The end of a popular IRS program will have significant ripple effects for taxpayers.
On March 13, 2018, the Internal Revenue Service announced that it would begin to ramp down the 2014 Offshore Voluntary Disclosure Program (OVDP) and would close the program effective as of September 28, 2018. The OVDP was offered to taxpayers with undisclosed offshore accounts or assets and was utilized by anyone with willfulness issues regarding their failure to disclose such accounts or assets in order to avoid criminal prosecution and to reduce or mitigate the penalties for noncompliance. The FAQs to the 2014 OVDP had always provided that “the terms of this program could change at any time going forward. For example, the IRS may increase penalties or limit eligibility in the program for all or some taxpayers or defined classes of taxpayers – or decide to end the program entirely at any point.” When the IRS made the recent announcement that the program would close, it urged anyone who would seek to voluntarily disclose the existence of any previously undisclosed foreign financial assets to participate in the OVDP before the September 28, 2018, program closure date.
Although taxpayers were always on notice that the IRS could close the OVDP at any time, it is still somewhat surprising that the IRS has chosen to close the program, particularly in light of the successes the government has enjoyed over the years in enforcing compliance and obtaining additional revenue through the collection of income taxes, interest and penalties, and the usefulness to noncompliant taxpayers who desired a defined and structured program by which they could become compliant with their reporting obligations.
By way of background, the Bank Secrecy Act requires United States persons to file a report with the government if they have a financial account in a foreign country with a value exceeding $10,000 at any time during the calendar year. Taxpayers comply with this law by noting the existence of the account on their income tax return and by filing a FinCEN 114, Report of Foreign Bank and Financial Accounts (FBAR). According to the FBAR instructions, a person must file an FBAR if all of the following elements are met: (1) a “U.S. person,” (2) had a “financial interest” in, or “signature authority” over, or “other authority” over, (3) one or more “financial accounts” (4) located in a “foreign country” (5) and the aggregated value of such account(s) exceeded $10,000, (6) at any time during the calendar year. The FBAR instructions indicate that a “U.S. person” means a U.S. citizen regardless of where the citizen lives.
For purposes of the FBAR, a direct interest and certain indirect interests qualify as “financial interests” in an account. A person has a direct “financial interest” in an account if such person is owner of record of, or holds legal title to, the account. Multiple people can have a direct interest in the same account. The definition of “financial account” includes bank accounts, securities accounts, securities derivatives accounts, other financial instruments accounts, savings accounts, demand accounts, time deposit accounts, mutual funds and any other accounts maintained with either a financial institution or a person engaged in the business of a financial institution.
Impact on Delinquent FBAR Filings
Prior to September 28, 2018, taxpayers generally had three options when dealing with delinquent FBAR filings: (1) submit the delinquent FBARs and file amended returns reporting income from previously undisclosed foreign financial assets without making a voluntary disclosure (this method is sometimes referred to as a “quiet disclosure”); (2) use the IRS’ Streamlined Filing Compliance Procedures – domestic or foreign – available only to those who have not willfully failed to file; or (3) participate in the IRS’ Offshore Voluntary Disclosure Program.
According to the IRS, more than 56,000 taxpayers made disclosures under the OVDP, paying more than $11.1 billion in back taxes, interest and penalties. The IRS, through its Criminal Investigation Division, conducted the OVDP with the stated purpose of bringing those that had used undisclosed foreign accounts and assets, including those held through undisclosed foreign entities, to avoid or evade tax into compliance with United States tax and related laws. The IRS had stated that “[w]hen a taxpayer truthfully, timely and completely complies with all provisions of the voluntary disclosure practice, the IRS [would] not recommend criminal prosecution to the Department of Justice for any issue relating to tax noncompliance or failure to file [the FBAR].” The OVDP was therefore intended to be utilized by taxpayers with willfulness issues regarding their offshore accounts or assets and for those who had criminal exposure or significant civil penalty exposure.
Fortunately, for those who are eligible to participate in the IRS’ Streamlined Filing Compliance Procedures (SFCP), both domestic and foreign, no changes have been announced by the IRS at this time. In its announcement of the closure of the OVDP, the IRS continued to encourage those “who have offshore compliance issues and [who] meet all of the qualifications of the Streamlined Filing Compliance Procedures to use these procedures while they are available.” Although the IRS has stated that it may end the Streamlined Filing Compliance Procedures at some point, these procedures remain viable options for taxpayers who are eligible and who desire to become compliant.
Importantly, the IRS’ SFCP are available only to taxpayers that can certify under penalties of perjury that their failure to report foreign financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part. The SFCP state that “[n]onwillful conduct is 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.” In addition, the SFCP are available only to individuals, including estates of individuals, and only to taxpayers who are not currently the subject of an IRS civil examination with respect to any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets, or under criminal investigation by IRS Criminal Investigation.
SFO and SDO Procedures
After meeting the general eligibility criteria for the SFCP, taxpayers must choose between either the Streamlined Foreign Offshore Procedures (SFO) or the Streamlined Domestic Offshore Procedures (SDO). The SFO procedures are generally available to U.S. taxpayers who meet a nonresidency requirement, have failed to report income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR with respect to a foreign financial account. The nonresidency requirement means that the taxpayer did not have a U.S. abode and was physically outside of the United States for at least 330 full days for one of the last three years.
The SFO procedures state that eligible SFO taxpayers must first file all delinquent or amended tax returns, along with any required informational returns, for each of the most recent three years for which the U.S. tax return due date has passed and must complete and submit Form 14653. Second, eligible SFO taxpayers must file any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed. At the same time the delinquent tax returns are submitted, the full amount of tax and interest owed must be submitted.
The SDO procedures are generally available to U.S. taxpayers who fail to meet the nonresidency requirement; have previously filed a U.S. tax return, if required, for each of the most recent three years for which the U.S. tax return due date, or properly extended due date, has passed; and have failed to report gross income from a foreign financial asset and pay tax as required by U.S. law, and may have failed to file an FBAR with respect to a foreign financial account. An important distinction between the SFO procedures and the SDO procedures is that SDO taxpayers may not be delinquent nonfilers.
The SDO procedures state that eligible SDO taxpayers must first file amended tax returns, along with any required informational returns, for each of the most recent three years for which the U.S. tax return due date has passed and must complete and submit Form 14654. Second, they must file any delinquent FBARs for each of the most recent six years for which the FBAR due date has passed. Finally, SDO taxpayers must pay a miscellaneous offshore penalty along with the full amount of tax and interest owed. The miscellaneous offshore penalty is equal to 5 percent of the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the miscellaneous offshore penalty during the years covered in the tax return periods and the covered FBAR periods.
Unlike the OVDP, which was a formal program conducted by IRS Criminal Investigation whereby each case was finalized with a closing agreement, the SFCP instead provides a set of procedures for taxpayers who do not need criminal protection and who do not have exposure to significant civil penalties. Consequently, the receipt of returns processed under the SFCP will not be acknowledged by the IRS upon filing, and the process will not culminate in the signing of a closing agreement. However, those who are eligible to use the SFO procedures and who comply with the procedures will not be subject to failure-to-file penalties, accuracy-related penalties, information return penalties or FBAR penalties. Taxpayers who are eligible to use the SDO procedures and who comply with the procedures must pay the 5 percent miscellaneous offshore penalty but will not be subject to accuracy-related penalties, information return penalties or FBAR penalties.
Despite the closing of the OVDP as of September 28, 2018, the IRS has stated that the closure does not signal a change in IRS priorities towards offshore tax noncompliance and that stopping offshore tax noncompliance remains a “top priority.” Fortunately for those taxpayers who are eligible, the Streamlined Filing Compliance Procedures exist as a viable alternative. It remains to be seen whether the IRS will reissue a subsequent iteration of the OVDP; however, taxpayers are encouraged to carefully scrutinize their tax filings and, where applicable, take appropriate steps to ensure compliance.
Andrew S. Rusniak is in the McNees estate planning and corporate & tax practice groups. He advises in all aspects of tax and estate planning, business succession planning, asset protection planning, charitable planning and estate and trust administration. Reach him at [email protected].
Published October 8, 2018.
