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Offshore Voluntary Disclosure – Not a Tax Amnesty

Offshore Voluntary Disclosure – Not a Tax Amnesty

In early January of this year the IRS announced that it is re-opening the 2011 Offshore Voluntary Disclosure Initiative (“OVDI”). The new program for 2012 has some changes from the prior program and further changes could come at any time by the IRS. Further, the IRS can terminate the program at any time.

IRS Intensifies its Investigations of Americans Overseas

As publicized widely in the press, in its efforts to flush out US persons hiding assets offshore the United States, the IRS continues to investigate many banks around the world – it has not stopped at Switzerland. Banks in India and even Israel are now known to be cooperating.  The IRS has also hired many new agents to tackle international tax investigations and has a strong whistleblower program in place with large rewards on offer.  Newly enacted tax laws under “FATCA” make hiding even more difficult by requiring foreign financial institutions to report on their US clients; extending the tax statute of limitations; and increasing the disclosure mandates of US taxpayers with regard to their foreign holdings.  Read my tax blog post for information on the new disclosure provisions for foreign financial assets applicable for filing of 2011 income tax returns and later years.  Time is definitely running out.

OVDI 2012

The terms of the 2012 OVDI (which are largely based on the terms of the 2011 OVDI) are different and more harsh than those announced in the original program in 2009.   Those who participate in the 2012 offshore disclosure initiative must generally pay all the back taxes they owe for an 8 year period, a 20% and / or 25% penalty imposed on the back taxes; interest, and a so-called “in lieu” or “FBAR” penalty equal to 27.5% of the offshore assets / accounts highest balance during the 8 year disclosure period. During the 2009 program, the so-called “FBAR” penalty was 20% of the highest account / asset balance; in 2011, the penalty rose to 25% and now it stands at 27.5%.

If you do not know what an FBAR is, please read my article “Worldwide Tax Laws for American Expatriates” see the sections titled: “Tax Information Reporting Requirements” and “Delinquent Tax Returns and FBARS” which discuss the required reporting for non-US bank and other financial accounts.

Reduced Penalties May Apply to the Typical US Expat

As in prior programs, certain taxpayers may be eligible for a reduced “in-lieu” / “FBAR” penalty.  This is very significant for US persons living in the Middle East region, where many jurisdictions have no individual income tax or have a tax asserted by withholding (e.g., on bank account interest).  Under the IRS announcement pertaining to OVDI, a reduced 5% penalty can apply if the individual is a foreign resident and meets all of the following requirements for all relevant years in the voluntary disclosure:

“taxpayer resides in a foreign country; taxpayer has made a good faith showing that he or she has timely complied with all tax reporting and payment requirements in the country of residency; and taxpayer has $10,000 or less of U.S. source income each year. For these taxpayers only, the offshore penalty will not apply to non-financial assets, such as real property, business interests, or artworks, purchased with funds for which the taxpayer can establish that all applicable taxes have been paid, either in the U.S. or in the country of residence. This exception only applies if the income tax returns filed with the foreign tax authority included the offshore-related taxable income that was not reported on the U.S. tax return.”

We have been informally advised by the IRS that this 5% reduced penalty can indeed apply to the typical situation of an expat living in, for example, the UAE or Saudi Arabia which generally have no income tax and do not require the filing of tax returns by individuals.  The IRS has informally advised that so long as the host country tax rules were abided, the reduced penalty is permitted (assuming the other requirements are met).

This reduced penalty can be a blessing to an expat who has not filed income tax returns or FBARs for many years. Take the typical expat who has unreported overseas salary and local bank accounts earning de minimis interest. Assume he purchased a home in Dubai with these unreported funds.  Without the special reduced OVDI penalty, the “in lieu” penalty that could be assessed against this expat would be 27.5% of the highest aggregate value of his offshore accounts and offshore assets. This penalty base would include the fair market value of his home in Dubai!   Another reduced penalty provision is available for those whose accounts never exceeded $75,000; being eligible for a reduced 12.5% “in lieu” penalty. This beneficial provision might be geared to the many expats who did not have significant offshore holdings and who were not fully aware of their US tax obligations and the FBAR reporting rules.

Other special reduced penalty provisions are also available under the program.

Get Qualified US Tax Help Now Before It Is Too Late

One thing is clear, the IRS will have no mercy if it finds a taxpayer hiding income or assets overseas – even if the amounts in question are not that large.  A New Jersey woman admitted she had concealed $750,000 in an account at UBS, Switzerland that had been opened and funded by her father.   It was stipulated that omitting the income from her UBS account on her tax returns between 2000 and 2007 resulted in a loss to the U.S. Treasury of more than $5,000 but less than $12,000.  She faced up to three years in prison; her father faced up to five years.

Protect Yourself as Much as Possible: Attorney-Client Privilege

Joining OVDI 2012 is not the only option available to taxpayers who have fallen out of compliance – there are others. Taxpayers with unreported income or assets must act now and obtain a full understanding of the various options open to them, the attendant implications and possible penalties under each. The best bet is to work with a US tax attorney to obtain the benefit of an attorney-client privilege.  The attorney will probably work with an accountant to get the amended or delinquent income tax returns and FBARs prepared. In this instance, the attorney  (rather thant the client) should hire the accountant for the work to be done and this should be carefully documented in what is called a “Kovel” agreement.  The purpose of having a Kovel agreement is to extend the attorney-client privilege to the greatest extent possible to the accountant’s participation and work product.

 

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