October 17, 2019 Articles

Updated Process for Offshore Voluntary Disclosures

The updated process for the OVDP may seem, on its face, to mirror the former program. Read on to determine whether and how the updates may impact you and your clients.

By Eli S. Noff and Mary Lundstedt

The objective of the former Offshore Voluntary Disclosure Program (OVDP) enabled willful U.S. taxpayers with undisclosed foreign assets to become compliant with U.S. tax laws, while concurrently avoiding serious statutory civil penalties and practically removing any risk of criminal prosecution. On November 29, 2018, the Internal Revenue Service (IRS) posted Internal Revenue Manual (IRM) §9.5 Interim Guidance in a memorandum (the Memo) addressing the process for all domestic and offshore voluntary disclosures since the closing of the OVDP on September 28, 2018. (LB&I-09-1118-014 (Nov. 20, 2018). We discussed the end of the OVDP in an earlier article, “End of Offshore Voluntary Disclosure Program Imminent.”) Generally, the voluntary disclosure process maintains similarity to the OVDP, but taxpayers and practitioners should note the revisions highlighted here, including the higher penalty for unreported taxes due.

The Memo clarifies that the IRS Criminal Investigations unit (CI) will be responsible for screening all domestic and offshore voluntary disclosure requests to determine taxpayer’s eligibility to make such disclosures. As such, the IRS stated that “CI will require all taxpayers wishing to make a voluntary disclosure to submit a preclearance request on a forthcoming revision of Form 14457.” LB&I-09-1118-014. The Form 14457 will require taxpayer-specific information, including “a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance.” Id.

Additionally, for all voluntary disclosures received after September 28, 2018, the Memo provides that, unlike the OVDP’s eight-year disclosure period, only the most recent six tax years are required to be disclosed under the new procedures. Upon the IRS’s review and consent, a “cooperative” taxpayer may be allowed to submit for prior years. Expansion of the disclosure period may be desirable when rectifying tax issues involving unreported taxable gifts, correcting tax problems before entity sale or acquisition, and other circumstances.

Significantly, under the Interim Guidance, taxpayers making a voluntary disclosure are subject to a much larger penalty for evasion. While the OVDP imposed a 20 percent annual penalty on unreported taxes due, the Interim Guidance provides for a 75 percent penalty. Specifically, the IRS states in the Memo that:

Except as set forth below, the civil penalty under I.R.C. §6663 for fraud or the civil penalty under I.R.C. §6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. For purposes of this memorandum, both penalties are referred to as the civil fraud penalty.

Note that, based on an analysis of the facts and circumstances of each case, the IRS may apply the civil fraud penalty to other years. Obviously, many practitioners see the increased penalty as having a chilling effect on voluntary disclosures; however, all things considered, for many the steep penalty may be a worthwhile price to pay to avoid criminal prosecution.

The Memo addresses other penalties, as well. As for the penalties for willfully failing to file FinCEN Form 114, Report of Foreign Bank Accounts (FBAR), the Memo explains that the IRS will assert such penalties per the existing IRS penalty guidelines under I.R.M. 4.26.16 and 4.26.17. Generally, willful FBAR violations result in a penalty of up to the greater of $100,000 or 50 percent of the maximum account value. Practically speaking, taxpayers utilizing the voluntary disclosure procedures in exchange for certain criminal protections, should expect to incur willful FBAR penalties. However, the Memo implies that a taxpayer assessed with steep FBAR penalties, for instance, might find that the IRS withholds imposing additional informational return penalties in light of the significant FBAR penalties. Specifically, the IRS states in the Memo that “[p]enalties for the failure to file information returns will not be automatically imposed.” Id. (Informational returns include forms such as Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and the Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.) Rather, the IRS will view the totality of the circumstances, such as imposition of the FBAR penalty, and in its discretion will account for the application of other informational reporting penalties in its final determination.

The Memo indicates that all impacted IRM sections will be updated within two years of the date of the Memo. Furthermore, the Memo’s procedures will be effective for all voluntary disclosures received after September 28, 2018. Note that the Memo also provides that

[a]ll offshore voluntary disclosures conforming to the requirements of “Closing the 2014 Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers” FAQ 3 received or postmarked by September 28, 2018 will be handled under the procedures of the 2014 OVDP. For all other voluntary disclosures (non-offshore) received on or before September 28, 2018, the Service has the discretion to apply the procedures outlined in this memorandum.

While the updated process continues to allow taxpayers to escape criminal prosecution by voluntary disclosure, taxpayers face a higher penalty for unpaid taxes and an array of new rules for the disclosure itself. An experienced tax professional’s guidance should be sought to navigate the new process.

Taxpayers should also remember that there are other procedures available to allow delinquent account holders to achieve compliance without facing harsh penalties, although these procedures are reserved for taxpayers who can certify their conduct was non-willful. These procedures include the Streamlined Domestic and Foreign Offshore Procedures and the Delinquent Submission Procedures. You can read more about these procedures in our previous post, “Coming Out of the Dark of International Tax Avoidance.”

Eli S. Noff is a managing partner and Mary Lundstedt is an associate at Frost & Associates, LLC, in Washington, DC.

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