last month the IRS released more than 6,500 pages from the Internal Revenue Service on the agency’s Offshore Voluntary Disclosure Program and how it trains its agents. The documents included material used in training IRS personnel in the Offshore Voluntary Disclosure Program, determining program penalties and instructing IRS employees about the program.
The purpose of the OVDP is for individuals who have failed to file an FBAR (Foreign Bank and Financial Accounts Report) form with the IRS, or didn’t report income from offshore activities to disclose their errors and to avoid criminal tax prosecution. The OVDP’s current penalty is 27.5 percent. However there are other alternatives available to certain taxpayers that may provide additional relief, including the SDOP and SFOP programs.
Some of the materials advise agents on interpretation of willfulness and other key legal terms in the SDOP and SFOP programs, which both require non-willfulness as an eligibility requirement.
Below is an illustrative summary of one document. We are carefully reviewing the documents to further understand the IRS’ analysis in reviewing our OVDP, SDOP and SFOP cases.
Document 11: page 52: “Willfulness is not present where a taxpayer has acted by mistake, accidentally, or in good faith. Making an honest mistake is not fraud while deliberately choosing to not comply with the law can be. Mistakes, inadvertence, reliance on others, honest differences of opinion, and mere negligence or carelessness do NOT constitute willful intent. Willfulness is determined by showing the following:
Document 11: Page 53-54: Taxpayer Involvement: Knowledge- Intent- Purpose.
- Did the client have control over the offshore accounts/transactions?
- How did the client access the funds?
- How complex was the client’s financial transactions? (Multiple Trusts, Multiple Countries, Convoluted Arrangements)- § What role(s), or title(s), did the taxpayer hold under the scheme arrangement? e.g. Manager, Director, Trustee, Beneficiary- § Did the taxpayer play an active role in the scheme?
- Who set up the scheme?
- What communications did the taxpayer initiate or become involved in- (emails, letters etc.) concerning the scheme?
- What types of reports, if any, did the taxpayer receive from the promoter regarding the funds and/or the program?- § Look for badges of fraud (unreported income, concealment, destruction of records, use of code words, etc.)- Taxpayer Knowledge of Scheme
- Did the taxpayer change accountants during the period of involvement in the scheme?- § Has the taxpayer participated in previous abusive schemes?
- Did the taxpayer disregard competent advice from the Service or other sources?- § How many years was the taxpayer involved in the scheme?- § Prior convictions for similar offenses?
- Prior civil examinations, adjustments, fines, penalties, criminal investigations and correspondence relative to illegal- schemes?
- Information/documentation in the possession of the taxpayer that address illegality of the scheme? The Examiner also needs to determine if the taxpayer was aware that the Offshore Arrangement was abusive and designed to circumvent the tax laws. Questions such as the ones listed should be considered during the interview. Did you notice the taxpayer get a new preparer? Why? Maybe the old preparer was uncomfortable with the situation? Maybe in the year the scheme started, the promoter referred the taxpayer to a new preparer familiar with the scheme? Talk to the old preparer, find out why the relationship ended? What details did the taxpayer have about the scheme? Does he have promoter material? What was he told about how the scheme works? Does he have an opinion letter? Did he ever question its reliability? Maybe get a second opinion from the IRS or another unrelated professional? Is the taxpayer a known abuser? Was he identified as participating in an earlier arrangement in e-trak of some other database? Can you tell from IDRS if the taxpayer has been examined in the past? If so what were the results? Were penalties assessed?
- Has he been convicted of things other than tax crimes?
The IRS updated its streamlined offshore compliance program to provide procedures taxpayers residing both inside and outside the United States should use to participate in the program. The streamlined offshore compliance program is for taxpayers whose failure to comply with requirements to report offshore assets is nonwillful. It is designed to allow U.S. taxpayers with offshore assets to become tax compliant with reduced or no penalties.
Under the streamlined offshore procedures for both U.S. residents and nonresidents, taxpayers must (1) file delinquent or amended tax returns, together with all required information returns for each of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, and (2) for each of the most recent six years for which the FBAR due date has passed, file any delinquent FBARs.
Under the streamlined offshore procedure for U.S. residents, the taxpayer must also pay a miscellaneous offshore penalty of 5% of the highest aggregate balance or value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years in the covered tax return period and the covered FBAR period.
In FAQ #1, the IRS clarified that the 5% penalty will not apply to assets in which the taxpayer has no financial interest but only signature authority. The IRS also clarified that the 5% penalty will not apply to assets in which the taxpayer has no or partial interest. The IRS will apply the principles announced in OVDP FAQs 31 through 33, 35.1, and 38 through 41. This interestingly may be the first time where the IRS Streamlined Filing Compliance Procedures is specifically applying OVDP regime principles. If appropriate, this could lead to the possibility of analogizing of principles and nuances from the OVDP regime (with 55+ detailed FAQs) to taxpayers under the Streamlined Filing Compliance Procedures (where fewer rules exist).
In FAQ #2, the IRS clarified that the 5% penalty applies only to assets reportable on either FBAR or Form 8938, not rental real estate.
In FAQ #4, the IRS made clear that the 5% penalty applies to a foreign business with assets including financial accounts. In FAQ #6, the IRS clarified that mechanical calculation of the 5% penalty. In FAQ #7, the IRS explained that a taxpayer can make a streamlined submission and pay a 5% penalty where compliant tax returns and FBARs were filed for the most recent three years but no FBARs for the three years prior to that.
In light of the new IRS clarifying announcements regarding the Streamlined Filing Compliance Procedures, the Streamlined program offers excellent opportunities to eligible taxpayer to clean up past compliance violations and move forward.
The IRS recently released frequently asked questions for the Delinquent International Information Return Submission Procedures (available here).
The IRS now states that these procedures are available to taxpayers even if they have unreported income. See below quote:
The Delinquent International Information Return Submission Procedures clarify how taxpayers may file delinquent international information returns in cases where there was reasonable cause for the delinquency. Taxpayers who have unreported income or unpaid tax are not precluded from filing delinquent international information returns. (emphasis added) Unlike the procedures described in OVDP FAQ 18, penalties may be imposed under the Delinquent International Information Return Submission Procedures if the Service does not accept the explanation of reasonable cause. The longstanding authorities regarding what constitutes reasonable cause continue to apply, and existing procedures concerning establishing reasonable cause, including requirements to provide a statement of facts made under the penalties of perjury, continue to apply. See, for example, Treas. Reg. § 1.6038-2(k)(3), Treas. Reg. § 1.6038A-4(b), and Treas. Reg. § 301.6679-1(a)(3).
In comparison, 2012 FAQ 18: (reads in part as follows):
“The IRS will not impose a penalty for the failure to file the delinquent Forms 5471 and 3520
if there are no under-reported tax liabilities and you have not previously been contacted
regarding an income tax examination or a request for delinquent returns.”
The above FAQ 18 assurances are not contained under the New Procedures for Delinquent Offshore International Returns. It is now more important than ever that a carefully drafted persuasive demonstration of reasonable cause be included with a taxpayer’s submission to avoid imposition of penalties.
The Internal Revenue Service’s collection efforts need to be improved to make sure that delinquent taxpayers residing in foreign countries comply with their U.S. tax obligations, according to a new government report. The report, from the Treasury Inspector General for Tax Administration (TIGTA), comes amid the implementation of many of the requirements of the Foreign Account Tax Compliance Act, or FATCA, which will require foreign financial institutions to begin reporting on the holdings of U.S. taxpayers to the IRS or else face stiff penalties of up to 30 percent on their income from U.S. sources.
TIGTA’s review found that ineffective management oversight has contributed to a number of control weaknesses in the IRS’s International Collection program. The review also discovered that the IRS does not have reliable statistics on the rate of noncompliance of taxpayers with their U.S. tax obligations.
In addition, there is no process to measure the value of the so-called “Customs Hold” as an enforcement tool against delinquent international taxpayers. International revenue officers at the IRS can request that a customs hold be input into the Treasury Enforcement Communication System for delinquent taxpayers, and the U.S. Department of Homeland Security will then notify the IRS whenever the taxpayer travels into the U.S. During TIGTA’s interviews with a sample of 15 international revenue officers and all five group managers, many identified the Customs Hold as one of the most effective enforcement tools available to them in dealing with delinquent international taxpayers. International revenue officers use information obtained through a Customs Hold to attempt to contact the taxpayers while they are in the U.S. or to locate the taxpayers’ assets.
In addition, there are over 78,000 global financial institutions that have entered into direct information exchange agreements with the IRS. These institutions will be issuing FATCA letters to U.S. taxpayers asking them to provide information required under FATCA. The failure to provide the information will result in the taxpayers being place on a FATCA “recalcitrant” list. The financial institutions will also withhold 30% of the U.S. taxpayers account earnings and remit those earning to the IRS.
Our firm expects that the Customs Hold will be used on a more now that the Swiss bank non-prosecution program participation deadline of September 15, 2014 has passed. U.S. taxpayers who have been placed on the “recalcitrant” list should expect tax audit letters and FBAR “willfulness” based assessments.
For those taxpayers who would like to come forward, the IRS has two solutions: First, for those taxpayers who qualify there are the Streamline Procedures (non-resident SFOP and domestic SDOP). For those taxpayers who do not meet the eligibility requirements of the Streamline Procedures there is the offshore voluntary disclosure program (OVDP 2014).
Our office has received many inquiries from taxpayers interested in the Streamlined Filing Compliance Procedures with the new lower penalty. However IRS guidance and instructions was unclear and ambiguous in certain areas. Last week, on October 9, 2014, the Internal Revenue Service published new additional guidance clarifying many details for participation in the Streamlined Filing Compliance Procedures.
Here are links to the new guidance published on the IRS website:
- New Streamlined Filing Compliance Procedures for U.S. Taxpayers Residing Outside the United States (SFOP) Frequently Asked Questions and Answers (FAQs) here.
Our firm recently presented a informational webinar on the Streamlined Filing Compliance Procedures and the Offshore Voluntary Disclosure Program. Materials from the webinar can be downloaded here: Game Changer Streamline.
The IRS has simplified the process of entering the OVDP Program by issuing the following forms:
Form 14457 – Offshore Voluntary Disclosure Letter
Form 14454 – Offshore Voluntary Disclosure Program Letter Attachment
The new forms (the old forms were simple Word documents) will likely standardize the IRS’ review process for OVDP eligibility, guide the IRS examiner in OVDP “issue spotting”, and assist in the identification of offshore promoters or facilitators.
While process improvement is needed to improve the IRS’ processing of OVDP applications,
In spite of the standardization of the forms, careful drafting and legal advocacy of a taxpayer’s particular circumstances are still recommended for a favorable result.
What Is The Difference Between the SDOP and the Current OVDP program?
The Streamlined Offshore Procedures (SDOP and SFOP) liberalizes the old restrictions and rewards taxpayers that disclose their offshore assets with a lower penalty and a very low tax. Taxpayers will only have to file 3 years of amended income tax returns instead of the current OVDP program’s requirement of 8 years of amended income tax returns. They will be assessed a penalty of only 5% of the account with the highest balance instead of the OVDP program’s 27.5% penalty.
In addition, the SDOP radically expands the previous Streamlined Program for Non-US residents which was only for non-tax filers with under $1,500 of income that was unreported.
SDOP Filing Risk Factors
It is extremely important that a taxpayer’s eligibility is carefully analyzed because once the SDOP is elected and the taxpayer claims the violations were non-willful, the taxpayer will not be eligible for the OVDP any longer. There are possible risk factors that need to be considered and analyzed such as the evidence of willfulness including intent of laws, knowledge and violations.
Although filing an SDOP does not automatically select the taxpayer for an IRS audit, the taxpayers is still subject to the possible normal audit selection. The taxpayer needs to be prepared to defend filing a SDOP and be able to demonstrate their non-willfulness and show there was no fraud.
In the streamlined procedures, taxpayers must certify that their failure to report foreign financial assets and pay all tax due was not the result of willful conduct (click here for further details). A taxpayer must complete and execute a certification form, Certification by U.S. Person Residing in the United States for Streamlined Domestic Offshore Procedures.
The most important first step in analyzing whether a taxpayer is eligible to participate in the streamlined procedures is to ascertain whether the taxpayer’s compliance failure, including the failure to file an FBAR, was actually non-willful. The IRS has defined “nonwillful conduct” as “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.” This definition is a little different from other legal cases. For failure to file FBARs, the IRS must establish knowledge of the law and evaluating indicators of willfulness (Internal Revenue Manual (IRM) §4.26.7).
Willfulness in criminal tax cases generally means a voluntary, intentional violation of a known legal duty (Cheek, 498 U.S. 192 (1991)). The taxpayer does not have to have an improper motive or a bad purpose. All that is required is that the taxpayer knew of the duty and intended to violate it (Pomponio, 429 U.S. 10 (1976)).
Willfulness means not only knowing violations, but reckless ones as well. For example, “[a] responsible person is reckless if he knew or should have known of a risk that the taxes were not being paid, had a reasonable opportunity to discover and remedy the problem, and yet failed to undertake reasonable efforts to ensure payment” (Jenkins, 101 Fed. Cl. 122, 134 (2011), aff’d, No. 2012-5019 (Fed. Cir. 2012)). “[W]illfulness has been found where ‘the facts and circumstances of a particular case, taken as a whole, demonstrate’ that the taxpayer ‘knew or should have known that there was a risk [of noncompliance] and failed to take available corrective action,’ with the result being the violation of the law” (McBride, 908 F. Supp. 2d 1186, 1209 (D. Utah 2012).
Whether a taxpayer’s conduct is non-willful is a critical question of fact and law, based largely on the taxpayer’s particular facts and circumstances. Taxpayers with foreign accounts would be wise to retain tax legal counsel, to better analyze the taxpayers’ position.
The IRS has just recently updated the Streamlined Procedure forms for both its “foreign” (SFOP) and “domestic” (SDOP) procedures. All of the information can now be typed directly into the fields. The statement of facts can be cut and pasted directly onto the Form, which should help simplify the process.
The forms can be found by clicking on the links below:
- Form 14653–Certification by U.S. Persons Residing Outside of the United States for Streamlined Foreign Offshore Procedures
- Form 14654–Certification by U.S. Persons Residing in the United States for Streamlined Domestic Offshore Procedures.
The streamlined filing compliance procedures are designed for only individual taxpayers, including estates of individual taxpayers. The streamlined procedures are available to both U.S. individual taxpayers residing outside the United States and U.S. individual taxpayers residing in the United States.
In order to enter the streamlined offshore procedures, the taxpayer must officially certify that their failure to report all income, pay all tax, and file all required information was due to non-willful conduct. The IRS’ two new forms simplify this certification process, Forms 14653 and 14654. Form 14653 is to be filed by U.S. persons residing outside of the United States, while Form 14654 is to be filed by U.S. persons residing within the United States.
In conjunction with filing the appropriate certification form, a taxpayer entering the streamline program must submit delinquent and/or amended tax returns for each of the most recent three tax years. Delinquent FBARs for the prior six tax years must also be filed. These returns must be complete and accurate, and accompanied by full payment of taxes, interest, and applicable penalties.
The new forms (the old forms were basic PDF text documents) will likely standardize the IRS’ review process for Streamline program eligibility and guide the IRS examiner in spotting issues.
In spite of the standardization of the forms, very careful drafting and persuasive legal advocacy of a taxpayer’s particular circumstances are still recommended for a clear demonstration of non-willfulness.
Many clients are asking our office about the new compliance solutions to clean up past errors in disclosing foreign assets.
In June 2014, the IRS announced major changes to its offshore voluntary compliance programs, providing new options to help taxpayers residing both overseas and in the United States. The changes are intended to give thousands of people a new avenue to comply with their U.S. tax obligations (IR-2014-73). Modifications were made in response to public comments that the existing program lacked a path to compliance for individuals whose failure to report offshore accounts was not willful.
Because taxpayers’ non-U.S. investments vary widely, the IRS offers the following options for addressing previous failures to comply with U.S. tax and information return obligations:
- The Offshore Voluntary Disclosure Program (OVDP); Taxpayers whose conduct was likely willful are directed to the OVDP—where they pay a much higher 27.5% miscellaneous offshore penalty;
- A new non-willful certification program, referred to as the IRS Streamlined filing compliance procedures (SDOP and SFOP); Under this program, taxpayers residing in the United States whose failure to report foreign financial assets and pay all tax due on those assets was not the result of willful conduct are subject to only a 5% miscellaneous offshore penalty (non-residents pay no penalty); (click here for further details); and
- Delinquent Report of Foreign Bank and Financial Accounts (FBAR) and delinquent international information return submission procedures.
Tax professionals must be familiar with each of these options to effectively advise taxpayers of the compliance solution that best fits the particular facts and circumstances of the case.
OVDP and/or the SDOP allow no u-turn. Once a taxpayer makes a submission under the streamlined program, the taxpayer may not participate in the OVDP. A taxpayer who submits an OVDP voluntary disclosure letter on or after July 1, 2014, is not eligible to participate in the streamlined program. To avoid creating a bigger problem, taxpayers should very carefully choose their compliance solution with the advice of competent experienced tax legal counsel.