On Jan. 9, 2012, the Internal Revenue Service announced the opening of its third Offshore Voluntary Disclosure Program (OVDP) for taxpayers with unreported foreign accounts who seek to come into compliance with their U.S. reporting obligations. This third OVDP follows on the heels of the first two OVDPs, which have collected more than $4.4 billion from more than 33,000 taxpayers who have entered them over the past three years. Unlike the first two OVDPs in 2009 and 2011, which each lasted for approximately seven months, the IRS has stated that this third program will be “open for an indefinite period until otherwise announced.” Although this third program assesses slightly higher civil penalties than prior programs, it strikes a reasonable balance for many taxpayers with unreported offshore bank accounts who want to avoid the risk of more draconian civil penalties and criminal prosecution.
The Third OVDP
The third OVDP will track the 2011 OVDP in many respects but has a few key differences. Like the 2011 OVDP, not all taxpayers who want to enter the program will be accepted into it. If taxpayers are currently under civil audit or criminal investigation for any of the prior eight years, then the IRS will deem the request to enter the program as “untimely” and not accept it. To determine if a taxpayer will be accepted, that taxpayer or her representative may contact the IRS Criminal Investigation Lead Development Center and provide the taxpayer’s name, date of birth, social security number and address. The IRS Criminal Investigation will notify the taxpayer if she passes the “pre-clearance” stage in order to move to the next level and make a voluntary disclosure.
In making the voluntary disclosure, the taxpayer will have to file all original and amended tax returns for the eight full years prior to disclosure and pay the back-taxes owed on the unreported income, a 20 percent accuracy-related and/or delinquency penalty and interest on the tax and penalty — the same conditions as in the 2011 OVDP. In addition, the participants must pay a 27.5 percent FBAR penalty stemming from the failure to file a Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (FBAR). An FBAR is the annual disclosure report required of every taxpayer who has a financial interest in, signature authority, or other authority over one or more financial accounts in foreign countries if the aggregate value of the accounts exceeds $10,000. On the FBAR, the filer lists her name, address, social security number, foreign bank(s), account number(s), bank address(es) and highest account balance(s) during the year. The FBAR is not included with the taxpayer’s tax return but must be separately filed with the IRS by June 30 of the following year.
The 27.5 percent FBAR penalty is calculated based on the highest aggregate balance in the foreign bank accounts during the eight years prior to the voluntary disclosure. For example, if a taxpayer had three foreign bank accounts that cumulatively totaled $2 million at their highest value in 2006, but are now worth $1 million, the 27.5 percent FBAR penalty will be calculated on the $2 million, not the $1 million. As with the 2011 OVDP, some taxpayers will be eligible in rare situations for a reduced penalty of 5 percent (e.g., taxpayers who are foreign residents and unaware they were U.S. citizens) or in limited circumstances for a 12.5 percent penalty (e.g., taxpayers with foreign accounts that did not exceed $75,000 in the aggregate). This 27.5 percent FBAR penalty is higher than the 2011 OVDP FBAR penalty of 25 percent and the 2009 OVDP FBAR penalty of 20 percent.
These OVDP civil penalties are in lieu of the panoply of civil penalties that could apply, including FBAR penalties of up to 50 percent of the accounts’ highest balance per year; fraud penalties of 75 percent; failure to file disclosure returns penalties of up to 35 percent; and failure to pay tax and underpayment penalties of up to 40 percent.
One of the most significant benefits the third OVDP continues is the elimination of the risk of criminal prosecution for the unreported foreign bank accounts and related income. Such prosecutions could charge felony violations of tax evasion, filing a false return and willful failure to file an FBAR. Depending on the crime, each felony carries a three-, five- or 10-year maximum prison sentence as well as fines up to $250,000 or $500,000 per violation.
In exchange for the reduced civil penalties and declination of criminal prosecution, the IRS requires the participants to provide detailed information regarding their dealings with the foreign banks’ representatives. For instance, participants must identify each person at the foreign bank with whom they dealt, describe the manner in which deposits and withdrawals were made, and disclose any steps that were used to prevent disclosure of the account.
An interesting difference between the third OVDP and the first two OVDPs is that the third OVDP does not have a set deadline established by which people have to apply. The IRS has stated that the third OVDP is “open for an indefinite period until otherwise announced.” The IRS makes clear that taxpayers who delay entering the program do so at their own risk because the terms of the third OVDP can “change at any time going forward,” penalties can be increased and the IRS can decide to “end the program entirely at any point.”
To Enter or Not To Enter the Third OVDP
In weighing whether to seek entry into the third OVDP, a taxpayer with unreported foreign accounts needs to balance the prospect and costs of getting caught against the costs of participating in the program. As IRS Commissioner Douglas Shulman has stated, the prospect of getting caught has risen significantly over the last several years:
Americans now understand that if they try to hide assets overseas, the chances of getting caught continue to increase. By any measure, we are in the middle of an unprecedented period for our global international tax enforcement efforts. We have pierced international bank secrecy laws, and we are making a serious dent in offshore tax evasion…Global tax enforcement is a top priority of the IRS. (IRS News Release, Sept. 15, 2011)
In support of Commissioner Shulman’s statements, the IRS has compiled a database of information provided by more than 33,000 OVDP participants over the past three years relating to hundreds of banks, bankers and financial advisers from countries around the world. Nations like Switzerland that used to pride themselves on their impenetrable bank secrecy now are disclosing some U.S. taxpayers’ bank information. Tax haven countries have entered into tax information sharing agreements with the United States. The IRS has increased its training and staffing significantly to address trans-border financial transactions. FATCA, the Foreign Account Tax Compliance Act, becomes effective in 2014 and will force foreign banks to disclose information about U.S. taxpayers or face a stiff 30 percent withholding penalty. The new IRS Form 8938, Statement of Specified Foreign Financial Assets, required to be filed starting with 2011 tax returns, forces taxpayers to disclose information of foreign financial assets of more than $50,000 (different thresholds apply for different situations). And the U.S. Department of Justice has instituted more than 150 offshore criminal tax investigations and brought criminal charges against more than 50 taxpayers, bankers and financial advisers to date.
Given the increased prospects of disclosure of a taxpayer’s unreported foreign bank accounts and the potential severe civil penalties, felony prosecution and incarceration if targeted, the financial costs of entering the third OVDP are acceptable, if not enticing, in many cases. Since the facts of each taxpayer’s situation — whether an individual, partnership, corporation, or trust — are different, taxpayers are well advised to seek expert legal guidance before deciding whether to participate in the third OVDP.