It’s Not Too Late To “Come Clean”— Offshore Voluntary Disclosure Is Still Available

By Paul Bercovici  |  June 28, 2019

HISTORY & BACKGROUND

Citizens of the United States (the “US”), “lawful permanent residents” of the US1 and individuals who meet the “substantial presence test”2 for a particular tax year are subject to US federal income tax on their worldwide income. For decades, many US individuals have owned assets located outside of the US and often derived significant amounts of income from such assets. In the late 2000s, there was a widely held belief that many such individuals were brazenly violating US income tax laws by not reporting their ownership of such assets or income derived therefrom.

Historically, significant numbers of American citizens and “lawful permanent residents” have chosen to live in Canada. It is probably safe to assume that a certain number of US citizens and “lawful permanent residents” who currently live in Canada have failed to report the existence of non-US situs assets and income derived from such assets to the IRS and/or the US Department of the Treasury. The following discussion outlines how such individuals can become compliant regarding such failures.3

In response to the perception that many US individuals were “hiding” assets outside of the US and were not reporting income derived from such assets, and in an effort to maintain the integrity of the federal income tax system, the IRS created the first offshore voluntarydisclosureprogramin2009. The purpose of the off shore voluntary disclosure program was to encourage noncompliant taxpayers to become compliant by voluntarily paying an offshore penalty and certain past due tax and interest amounts. The original 2009 voluntary disclosure program was replaced and superseded by newer iterations of the program in 2011, 2012 and 2014 (the “2014 OVDP”).

Under the terms of the 2014 OVDP, taxpayers who were accepted into the program were required to, amongst other things: file a certain number of years of delinquent or amended income tax return store port previously unreported off shore income, pay all past due tax and interest amounts on such unreported income, file a certain number of delinquent or amended international information returns4 and Foreign Bank Account Reports (“FBARs”)5 and pay an offshore penalty.6 The offshore penalty was intended to substitute for a myriad of otherwise potentially applicable penalties and was equal to 27.5% of the highest aggregate value of “OVDP assets” during the period covered by the voluntary disclosure.7 The term “OVDP assets” was defined to mean assets that were in any wayrelatedto“taxnoncompliance”.8 For these purposes, the term “tax noncompliance”9 included the failure to report gross income from the assets, as well as the failure to pay US tax that was due with respect to the funds used to acquire the asset.

The primary benefits associated with voluntary participation in the 2014 OVDP were:

(i) it shielded participants from potential criminal prosecution for their failure to comply with US federal tax laws in connection with the ownership of offshore assets and the receipt of income attributable to such assets; and

(ii) It provided certainty regarding the amount of penalty payable in connection with the taxpayer’s failure to comply with the tax laws regarding the ownership of offshore assets and the receipt of income attributable to such assets.

On March 13, 2018, the IRS announced that the 2014 OVDP would be closed on September 28, 2018. As of March 2018, the IRS estimated that since the launch of the first offshore voluntary disclosure program in 2009, more than 121,000 taxpayers had participated in the various versions of the offshore voluntary disclosure programs and that participants had paid a total of approximately $11.1 billion dollars in back taxes, interest and penalties.10

On November 20, 2018, the IRS announced certain updated procedures for foreign disclosures submitted after September 28, 2018. Memorandum LB&I-09-1118-014 supplements already existing procedures contained in the Internal Revenue Manual (“IRM”) and is designed to provide taxpayers who have potential criminal liability to come into compliance and avoid criminal prosecution. Foreign offshore disclosures submitted after September 28, 2018, pursuant to these procedures will generally involve the most recent six tax years. As a general rule, a civil penalty for fraud or for fraudulent failure to file income tax returns will apply to the one tax year with the highest income tax liability. In addition, other significant penalties may apply depending on the particular facts and circumstances of the particular case. For more information see IRM 9.5.11.9, Memorandum LB&I-09-1118-014 and the IRS Notice entitled “Closing the 2014 Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers”.11

THE STREAMLINED VOLUNTARY DISCLOSURE PROGRAM

In September 2012, the IRS announced that it was implementing a “streamlined” offshore voluntary disclosure program (the “2012 Streamlined Program”). The 2012 Streamlined Program was designed for taxpayers whose cases were less complex and smaller in scope than cases for which the 2014 OVDP was more appropriate. Underthetermsofthe2012 Streamlined Program, only individuals who were nonresidents of the US and who had $1,500 or less of unpaid tax per year were permitted to participate. The 2012 Streamlined Program was superseded by a new streamlined disclosure program announced in June 2014 (the “2014 Streamlined Program”). Unlike the 2012 Streamlined Program, the 2014 Streamlined Program permitted certain residents of the US to participate and eliminated the above-noted $1,500 tax liability threshold. As a result, the number of taxpayers who could potentially participate in the 2014 Streamlined Program (as opposed to the 2012 Streamlined Program) was significantly increased. The other key feature of the 2014 Streamlined Program was that it introduced the requirement that the taxpayer was required to certify, under penalties of perjury, that their failure to report the existence of foreign financial assets and/ or to report income derived from and pay all tax due in respect of the ownership of such assets was due to “non-willful” conduct. As discussed more fully below, the IRS’s interpretation of the “non-willful” standard is quite broad. The terms of the 2014 Streamlined Program applied to applications for acceptance into the streamlined programmed on or after July 1, 2014.

GENERAL RULES APPLICABLE TO ALL STREAMLINED PARTICIPANTS

The 2014 Streamlined Program has a certain set of eligibility criteria that apply to all applicants. In addition, there are certain other specific rules that apply to taxpayers who reside in the US and a different set of rules that apply to taxpayers who live outside of the US. The IRS has always reserved the right to terminate the 2014 Streamlined Program at any time, but as of the time of publication of this article it has not exercised its right to do so.

Among the rules that apply to all applicants for admission into the 2014 Streamlined Program12 are the following:

  • The 2014 Streamlined Program is only available to taxpayers who are individuals, including estates of individuals;
  • Prior to seeking admission into the 2014 Streamlined Program, the IRS must not have initiated a civil examination of an individual’s income tax returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets, and the individual must also not be under criminal investigation by the IRS Criminal Investigation unit;
  • Individuals seeking admittance into the 2014 Streamlined Program must have a valid Taxpayer Identification Number (“TIN”);13
  • Individuals seeking admittance into the 2014 Streamlined Program are required to certify, under penalties of perjury, that their failure to report all income, pay all tax and submit all required information returns (including FBARs) was due to “non-willful conduct”. The IRS’s position as to what constitutes “non-willful conduct” is quite broad and includes 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.

PARTICULAR ELIGIBILITY CRITERIA FOR TAXPAYERS RESIDING IN THE US

The eligibility criteria that are specific to individuals residing in the US are contained in the IRS release entitled “U.S. Taxpayers Residing in the United States”. 14 Participants in the 2014 Streamlined Program who are residents of the US are required to:  

  • File amended15 US federal income tax returns (including all required international information reporting forms) for each of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed;
  • File delinquent FBARs for each of the most recent six years for which the FBAR due date has passed;
  • Submit payment of all tax due and all applicable statutory interest;
  • Pay an offshore penalty equal to five percent of the highest aggregate balance/value of the taxpayer’s “foreign financial assets”. The five percent penalty applies to “foreign financial assets” that should have been, but were not, reported on an FBAR or on IRS Form 893816 and “foreign financial assets” that were properly reported, but gross income derived from which was not reported. For these purposes, the term “foreign financial asset” includes financial accounts held at foreign financial institutions or branches of US financial institutions, foreign stock or securities not held in a financial account, foreign mutual funds, foreign hedge funds and foreign private equity funds. For these purposes, the highest aggregate balance/value is determined by aggregating the year-end account balances and year-end asset values of all of the “foreign financial assets” subject to the five percent offshore penalty for the past six years for which the FBAR due date has passed and selecting the highest aggregate balance/value from among those years; and
  • Complete and sign Form 14654 (Certification by U.S. Person Residing in the U.S.) certifying, amongst other things, that the failure to file tax returns, report all income, pay all tax, and submit all required information returns (including FBARs) resulted  from “non-willful conduct” and that the calculation of the five percent offshore penalty amount is accurate.

A US resident taxpayer who complies with all the requirements for admission into the 2014 Streamlined Program and who pays the above-noted five percent offshore penalty will not be subject to any other potentially applicable penalties, including accuracy-related penalties, information return penalties and FBAR penalties.

PARTICULAR ELIGIBILITY CRITERIA FOR TAXPAYERS RESIDING OUTSIDE THE US

The eligibility criteria that are specific to individuals residing outside the US are contained in the IRS release entitled “U.S. Taxpayers Residing Outside the United States”.17 Participants who meet certain non-residency requirements are not subject to any offshore penalty in connection with their participation in the 2014 Streamlined Program.

US citizens and “lawful permanent residents” meet the non-residency requirement if, in anyone or more of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed, the individual did not have a “US abode”18 and the individual was physically outside of the US for at least 330 full days.

Individuals who are not US citizens or “lawful permanent residents” meet the non-residency requirement if, in any one or more of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed, the individual did not meet the “substantial presence test”.19

Participants in the 2014 Streamlined Program who are nonresidents of the US are required to:

File delinquent or amended US federal income tax returns (including all required international information reporting forms) for each of the most recent three years for which the US tax return due date (or properly applied for extended due date) has passed;

  • File delinquent FBARs for each of the most recent six years for which the FBAR due date has passed;
  • Submit payment of all tax due and all applicable statutory interest; and
  • Complete and sign Form 14653 (Certification by U.S. Person Residing Outside of the U.S.) certifying, amongst other things, that the failure to file tax returns, report all income, pay all tax, and submit all required information returns (including FBARs) resulted from “non-willful conduct”.

A taxpayer who lives outside of the US and who complies with all the requirements for admission into the 2014 Streamlined Program will not be subject to any other potentially applicable penalties, including failure-to-file and failure-to-pay penalties, accuracy-related penalties, information return penalties, and FBAR penalties.

FILING OF DELINQUENT INTERNATIONAL INFORMATION RETURNS

Individuals who did not fail to report income derived from offshore assets and pay US federal income tax on such income, but who failed to include certain required international information returns with their previously filed income tax returns can rectify such failure under a special procedure which came into effect in 2014 as part of the expanded streamlined disclosure program.20 Individuals who submit delinquent international information returns under this procedure will not be subject to any penalties arising out of such failure to timely file such returns.

In order to participate in this program, a taxpayer must:

  • Have failed to file one or more international information returns;
  • Have “reasonable cause” for not timely filing the information returns;
  • Not be under a civil examination or criminal investigation by the IRS; and
  • Have not already been contacted by the IRS about the delinquent information returns.

The IRS notice entitled “Delinquent International Information Return Submission Procedures” does not provide any guidance as to the meaning or interpretation of the concept of “reasonable cause”. Some guidance is provided in certain sections of the IRM, but the concept of “reasonable cause” has been largely developed by the courts. Common examples of circumstances that have been held by courts to constitute “reasonable cause” include such things as reasonable reliance on a tax advisor, death, serious illness or unavoidable absence, and erroneous advice received from the IRS.

FILING OF DELINQUENT FOREIGN BANK ACCOUNT REPORTS

Similar to the procedures outlined immediately above for taxpayers who failed to timely file certain international information returns, a special procedure for filing delinquent FBARs also came into effect in 2014 as part of the expanded streamlined disclosure program.21 Individuals who submit delinquent FBARs under this procedure will not be subject to any penalties arising out of such failure to timely file such FBARs if they properly reported on their US federal tax17returns, and paid all taxon, any income derived from the foreign financial accounts reported on the delinquent FBARs.

In order to participate in this program, a taxpayer must:

  • Have failed to file one or more FBARs;
  • Not be under a civil examination or criminal investigation by the IRS; and
  • Have not already been contacted by the IRS about the delinquent FBARs

One of the key differences between the program for the filing of delinquent international information returns and delinquent FBARs is that taxpayers who are taking advantage of the procedures to only file delinquent FBARs do not have to include a “reasonable cause” statement with their submission.

CONCLUSION

Despite the September 2018 elimination of the 2014 OVDP, US individual taxpayers who have failed to report the existence of offshore assets and/ or to report income derived from such assets continue to have access to options to become compliant regarding such past failures. Taxpayers who are concerned about potential criminal liability can make a voluntary disclosure pursuant to the relevant provisions contained in the IRM as supplemented by Memorandum LB&I-09-1118-014. Taxpayers who do not have concerns regarding potential criminal liability, and who are confident that their failure to report the existence of offshore assets and/ or report income derived from such assets was due to “no willful” conduct, can continue to seek admission into the 2014 Streamlined Program. In addition, there are separate programs available to taxpayers whose only failure was to not include certain international information returns with their originally filed US federal income tax returns or to timely file FBARs and who have otherwise complied with the US federal income tax laws in connection with their ownership of offshore assets.

This article originally appeared in the June 2019 issue of the Taxes & Wealth Management publication by Thomson Reuters.


1Commonly referred to as “green card” holders.

2In determining whether or not an individual meets the “substantial presence test” for a particular tax year, the individual must be physically present in the US on at least 31 days during the current tax year, and 183 days during the three-year period that includes the current tax year, the first preceding tax year and the second preceding tax year, counting: all of the days that the individual was physically present in the US in the current tax year; 1/3 of the days that the individual was physically present in the US in the first preceding tax year; and 1/6 of the days that the individual was physically present in the US in the second preceding tax year.

3The following discussion does not consider taxpayers making a voluntary disclosure regarding the ownership of offshore assets and the income derived therefrom by “silent” or “quiet” disclosure because such discussion is beyond the scope of this article. However, “silent” or “quiet” disclosure does remain an option in the appropriate circumstances.

4For example, IRS forms 3520, 3520-A, 5471, 5472, 8938, 926 and 8621.

5Department of the Treasury Form Fin CEN114, formerly Form TDF90-22.1.

6See “Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers 2014”, hereinafter referred to as the “2014 OVDP FAQs”.

7A 50% offshore penalty rate applied in cases where either a foreign financial institution at which the taxpayer had an account or a facilitator who helped the taxpayer establish or maintain an offshore arrangement had been publicly identified as being under investigation or as cooperating with a government investigation.

82014 OVDP FAQs, FAQ 35. 9 Ibid. 10 IR 2018-52 entitled “IRS to End Offshore Voluntary Disclosure Program; Taxpayers with Undisclosed Foreign Assets Urged to Come Forward Now” (March 13, 2018).

9Ibid.

10IR 2018-52 entitled “IRS to End Offshore Voluntary Disclosure Program; Taxpayers with Undisclosed Foreign Assets Urged to Come Forward Now” (March 13, 2018).

11Last reviewed or updated on May 2, 2019.

12The general eligibility criteria that apply to individuals seeking admittance into the 2014 Streamlined Program are set out in the IRS release entitled “Streamlined Filing Compliance Procedures”. The release is available on the IRS website and is periodically reviewed and/or updated. The release was last reviewed and/or updated on July 26, 2018.

13For US citizens, “lawful permanent residents” and individuals who meet the “substantial presence test”, the proper TIN is a valid Social Security Number (“SSN”). Individuals who are not entitled to receive an SSN are required to apply for a TIN as part of their application for admission into the 2014 Streamlined Program.

14Last reviewed or updated on March 27, 2019.

15It should be noted that participants in the 2014 Streamlined Program who are residents of the US are not permitted to file delinquent federal income tax returns under the terms of the program; they are only permitted to file amended federal income tax returns.

16IRS Form 8938 is entitled “Specified Foreign Financial Assets”.

17Last reviewed or updated on May 7, 2019.

18The IRS refers to IRS Publication 54 for more information regarding the meaning of the word “abode”. As a general rule, the determination of an individual’s “abode” is based on a determination of where they maintain their family, economic and personal ties.

19See footnote number 2 for a discussion of the mechanics of applying the “substantial presence test”.

20See IRS notice entitled “Delinquent International Information Return Submission Procedures”.

21See IRS notice entitled “Delinquent FBAR Submission Procedures”.

About Paul Bercovici

Paul Bercovici

Paul Bercovici, LL.B., is a Principal at Marks Paneth LLP. Mr. Bercovici specializes in international tax matters including advising US individuals on the income tax implications associated with working and living outside of the United States. He also advises foreign individuals on the income tax implications associated with working and living in the US. Further, he assists foreign and domestic corporations with structuring their US and offshore operations. Immediately prior to joining the firm in 2009,... READ MORE +

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