IRS Clarifies Recommended Disclosure Routes for Americans with Offshore Assets
We have previously discussed heightened enforcement efforts by the IRS against undisclosed offshore assets. In 2013 the IRS “urged” cooperation from hundreds of Swiss banks, with the cooperation in question taking the form of handing over information on account holders they might suspect of violating U.S. tax laws. The IRS has now clarified the rules for noncompliant offshore account holders based on their individual circumstances..
First Some Background
3 years ago the only option offered by the IRS was OVDI (this is how the Voluntary Disclosure was referred to originally). The program was ultimately recognized as an abject failure. OVDI participants, even those with small assets, were doomed to pay penalties of at least 25% of balances on their foreign accounts. In exchange IRS guaranteed protection against criminal prosecution.
Quiet Disclosure was labeled as dangerous, leading to higher penalties - yet in practice delinquent taxpayers who filed used that venue managed to get in compliance with the IRS and kept their foreign assets intact.
In 2012 the IRS finally realized they needed to take an alternative approach that did not penalize taxpayers who came forward voluntarily. The Streamlined Procedure came in place. The program guaranteed amnesty from FBAR penalties to those who qualified as "low risk" . That program was a real success as hundreds of thousands of previously dormant overseas Americans used the opportunity to become compliant without the risk of losing a significant share of their life savings.
Yes, the question about those who do not qualify as low risk remained open - what are their options? As you will see from the below, the IRS clearly considers the OVDP as the last and least attractive option - required for
"Taxpayers with undisclosed foreign accounts and unreported income. Taxpayers seeking protection from criminal prosecution."
Quiet disclosure is not among the four listed options below. However, in reality, this is the fifth option remaining to those who do not qualify for options 1 through 3 yet who are not in the position where they must seek protection from criminal prosecution and are ready to pay a high price for it. High price includes high fees to OVDP lawyers (assume $10,000 - $25,000) and then high civil penalties calculated as a percentage of their foreign accounts.
1) You have reported all taxable income but have not filed FBARs.
Anyone with a personal account held in a foreign bank or—and this is the requirement that may ensnare the unaware—signature authority over a foreign bank account that is held by their employer must file an FBAR—the Report of Foreign Bank and Financial Accounts—along with their tax return each year. If your only omission has been the FBAR, meaning you have filed returns every year, reported all taxable income (including that derived from foreign sources), and paid any tax due, you can file delinquent FBARs without any penalty.
This amnesty applies only if you have not underreported your income or tax liability. You also must not have been contacted by the IRS already with a request for delinquent returns or for an income tax examination. Past due FBARs should be filed according to the form instructions; the only addition is that a statement explaining why the reports are delinquent must be included with them.
2) You have delinquent information returns, but no tax is due on any of them.
Certain supporting forms are required of those with foreign assets, including Form 3520 (Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts) and Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations). If you have reported all taxable income and paid all resultant tax liabilities but failed to file one or more of these information returns, you may submit the delinquent returns without penalty.
The basic requirements are the same: no unpaid or underreported tax liabilities and no prior contact by the IRS for an income tax examination or to request delinquent returns. As with the FBAR, a statement explaining the delinquency must be included with any late-filed information returns, and by definition some—such as Form 5471—will require the submission of an amended return, albeit with no changes to income or tax liability.
3) You are a non-resident taxpayer and have delinquent returns with low risk factors.
The main risk factor under consideration here is tax owed; “low” is defined as less than $1,500 per year with a delinquent return. Compliance is accomplished by filing all missing returns (whether tax or information) within the past three years and all delinquent FBARs within the past six years. The IRS requires the inclusion of additional information regarding compliance risk, and while penalties will be waived, interest on unpaid tax is not. The delinquent filings must be accompanied by payment for any unpaid tax liability.
4) You have undisclosed foreign accounts and unreported foreign income, and you wish to avoid criminal prosecution.
If you have committed serious and multiple breaches of offshore account and income reporting that have created a significant tax liability, the best option is the Offshore Voluntary Disclosure Program (OVDP). The OVDP is a civil settlement option that reduces penalties and eliminates the threat of criminal prosecution. The multiple penalties that can be imposed in such cases are waived in favor of a single OVDP penalty, although interest on unpaid tax liabilities will still be levied.
If you are in this situation, you must first request acceptance into the OVDP. Based on the information provided during the application process, the IRS will determine your eligibility and if appropriate issue a preliminary acceptance. At that point you must provide eight years of amended tax returns, file all missing FBARs and information returns, and submit additional specified information regarding your foreign assets. Needless to say, all taxes and interest due must be paid as well.
Here is the link to the official IRS announcement.