Last chance

  • Author : Barbara T Kaplan
  • Author : Scott E Fink
  • Date : April 2011
ABOUT THE AUTHORS: Barbara T Kaplan and Scott E Fink, Greenberg Traurig, LLP

The Internal Revenue Service (IRS) announced a second offshore voluntary disclosure initiative (2011 OVDI) on 28 February 2011, which eliminates criminal tax exposure associated with undisclosed foreign financial accounts and foreign assets and offers reduced monetary penalties for participating. The 2011 OVDI is designed to encourage taxpayers with such undisclosed foreign assets to become tax compliant for the past eight years.

The 2011 OVDI is considered to be a special programme offered under the IRS’s general policy relating to voluntary disclosures found in the Internal Revenue Manual. The Manual provides that a taxpayer’s timely and truthful voluntary disclosure of previously undisclosed income is an important factor in determining whether criminal prosecution will be recommended. A timely voluntary disclosure does not automatically guarantee immunity from prosecution, but may result in the IRS not recommending criminal prosecution to the Department of Justice. A voluntary disclosure occurs when the disclosure is truthful, timely and complete and when the source of the funds at issue is not from an illegal activity. A disclosure is considered timely if it is made before the IRS has initiated a civil examination or criminal investigation of the taxpayer or notified the taxpayer that it intends to do so, or received information about the taxpayer’s non-compliance from a third party or from a criminal enforcement action. The taxpayer also must show a willingness to cooperate with the IRS in computing the correct tax liability.

The 2011 OVDI is open to all taxpayers subject to the requirements above. The programme expires on 31 August 2011. Participating taxpayers will receive a single 25 per cent penalty based on the highest value of their undisclosed foreign assets over the eight-year OVDI period of 2003 to 2010. This compares with a potential annual penalty as high as the greater of USD100,000 or 50 per cent of the total balance in the foreign account each year. The offered 25 per cent penalty is slightly higher than the 20 per cent penalty that was offered in the IRS’s first offshore voluntary disclosure initiative in 2009 (2009 OVDI) covering the period from 2003 to 2008. Those taxpayers that participated in the 2009 OVDI were required to file amended tax returns for the years 2003 to 2008.

Penalties

The taxpayer is required to pay all of the tax and interest due for the OVDI years along with a 20 per cent accuracy-related penalty, and, in certain circumstances, delinquency penalties. These penalties are in addition to the 25 per cent penalty based on asset value. What makes the 2011 OVDI potentially more expensive, as was the case with the 2009 OVDI, is the IRS’s insistence that the 25 per cent penalty be applied to the fair market value of undisclosed assets held in a foreign jurisdiction that are related to tax non-compliance, in addition to the value of the assets held in foreign financial accounts. The IRS says that assets will be treated as related to tax non-compliance if the income generated from the assets was not reported during the eight-year period or if the taxpayer failed to pay the US income tax on the funds used to acquire the foreign assets.

Relief

The 2011 OVDI gives relief from the 25 per cent penalty in certain specified circumstances. The first is for small accounts. If the highest aggregate value of the undisclosed accounts and assets does not exceed USD75,000 in any of the eight years under the initiative, the penalty is cut in half to 12.5 per cent applied to the year with the highest total value. Another exception provides for a mere 5 per cent penalty if all of the following conditions are met: (i) the accounts were not opened by the taxpayer (for example, the accounts were inherited or gifted); (ii) there was only minimal contact between the taxpayer and the bank; (iii) no more than USD1,000 was withdrawn from the accounts in any year under the 2011 OVDI (except if the account was closed and the funds were repatriated to the US); and (iv) the taxpayer can establish that all US taxes have been paid on the funds deposited in the accounts. (The IRS will presume that funds deposited into an account before 1 January 1991 were appropriately taxed.) Finally, taxpayers also can qualify for the 5 per cent penalty if they can show that they are a foreign resident and were unaware that they were US citizens.

A 5 per cent penalty also was offered in the 2009 OVDI, but was never clearly defined and was applied inconsistently. Under the 2009 OVDI, a taxpayer could qualify for a 5 per cent penalty if: (i) the taxpayer did not open or cause any accounts to be opened or entities formed (intended to address inherited accounts); (ii) there was no activity in any account or entity during the period the account/entity was controlled by the taxpayer; and (iii) all applicable US taxes were paid on the funds in the account/entities. The IRS applied these factors narrowly and frequently rejected cases that seemed to qualify. With the greater certainty offered for 5 per cent penalty relief in the 2011 OVDI, the IRS seems to acknowledge that the 5 per cent penalty may not have been given adequate consideration during the first initiative. Therefore, the announcement of the 2011 OVDI contains provisions to allow taxpayers that participated in the 2009 OVDI and who would otherwise qualify for the newly defined 5 per cent or 12.5 per cent penalties to reopen their cases to seek to have the lower penalty imposed.

The 2011 OVDI also includes a provision that limits the penalties asserted against a participating taxpayer if the amount of the penalties imposed in the OVDI exceeds those that could be asserted outside of the programme, i.e. under the Internal Revenue Code or the Bank Secrecy Act. The 2009 OVDI had a similar provision. This provision was utilised by practitioners, sometimes successfully, to argue that the statutorily imposed penalties warranted a reduced offshore penalty. For example, if the facts of the case demonstrated that there was no willful intent on the part of the taxpayer in failing to file an FBAR (Report of Foreign Bank and Financial Accounts), the penalty would be limited to USD10,000 per violation. It also could be argued that outside the 2009 OVDI the penalty would be further reduced pursuant to the IRS’s mitigation guidelines, which give the IRS latitude to reduce the penalty depending on the taxpayer’s history and the value in the account. The IRS has revised the language of the mitigation provision in the 2011 OVDI to provide that under no circumstances will taxpayers be required to pay a penalty greater than their maximum liability under existing statutes. The inclusion of the term ‘maximum penalties’ seems to be intended to do away with the non-willful and mitigation arguments, implying that an examiner must consider the application of a 50 per cent FBAR penalty based on the highest balances in the accounts in comparing whether the taxpayer would pay less outside of the programme.

Requirements

In order to participate in the 2011 OVDI, taxpayers must come forward and complete all filing requirements, including filing a supplemental estate tax return, if applicable, on or before 31 August 2011. A disclosure is made by submitting a letter signed under penalties of perjury that includes complete identifying information about the taxpayer and details of the foreign accounts/assets, such as the institutions where they are held, the years the accounts were open, the balances in the account, the income generated in the accounts, the identification of all people or entities affiliated with the account, the contacts at the bank and a description of any face-to-face meetings with the bankers. Upon submission of this letter, the IRS Criminal Investigations will check to see if the taxpayer has made a timely disclosure and is eligible to make a voluntary disclosure. The 2011 OVDI also provides a formal pre-clearance process whereby a taxpayer can submit limited identifying information to a centralised unit of the IRS before a full disclosure is made to find out if they qualify to make a voluntary disclosure.

Once a taxpayer submits the voluntary disclosure letter and has been cleared by the IRS Criminal Investigations, the taxpayer must submit a complete package to a centralised IRS location consisting of the following:

aCopies of previously filed income tax returns for the years 2003 to 2010.bComplete and accurate amended income tax returns for the years 2003 to 2010.cCompleted financial and information statements, as required, including Forms TDF 90-22.1 (the FBAR). For example:
1a Foreign Account or Asset Statement is required for each undisclosed foreign account or asset. This form requires detailed information about all foreign assets and foreign accounts, including what type of assets are held in the account (i.e. passive foreign investment companies);2for accounts over USD1 million, a completed Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer had an undisclosed account. This statement asks a few yes and no questions in order to obtain information regarding the representatives of the institutions where the accounts are held and the promoters of any offshore entities; and3a Taxpayer Account Summary with Penalty Calculation. This form requires the high balance of each unreported account, the fair market value of any undisclosed foreign asset and the computation of the 25 per cent penalty. The taxpayer must sign this form.
dPayment of all tax, interest and income tax penalties for each year. If full payment cannot be made, the taxpayer must submit a proposed payment arrangement.eFor accounts with a value of over USD500,000, copies of the account statements showing all account activity during the years at issue.fA signed extension of the statute of limitations for all taxes and penalties.

Upon receipt of this package, a revenue agent will be assigned to review the documents and work with the taxpayer to enter into a closing agreement resolving the matter.

Risks

The 2011 OVDI announcement included statements that taxpayers that do not come forward will bear the risk of criminal prosecution and higher penalties if they are detected by the IRS. The IRS has expanded its focus on foreign banks from Europe to banks in Asia, the Middle East and Central America and has obtained information about the banks’ US account-holders from treaty requests, summonses, whistleblowers and mining information supplied during the 2009 OVDI. The IRS also will begin to receive additional information about foreign accounts when the new Foreign Account Tax Compliance Act and the Statement of Foreign Financial Assets Form become effective. Thus, the potential for detection by the IRS is increasing, but the cost of taking advantage of the 2011 OVDI can be substantial, especially for those with foreign assets in addition to bank accounts.


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