On June 18 the IRS unveiled changes to its offshore amnesty programs. Specifically, the IRS modified its streamlined filing compliance procedures and the Offshore Voluntary Disclosure Program (“OVDP”).
By way of background, under current law, “each United States person having a financial interest in, or signature or other authority over, a…financial account in a foreign country shall report such relationship.” 31 CFR § 1010.350(a). The FBAR is due by June 30th of each calendar year with respect to foreign financial accounts exceeding $10,000 during the previous calendar year. 31 CFR § 1010.306(c). Taxpayers who wilfully fail to report their foreign financial accounts are assessed a maximum penalty equal to the greater of 50% of the balance of the account at the time of violation or $100,000, per violation. 31 USC § 5321(a)(5). Many taxpayers who failed to report foreign income and file FBARs in past years continue to not report these items to avoid paying heavy FBAR penalties and possibly face criminal prosecution.
To encourage noncompliant taxpayers to come back into the tax system, the IRS has implemented several offshore voluntary disclosure programs. Under the current program, the 2012 OVDP, taxpayers must generally pay a penalty equal to 27.5% of the highest aggregate account balance during the disclosure period. Although substantial, the OVDP penalty pales in comparison to the 50% of account balance penalty for each FBAR violation, a penalty which recently resulted in a jury awarding the IRS 145% of a taxpayer’s account value.
The FBAR and OVDP penalties are intended to discourage taxpayers from concealing their income in offshore accounts. Recognizing the inequity of applying stiff penalties against individuals who failed to report foreign income but clearly did not intend to deceive the government, the IRS initiated the streamlined filing compliance procedure in September 2012 for non-resident U.S. taxpayers, many of whom simply do not know of their U.S. filing obligations. The program waived penalties for non-resident U.S. taxpayers who presented a low compliance risk. The IRS determined the level of compliance risk based on the taxpayer’s return and information provided in response to a required questionnaire. Generally speaking, the Service treated non-resident taxpayers owing less than $1,500 in tax for each year as low compliance risks.
The initial version of the program disappointed many. For one, the program only applied to non-residents and therefore eliminated many low risk taxpayers from participation. Additionally, the $1,500 cap in tax due and the risk questionnaire further complicated the ability of low risk individuals to come into compliance through the program.
The recent changes to the streamlined filing compliance procedure address these concerns. The IRS has eliminated the requirement that the taxpayer have $1,500 or less of unpaid tax per year. The IRS also eliminated the required risk questionnaire and only requires the taxpayer to certify that previous failures to comply were non-willful. For eligible taxpayers residing outside the U.S., all penalties will be waived. For eligible taxpayers residing in the U.S., the only penalty will be a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets giving rise to the tax non-compliance. Taxpayers participating in the program still have to file delinquent tax returns for the past three years and delinquent FBARs for the past 6 years.
While the IRS made welcome changes to the streamlined filing compliance procedure, the changes made to the OVDP may give pause to practitioners and taxpayers. Most significantly, the Service increased the offshore penalty percentage from 27.5% to 50% if it becomes public knowledge that the taxpayer’s bank is under investigation by the IRS or DOJ before the taxpayer submits the pre-clearance request. Additionally, the IRS will now require taxpayers to submit additional information to apply for OVDP, and submit all account statements and pay the offshore penalty at the time of the OVDP application. Also, in light of the expansion of the streamlined compliance procedure, the reduced penalty structure will no longer be available for certain non-willful taxpayers. Finally, the IRS will now allow taxpayers to submit voluminous records electronically instead of on paper.
In light of these changes, as well as the looming July 1 FATCA implementation and continued enforcement pressure from U.S. authorities, those with unreported offshore income and accounts should consult with their trusted advisors to determine the best way to come into compliance.