In 2009, the Internal Revenue Service announced a voluntary disclosure program for U.S. taxpayers with unreported income in offshore accounts, which gave them a limited period of time to come forward, disclose this income and avoid criminal prosecution. Approximately 15,000 taxpayers participated, disclosing bank accounts in some 60 countries. Now, taxpayers with offshore income and assets are getting another chance to “come in from the cold.” On Feb. 8, 2011, the IRS announced the 2011 offshore voluntary disclosure initiative (OVDI).
It’s often not easy for advisors to persuade clients to disclose unreported income to the IRS. But in the case of U.S. taxpayers with unreported income in banks overseas, it’s vitally important to convey a harsh new reality: The IRS is much more likely to track them down than ever before.
Come Forward ASAP
Switzerland just announced that it has simplified the procedure that foreign governments can use to request account information. Now, governments need only provide a bank account number, a Social Security number, a credit card account number or other details. Of equal importance, the IRS has moved beyond its well-publicized initiatives involving major Swiss banks with U.S. taxpayer’s accounts, such as UBS and Credit-Suisse. It’s now focusing on small cantonal banks in Switzerland as well as major financial institutions in places such as Asia, Singapore, India and Israel.
Indeed, IRS Commissioner Douglas Shulman has called the 2011 OVDI the “last, best chance” for taxpayers to come clean “while we have other banks in our sights.”1 Taxpayers who fully comply will generally avoid criminal prosecution—although those with an illegal source of income won’t be eligible to participate—and will be subject to penalties imposed by the IRS for prior non-compliance.
In addition to advising clients to disclose offshore income, advisors should urge them to do it quickly. For one thing, the 2011 OVDI requires all taxpayers to file all amended returns, pay all tax and interest due in full, and pay accuracy-related penalties as well as failure-to-file and failure-to-pay penalties by Aug. 31, 2011. In the 2009 voluntary disclosure program, taxpayers were obligated only to make a request to participate in the program before the deadline, not to file returns and make payments.
Taxpayers also may have a difficult time obtaining the necessary information from the banks in time to file amended returns by the Aug. 31 deadline, based on prior experience with the 2009 program. During that program, proper records in overseas banks were sometimes unavailable or difficult to track down. Banks in some countries didn’t keep summaries of capital gains and losses and other important records, forcing taxpayers’ accountants to spend a great deal of time making the calculations necessary for compliance. Also, taxpayers participating in OVDI will be required to report on all global holdings and will be required to get records of assets in different banks in different countries, which could take many months. The potential for these and other hurdles created by non-U.S. banks are another reason to come forward and voluntarily disclose as soon as possible.
The IRS sets forth the details of the 2011 OVDI in “Frequently Asked Questions and Answers.”2 This e-newsletter will touch on a few highlights. Participants in the program must file amended returns covering the years 2003-2010, along with appropriate schedules detailing the amount of previously unreported income. They will face a 20 percent accuracy or a 25 percent negligence penalty on any underpayment of tax and a failure-to-file penalty, as well as a failure-to-pay penalty, if applicable.
They also will be subject to a maximum penalty of 25 percent for failure to file so-called FBARs (Report of Foreign Bank Account and Financial Accounts), for 2003 through 2010. This penalty will be imposed on the highest aggregate balance in unreported foreign accounts and the value of foreign income-producing entities during the period covered by the voluntary disclosure.
However, taxpayers may get some relief from the FBAR penalty. They won’t be required to pay a penalty greater than what they would otherwise owe in penalties under existing law. Thus, for example, if a taxpayer can establish that the failure to file an FBAR wasn’t willful, the penalty may be as low as $10,000 per year per account.
The FBAR penalty will be reduced to 12.5 percent if the highest value of the unreported offshore financial account and undisclosed offshore entities during the OVDI years is less than $75,000. There will also be a reduced penalty available to some taxpayers with inherited accounts, who may owe a 5 percent penalty.
The penalty is also reduced to 5 percent for “accidental” Americans, that is, those individuals who aren’t aware that technically they are U.S. citizens who owe U.S. taxes. An accidental American could be someone born in the United States to non-U.S. parents and who was raised overseas or someone who has never even been to the United States but has one parent who is a U.S citizen. An untold number of people are in this category and some are people of means. Financial advisors should be cognizant of those individuals’ U.S. tax liabilities.
Under the OVDI program, the IRS is also offering a special, simplified procedure for reporting passive foreign investment companies (PFICs) such as foreign mutual funds, that’s consistent with a mark-to-market methodology. The OVDI program offers various shortcuts to determine PFIC income, a reduced tax rate and a simplified interest regime.
It’s also important to note that the OVDI program is only available to taxpayers who specifically follow the new program rules. The caps on penalties, the limitation on the years that will be subject to penalties, as well as the reduced risk of criminal prosecution won’t apply to taxpayers who make a so-called “quiet” disclosure and merely file past due returns without coming forward and actively cooperating with the IRS as required under the OVDI. Those who have previously made a “quiet” disclosure are eligible to participate in the 2011 OVDI, but they must make a formal request to do so.
The IRS has indicated that there are approximately 3,000 taxpayers who filed requests to participate in the 2009 voluntary disclosure program after it closed. All of them will be automatically swept into the 2011 OVDI.
U.S. taxpayers with offshore accounts may find the penalties detailed above to be onerous. But these penalties are far less stiff than those that will be imposed if the IRS catches up to them. In addition to facing possible jail time and criminal penalties, they may well pay up to 75 percent of the tax amount owed, plus FBAR and other penalties that could be as much as 30 percent of the value of unreported offshore assets.