percent penalty noted above is the default penalty regime for the 2011 OVDI. This can be reduced to the 5 percent penalty if the taxpayer is (1) a foreign resident who was unaware that he was a U.S. citizen or (2) if he or she meets all four of the following conditions:
(a) did not open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of an existing account, upon the death of the owner of the account); (b) ha[s] exercised minimal, infrequent contact with the account, for example, to request the account balance, or update accountholder information such as a change in address, contact person, or email address; (c) ha[s], except for a withdrawal closing the account and transferring the funds to an account in the United States not withdrawn more than $1,000 from the account in any year covered by the voluntary disclosure; and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation). For funds deposited before January 1, 1991, if no information is available to establish whether such funds were appropriately taxed, it will be presumed that they were.[xxiv]
Even if a taxpayer cannot meet those requirements, the OVDI penalty will be reduced to 12.5 percent if the “highest aggregate account balance (including the fair market value of assets in undisclosed offshore entities and the fair market value of any foreign assets that were either acquired with improperly untaxed funds or produced improperly untaxed income) in each of the years covered by the 2011 OVDI is less than $75,000.”[xxv]
Waiver of Civil Disclosure Penalties for Tax-Compliant Taxpayers
Taxpayers who are compliant with their income tax obligations should not participate in the 2011 OVDI – even if they are delinquent in the filing of FBARs and Title 26 offshore-related information returns. These tax-compliant taxpayers will be able to avoid civil penalties for nondisclosure by filing accurate and complete FBARs and Title 26 offshore-related information returns by the August 31, 2011 filing deadline along with proof of tax-compliance.[xxvi],[xxvii]Circular 230 Warning to Tax Return Preparers
Tax practitioners—and particularly licensed attorneys and CPAs—need to take special precautions when preparing returns for clients with foreign bank accounts or assets.
According to the 2011 OVDI FAQs, “[a] practitioner whose client declines to make full disclosure of the existence of, or any taxable income from, a foreign financial account may not prepare a current or future income tax return for that taxpayer without being in violation of Circular 230.”[xxviii] Therefore, practitioners should make a vigilant effort to obtain a truthful and complete assessment of their clients’ offshore holdings before preparing any current or future tax returns for those clients.
Copyright © M. Robinson & Company, P.C. All rights reserved.
[i]The information for this Overview is primarily derived from the 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers (hereinafter, “FAQs”), published by the IRS and accessible at IRS.gov.
Seealso Hale E. Sheppard, IRS Giveth and DOJ Taketh Away: Recent Opinion Jeopardizes Retroactive FBAR Relief, 114 J. Tax’n18 (Jan. 2011).
Seealso Hale E. Sheppard, IRS Giveth and DOJ Taketh Away: Recent Opinion Jeopardizes Retroactive FBAR Relief, 114 J. Tax’n18 (Jan. 2011).
[ii] FAQ A12.
[iii]See FAQs A12, A13, A14, A17, A18.
[iv]See FAQ A23.
[v]See FAQ A25
[vi]Id.
[vii] FAQ A25. August 31, 2011, is a hard deadline without any extensions or grace periods available.
[viii]See FAQ A7, bullet 9; A25, bullet 6.
[ix] Other information may be required to process the voluntary disclosure, as requested by the IRS examiner.
[x]See FAQ A3.
[xi] The United States Department of Justice has its own voluntary disclosure policies, which are described in 4.01 of the DOJ’s Criminal Tax Manual. The DOJ may prosecute taxpayers for tax evasion and violations of the United States Bank Secrecy Act unless these taxpayers have also complied with the DOJ’s own voluntary disclosure policy.
[xii] FAQ A50.
[xiii]See 31 U.S.C. §5321.
[xiv] FAQ A51.
[xv]Id.
[xvi]See FAQ A7, bullet 5.
[xvii]Seeid. at bullet 6.
[xviii]Seeid. at bullet 7.
[xix] Unlike the 2009 OVDI penalty, the 2011 OVDI penalty “is intended to apply to all of the taxpayer’s offshore holdings that are related in any way to tax non-compliance, regardless of the form of the taxpayer’s ownership or the character of the asset.” FAQ A35. This means, for example, that property purchased indirectly by a taxpayer with the unreported and untaxed proceeds of a foreign real estate transaction would be included in the base for the 25 percent penalty. See FAQ 35 & 36.
[xx]See FAQ A7, bullet 8.
[xxi] FAQ A50, ¶¶ 1, 2.
[xxii]See note 6, supra.
[xxiii]See FAQ A11.
[xxiv] FAQ A52.
[xxv] FAQ A53.
[xxvi] FAQs A17, A18.
[xxvii]See note 12, supra.
[xxviii] FAQ A48.