The Internal Revenue Service has had a longstanding voluntary disclosure practice, permitting taxpayers to disclose compliance failures in exchange for a recommendation that those taxpayers not be criminally prosecuted. In March 2009, the IRS announced the Offshore Voluntary Disclosure Program (the Initial Program), which was designed to encourage eligible taxpayers to disclose previously unreported financial accounts outside of the United States and to report the last six years of income associated with those accounts.
In exchange for their timely, accurate and complete disclosures, participants in the Initial Program were offered as an incentive not only assurances that criminal penalties would not be sought but also a fixed six-year “look back” period, and limitations on civil penalties. The Initial Program resulted in approximately 15,000 disclosures prior to the October 15, 2009 deadline and approximately 3,000 disclosures between then and February 8, 2011, when the 2011 Offshore Voluntary Disclosure Initiative (the New Program) was announced by the IRS. In announcing the New Program, IRS Commissioner Douglas H. Shulman stated that “The situation will just get worse in the months ahead for those hiding assets and income offshore. This new disclosure initiative is the last, best chance for people to get back into the system.”1
The goal of the New Program is almost identical to the goal of the Initial Program. As discussed further below, the affirmative incentives for the New Program are somewhat less appealing than those associated with the Initial Program. However, the risks of failing to participate are heightened by virtue of the wealth of information that the IRS and other US enforcement agencies, such as the Department of Justice, have obtained (and will continue to obtain) through the approximately 18,000 disclosures that have occurred, through investigations of multiple financial institutions, through information obtained from stolen data and through whistleblowers, as well as through exchange of information provisions contained in bilateral tax treaties and tax information exchange agreements and the increased cooperation of taxing authorities and financial institutions worldwide.
Since 2009 and the announcement of the Initial Program, the Department of Justice has prosecuted approximately 30 cases involving taxpayers who have failed to report income associated with financial accounts outside of the US. In addition, since 2008 the Department of Justice has filed criminal charges against several advisors assisting US taxpayers to evade the payment of taxes relating to non-US financial accounts. Both the IRS and the Department of Justice have indicated that international tax evasion is a priority and that additional prosecutions should be anticipated. Even absent the risk of prosecution for prior conduct, persons (including businesses) with undisclosed financial interests and/or income from sources outside the US risk imposition of substantial civil penalties and the prospect of knowing non-compliance with US tax laws in future years.
Features of the New Program
The core features of the New Program, as described in 53 Frequently Asked Questions and Answers issued by the IRS (the New Guidance) 2 are (a) the imposition of a penalty equal to 25 percent of the amount in the accounts outside of the US in the year with the highest aggregate account balance during the years 2003 through 2010 (the 25 Percent Penalty); (b) the required filing of amended tax returns and payment of associated tax, interest and accuracy related and/or delinquency penalties for any years during the period 2003 through 2010 when the taxpayer had an undisclosed account and/or unreported income; (c) the required filing of Forms TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBARs) for any years during the period 2003 through 2010 when the taxpayer had an undisclosed account; and (d) completion of the entire submission process not later than August 31, 2011. By comparison, the Initial Program featured a 20 percent penalty, six years of amended tax returns and tax payments and a more open-ended time frame for resolution.
Another key feature of the New Program, as set forth in the New Guidance, is the calculation of the 25 Percent Penalty – specifically, what is to be included in the base of that calculation. FAQ 32 indicates that when a taxpayer has an undisclosed business account outside of the US, “If the business to which the foreign account relates is a foreign business, the value of the entire business would be included in the penalty base, to the extent of the taxpayer’s interest.” FAQ 35 and FAQ 36 address related issues, with FAQ 35 stating, “The offshore penalty is intended to apply to all of the taxpayers 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. The penalty applies to all assets directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets; tangible assets such as real estate or art; and intangible assets such as patents or stock or other interests in a U.S. or foreign business.”
FAQ 50 confirms that “there may be cases where a taxpayer making a voluntary disclosure would owe less if the special offshore initiative did not exist. Under 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.” However, the example in that case assumes that the maximum penalty would be a penalty for willful failure to file an FBAR, suggesting that in making this determination the IRS will not consider whether the failure was willful (which under existing statutes could result in a penalty of up to 50 percent of the highest amount in an account for each year) or not willful (which under existing statutes would result in a penalty of up to $10,000 per failure to file an FBAR).3
The New Program does offer some additional variations from the Initial Program, particularly in distinguishing among taxpayers who had $75,000 or less in their accounts (who will be eligible for a lower penalty than others), and those who had either $500,000 or $1,000,000 in their accounts (who will be subject to documentation requirements somewhat different than those required under the Initial Program).
The IRS has endeavored to ensure that participants in the Initial Program are not penalized for having disclosed earlier rather than later. For example, the New Program includes a reduced penalty of 12.5 percent (of the highest aggregate account balance) for taxpayers whose highest aggregate balance in each year was less than $75,000. Participants in the Initial Program whose cases have been resolved are afforded an opportunity to seek these reduced penalties Further, where the Initial Program included a reduced 5 percent penalty that applied to an extremely limited population, the New Program expands the eligible population slightly.
Despite apparent efforts to ensure that participants in the Initial Program benefit from early disclosure, no such benefit appears to accrue to persons who came forward between the conclusion of the Initial Program and the announcement of the New Program. FAQ 19 suggests that such persons will be required to affirmatively seek admission to the New Program, rather than being automatically included. FAQ 25 suggests that such persons will be obliged to expand their disclosure to include 2003 and 20104 and duplicate efforts (such as requesting bank records and re-doing PFIC calculations) previously undertaken for the six-year look back period. Practitioners are hopeful that the IRS will endeavor to make it as easy as possible for those persons to participate in the New Program.
Taxpayers will only receive the benefit of the New Program if they are eligible. FAQ 12 provides that “taxpayers who have undisclosed offshore accounts or assets are eligible…” and FAQ 14 clarifies that if a person is under investigation by the IRS, whether civil or criminal, that person will not be eligible. If the IRS has already learned of the existence of a taxpayer’s account outside the US, that person will also not be eligible as the account will have been disclosed. Guidance for the Initial Program referred taxpayers to Internal Revenue Manual section 220.127.116.11 for further limitations on eligibility – including barring taxpayers with illegal source income from the voluntary disclosure practice. It seems that those limitations still apply but it is not clear from the New Guidance. FAQ 23 provides a formalized pre-clearance process, allowing taxpayers or their representatives to contact the IRS to determine whether that person is eligible to participate in the New Program. As with the Initial Program, the New Guidance provides that failure to cooperate or make payment arrangement will result in expulsion from the New Program, which may result in a civil and/or criminal investigation and/or the imposition of increased civil penalties, which can substantially exceed the amounts of funds in accounts held outside of the US.5
Importance of Consulting a Lawyer
Voluntary disclosure pursuant to the New Program may or may not be appropriate for every non-compliant taxpayer (including green card holders) with financial interests outside of the US. Taxpayers should seek the advice of counsel and should share all information with such counsel in order to receive the maximum benefit of such a consultation.
Whether a taxpayer qualifies for voluntary disclosure depends on the individual facts and circumstances involved in each case. However, even if a taxpayer is not eligible to participate in the New Program, there may still be a benefit to contacting either the IRS or the Department of Justice before being contacted by one of their representatives. Taxpayers with unreported income from sources outside of the US should also discuss the state and local tax and other ramifications of any disclosure to the IRS with their tax counsel.
Taxpayers may also wish to consult a tax lawyer in order to ensure continuing compliance with tax payment, filing and reporting obligations.
DLA Piper represents taxpayers participating in both the Initial Program and the New Program. For more information, please contact Ellis L. Reemer.
1 Internal Revenue Service Commissioner Douglas Shulman, quoted in IRS News Release, February 8, 2011
2 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers issued on February 8, 2011. The FAQs address a multitude of circumstances, not all of which are specifically addressed in this Alert. References to FAQs are to the New Guidance unless otherwise indicated.
3 It should be noted that the Internal Revenue Manual (IRM) section 18.104.22.168.5.3.3 places the burden on the IRS to prove willfulness.
4 This will effectively require filing of 2010 federal income tax returns on or prior to August 31, 2011.
5 FAQ 15 and 16 provide that those who have made “quiet disclosures” may be eligible for participation in the New Program and reiterate statements previously made by the IRS that “quiet disclosures” do not offer protection from civil or criminal investigations.
Circular 230 Notice: In compliance with US Treasury Regulations, please be advised that any tax advice given herein (or in any attachment) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax penalties or (ii) promoting, marketing or recommending to another person any transaction or matter addressed herein.