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Offshore Voluntary Disclosure Program and Streamlined Filing Compliance Procedures

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Rödl & Partner Tax Matters Vol 2014 – 11, published in August 2014

 

Overview

On June 18, 2014, the IRS announced a continuation of the 2012 Offshore Voluntary Disclosure Program ("2012 OVDP"), but modified many of the terms of the program. The IRS also announced changes to its Streamlined Filing Compliance Procedures ("SFCP") as well as the process for submitting delinquent Report of Foreign Bank and Financial Accounts ("FBARs") and international information returns. The new procedures are effective July 1, 2014.

 

As with the original program, taxpayers with undisclosed foreign accounts, assets, or entities may make a voluntary disclosure utilizing either the OVDP or SFCP to become compliant with tax reporting obligations and avoid substantial civil penalties. Participation in the OVDP also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues and generally eliminate the risk of criminal prosecution. Taxpayers who do not participate in the OVDP or SFCP run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. The IRS remains actively engaged in ferreting out the identities of those with undisclosed foreign accounts. Moreover, increasingly this information is available to the IRS under tax treaties, through submissions by whistleblowers, and through information obtained under FATCA and Foreign Financial Asset Reporting on Form 8938. The current program has no deadline to apply, although the terms of the program could be changed or the program could be ended at any time.

 

The modifications to the OVDP are outlined in four distinct sets of procedures:

        • 2014 Offshore Voluntary Disclosure Program,
        • 2014 Streamlined Filing Compliance Procedures,
        • Delinquent FBAR submission procedures, and
        • Delinquent international information return submission procedures.

 

2014 Offshore Voluntary Disclosure Program

The IRS has theoretically narrowed the applicability of the OVDP to a smaller group of taxpayers by expanding the SFCP to encompass a greater number of taxpayers. The OVDP is now designed for taxpayers whose failure to disclose foreign accounts and related income may be viewed as willful by the IRS. Assuming the criteria for participation in the new SFCP is met; a taxpayer's decision to participate in the OVDP or the SFCP should be based on an evaluation of the taxpayer's willfulness or non-willfulness in his or her failure to report foreign assets and any associated income. The definition of willful is broad and encompasses many scenarios the layperson may not view as willful such as signing Form 1040 (including signing e-file authorizations as being accurate and complete. The IRS has stated that the concept of willfulness is well documented in case law and they would rely on practitioners to advise their clients on risks of criminal prosecution. Therefore, all potential OVDP or SFCP cases must be referred to an attorney who will, together with the taxpayer, assess whether or not a taxpayer can certify, as required by SFCP, that their lack of compliance is non-willful.

 

The OVDP will continue to be administered through a set of Frequently Asked Questions ("FAQs"). Significant changes to the FAQs include the following:
    • An increased penalty from 27.5% to 50% on all applicable assets, if a taxpayer has or had a foreign financial account, or had a facilitator who helped the taxpayer establish or maintain an offshore arrangement, and the financial institution or facilitator has been publically identified as being under investigation by the IRS or Department of Justice. The increased penalty applies if the identification has been made on or after August 4, 2014 and the taxpayer has not yet submitted a preclearance letter to IRS Criminal Investigation by that date.
    • The 5% and 12.5% penalty structure has been removed and replaced with various options under the new SFCP.
    • The FAQs addressing failure to file FBARs and foreign information returns when no tax is due has been removed and replaced with other options.
    • The offshore penalty must be paid at the time of the OVDP submission.
    • The option to "opt-out" of the OVDP and seek reduced penalties remains.

 

Utilizing the Streamlined Filing Compliance Procedures

The purpose of the new streamlined procedures is to encourage taxpayers to come forward without fear of steep penalties in cases where non-compliance is non-willful. Therefore, as mentioned above, a taxpayer participating in the SFCP will be required to sign a certification that the failure to report all income, pay tax, and submit all required information returns, including FBARs, was due to non-willful conduct. Non-willful conduct is defined as conduct that is due to negligence, inadvertence, or mistake, or conduct that is the result of a good faith misunderstanding of the requirements of the law. As mentioned above, attorney representation is required to make this determination.

 

The IRS has outlined eligibility requirements and procedures for both residents and non-residents.

 

General Eligibility Requirements Applicable to Residents and Non-Residents

  • Streamlined procedures are only available to individual taxpayers including estates.
  • If a civil examination or criminal investigation has already been initiated by the IRS, then the taxpayer is not eligible to use the streamlined procedures (or OVDP).
  • The IRS will not acknowledge receipt of the returns and there will not be a closing agreement.
  • Submitted tax returns are subject to audit under existing audit selection guidelines applicable to all U.S. tax returns.
  • Once a taxpayer has made a submission under the streamlined procedures, the taxpayer may not participate in the OVDP.
  • A taxpayer who submitted an OVDP voluntary disclosure request on or after July 1, 2014, is not eligible to submit returns under the Streamlined Procedures.

 

Eligibility Requirements for Residents

  • Fail to meet the applicable non-residency requirement (i.e. is a U.S. citizen, green card holder or meets the substantial presence test) (for joint return filers, one or both of the spouses must fail to meet the non-residency requirement,
  • Has previously filed a U.S. tax return (if required) for each of the most recent 3 years for which the U.S. tax return due date (including extensions) has passed,
  • Has failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR and/or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset, and
  • Such failures resulted from non-willful conduct.


Eligibility Requirements for Non-Residents

  • Was physically outside the United States for at least 330 days in one or more of the past three years.  At this point, the relevant three years could be (i) 2011, 2012, and 2013, or (ii) 2010, 2011, and 2012, depending on whether the taxpayer obtained a six-month filing extension for Form 1040 for 2013,
  • Did not have an "abode" in the United States at any point during the three-year period explained above.  Generally, an "abode" is a permanent home, habitation, residence, domicile, or place of dwelling.  The term "abode" also refers to the place where a taxpayer maintains economic, family, and personal ties,
  • Failed to file annual Forms 1040, or filed annual Forms 1040 that did not properly report worldwide income,
  • Has failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR and/or one or more international information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621) with respect to the foreign financial asset, and
  • Such failures resulted from non-willful conduct.

 

Procedures for Residents and Non-Residents

The resident and non-resident Streamlined Procedures require a taxpayer to:

  1. File amended tax returns for the most recent three years for which the tax return due date (or properly applied for extended due date) has passed
  2. File any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed,
  3. File all relevant international information returns for the past three years.  These include, but are not limited to, Forms 8938 for foreign financial assets, Forms 5471 for foreign corporations, Forms 8865 for foreign partnerships, Forms 3520 and Forms 3520-A for foreign trusts, Forms 8621 for passive foreign investment companies, etc.
  4. Sign and date a certification for the IRS, under penalties of perjury, stating to the IRS that the failure to report all foreign income, accounts, assets, etc. was not "willful" including providing a detailed description of the facts supporting the position that the U.S. tax violations were unintentional/non-willful and the taxpayer acted reasonably and in good faith. 
  5. Pay the income taxes and interest charges related to the delinquent or amended tax returns for the past three years. A taxpayer who is eligible to use the non-resident Streamlined Procedures, and complies with the procedures, will not be subject to failure-to-file and failure-to-pay penalties, accuracy related penalties, information return penalties, or general FBAR penalties.


Resident taxpayers must also pay a miscellaneous offshore penalty. The miscellaneous offshore penalty is equal to 5% of the highest aggregate balance or value of the taxpayer's foreign financial assets that are subject to the penalty during the years in the relevant tax return period and relevant FBAR period. The various provisions under the OVDP allowing certain accounts to be excluded from the penalty base (e.g. transfers between accounts or accounts with no unreported income) do NOT apply to the 5% miscellaneous penalty. Therefore, it is possible that some taxpayers may be better off in the OVDP rather than SFCP. A careful analysis of each taxpayer's situation will need to be completed.

 

Transitional Rules for Taxpayers Already Participating in OVDP

Taxpayers who submitted an OVDP voluntary disclosure request prior to July 1, 2014, but who have not yet executed a closing agreement, and are otherwise eligible to participate in the streamlined procedures, may request consideration under the streamlined procedures pursuant to transitional rules while remaining in OVDP. The benefit of transitioning a case from the OVDP to the SFCP is a potentially significant reduction of the "offshore" penalty. Careful analysis of the penalty is required; however, as the penalty reduction provisions available under the OVDP are not available under the SFCP. Transitioning from the OVDP to the SFCP is not automatic. Various items must be filed with the IRS where they will undergo multiple reviews. The focus of the review by the IRS will be on whether the tax violations were "willful" or "non-willful." If a taxpayer is allowed to transition to the SFCP, all other existing requirements of the OVDP, such as resolving tax non-compliance for the past eight years as opposed to three years under SFCP, remain the same.

 

Delinquent FBAR Submission Procedures

Taxpayers who do not need to use either the 2014 OVDP or the SFCP to file delinquent or amended tax returns to report and pay additional tax, may use the delinquent FBAR submission procedures as long as the following requirements are met:

  1. Have not filed a required FBAR(s),
  2. Are not under civil examination or criminal investigation by the IRS,
  3. Have not been contacted by the IRS about the delinquent FBAR, and
  4. Have reported and paid tax on income from the foreign financial accounts reported on the delinquent FBAR.

The taxpayer should file the FBAR for up to six years, if needed, according to the form's instructions (including electronic filing requirements) and include a statement why the FBAR is being filed late. The IRS will not impose a penalty for the failure to file the FBAR if the taxpayer has properly reported on a U.S tax return, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBAR(s).

 

Delinquent International Information Return Submission Procedures

Taxpayers who do not need to use either the 2014 OVDP or the SFCP to file delinquent or amended tax returns to report and pay additional tax, may use the delinquent international information return submission procedures as long as the following requirements are met:

  1. Have not filed one or more required international information returns,
  2. Have reasonable cause for not timely filing the information returns,
  3. Are not under a civil examination or a criminal investigation by the IRS, and
  4. Have not already been contacted by the IRS about the delinquent information returns.

The taxpayer should file the delinquent information returns (attached to an amended return for the year or years for which the compliance failure exists) with a statement of all facts establishing reasonable cause for the failure to file the information returns. The taxpayer must also certify in a statement that any entity for which the information returns are being filed was not engaged in tax evasion. A reasonable cause statement must be attached to each delinquent information return.

 

Conclusion

The OVDP and SFCP are full of traps for the unwary. What appears beneficial on the surface may turn out to not be so. The evaluation of whether to participate in OVDP or SFCP requires careful analysis of each taxpayer's situation including a legal analysis of the potential civil and criminal risks to the taxpayer. If you have any questions regarding OVDP or SFCP, please contact your Rödl and Partner tax advisor.

 

If you have any questions, please contact your Rödl & Partner office.

 

 

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