2014 Offshore Voluntary Disclosure Program

offshore voluntary disclosure

Christian Reeves

If you’re a U.S person with an unreported offshore bank account, the IRS is making you an offer you can’t refuse… again. Come forward now and you can avoid the Foreign Bank Account Reporting (FBAR) penalty, which can be as high as $100,000 per year.

The proposal, known as the Offshore Voluntary Disclosure Initiative (OVDI), is the third and final offer from the IRS before various laws come in to affect that will force foreign banks to disclose accounts owned by U.S. persons (residents and citizens). Come clean now and the Service will go easy on you. Make them come after you and pay the price later.

Show me the Money

These OVDIs, three in all, are about cash… and lots of it. As of June 26, 2012, the second iteration of the program had brought in a little over $5 billion in new taxes, interest and penalties. Through June 2014, the program has brought forth an additional $1 billion, or $6 billion in total, from about 45,000 persons who voluntarily reported their offshore accounts.

To get these numbers, the IRS indicted 100 of its citizens, locked them in boxes for years on end, and issued press releases touting the pelts they had hung. The message was clear: come forward or we will get you. And, come forward they did.

The IRS wasn’t done there. They took $780 million in fines from UBS in 2011 and another $2.6 billion from Credit Suisse in May of 2014. The Service is currently pursuing banks in Hong Kong, Australia, Israel, and a number of other countries. Rest assured that more big pay outs are on the way… along with a list of the Americans who hold accounts at these targeted banks.

2012 Offshore Voluntary Disclosure Initiative

(The previous offer)

Under the second installment of the OVDI, if you were living and working abroad, you could come forward and file your returns, and if the taxes you owe as a result were less than $1,500, you were exempt from the FBAR penalty.

If your tax bill was more than $1,500, you were hit with a penalty of 27.5% on your highest balance throughout the life of the account. So, if you had $1 million offshore for a few months while you bought a foreign property, your penalty was based on that amount. It did not and does not matter that your average account balance over the years was significantly lower.

Also, the FBAR penalty was and is based on your highest balance without respect to income earned in the account. Even if you lost money year in and year out, you are still paying 27.5% on the highest balance (presumably the balance the year the account was opened).

2014 Offshore Voluntary Disclosure Initiative

The 2014 version of the OVDI still charges you based on your highest account balance and does not take in to account losses. No relief here.

But, while the 2012 OVDI had only two options, pay no penalty if your tax due was less than $1,500, or 27.5%, the 2014 offer is more versatile. First, the $1,500 tax due requirement is gone. In its place is a “showing of good cause” standard.

Unfortunately, the definition of good cause is that you did not intend to cheat on your taxes. Also, the burden of proving your intent falls on you. If you can convince the agent that you did not intend to violate the tax law, and you are living abroad, then you pay no penalty. If you are living in the United States and can prove your innocence to their satisfaction, then you will pay a 5% penalty.

Second, in order to qualify for the 2014 OVDI, you must file and pay your last three years of income tax returns and submit an application that discloses all of your income sources and foreign assets. Basically, you must give the IRS a road map to your assets.

If you are unable to sell your story of good cause, you will pay the 2012 penalty rate of 27.5%. You should note that the IRS is the final arbiter of your OVDI. If you don’t like the result, there is no way in to U.S. Tax Court or Federal Court. And, as you have told them where to find your cash, it would be unwise to back out of the deal.

The 0% and 5% penalties are the carrot. Now comes the stick: If the IRS is in negotiations or otherwise going after, the bank where you have your account, the penalty jumps all the way up to 50%. In other words, if the IRS has you within range, and are closing in on your assets, your penalty goes from 0%, 5%, or 27.5% to 50%.

Remember, you don’t know where the IRS is in its negotiations with the various banks, so you have no idea of your risks (probability of being caught). You might file only to find that it is too late and be forced to pay 50% on your highest balance.

Again, this is at the discretion of the IRS and you must provide the road map before you hear their decision. If you want in the program, time is of the essence.

Another benefit of the 2012 and 2014 OVDIs that is often overlooked and misunderstood is that it reduces your risk of criminal prosecution. Joining the OVDI does not guarantee you won’t be persecuted, but, if you come forward voluntarily and they are not already investigating you or your bank, it is unlikely you will go to jail.

According to the IRS website regarding the OVDI: It is the long standing practice of the IRS Criminal Investigation Unit to take timely, accurate, and complete OVDIs in to account in deciding whether to recommend to the Department of Justice that a taxpayer be criminally prosecuted. The OVDI enables noncompliant taxpayers to resolve their tax liabilities, minimize their tax liabilities, and minimize their chance of criminal prosecution. When a tax payer truthfully, timely, and completely complies with all provisions of the OVDI, the IRS will not recommend criminal prosecution to the Department of Justice.

Why is the IRS doing this?

So, why is the IRS pushing this third and final version of the OVDI now, just ahead of FATCA and other measures that require foreign banks to report American’s offshore transactions? According to the IRS commissioner, John Koskinen, the “aim is to get people to disclose their accounts, pay the tax they owe and get right with the government.” The stated goal of the initiative is to provide a path for those who are not “willfully violating the law.”

If you are willing to tell the U.S. government where your assets and income are held in exchange for peace of mind, then this program is for you. Just be sure to come forward before your bank makes its own deal and sells you out like UBS did to 4,400 of its clients. If that happens, your best case is the 50% penalty and your worst case is an orange jumpsuit.

Adding to the mix, the IRS has budget holes it hopes to fill with this version of the program. The mighty collector has seen its budget cut by about $900 million since 2010. Around $500 million of this is from the Sequester and much of the remainder is the result of Republicans, angry about how the IRS targeted their fund raising cash machines, slashing their share of the budget.

And these budget cuts have had a significant impact on the IRS. For example, the $500 million lost in the Sequester led to a drop in tax revenues of more than $2 billion (according to the IRS Commissioner).

• This means the IRS has a return on investment of $4 to $1 – for every $1 spent by the collector, it puts $4 in Uncle’s pocket.

Again, according to the Commissioner, these budget cuts have led to an “intolerable level of public service.” For example, 15.4 million telephone calls from taxpayers went unanswered in 2013. Of those who made it to the automated system, 33% gave up (a 66% success rate!).

Add to this the fact that per-employee education spending dropped from $1,450 to less than $250 from 2009 to 2013, and you can understand why taxpayers are frustrated and employees are lost.

It is you, the expat or international investor, who pays the highest price for this lack of service and training. If you are living, working, or investing abroad, your tax obligations are much more complex than the average American’s. Your chances of finding any answers on the IRS help line are about nil.

Next, these budget shortfalls have put an even larger target on your back. Most international persons have a high net worth and the penalties that can be extracted for even a minor error can be severe. Therefore, those with international transactions, especially the do-it-yourselfers among you, have the highest risk because you are the highest returning audits available to the IRS. You are the pie on the windowsill that is just too hard to pass up. The slot machine that always pays out.

This goes a long way towards explaining the current OVDI. The IRS is hoping to pick up a few hundred million in scraps it left on the table with the first two iterations. And, because you, the international investor, have the cash to pay for peace of mind, they feel confident a significant number will come forward.

If you stay in the shadows, no problem. The IRS is playing the long game. If you don’t get out of harms way now, they will try and add a few new pelts to their wall… which always brings in the cash.

Who might qualify for the 2014 OVDI?

I should point out that this article is being written two days after the 2014 OVDI was announced, on June 20, 1014. No applications have been accepted, so my suggestions below are just that… suggestions from someone who has completed 75 OVDI applications in the first and second editions and has been through the wars.

I should point out that this article is being written two days after the 2014 OVDI was announced, on June 20, 1014. No applications have been accepted, so my suggestions below are just that… suggestions from someone who has completed 75 OVDI applications in the first and second editions and has been through the wars.

For the American living in a high tax country, one with a tax rate similar to the U.S., this is a great offer. You should owe little or no taxes to the U.S. when you file because of the foreign tax credit. If you are in good standing with your country of residence, the U.S. will have little to quibble over.

If you’re living in a low tax country, the 2012 version probably did not work for you because your resulting U.S. tax bill was well over $1,500 and you were willing to pay the 27.5% fine. The 2014 program might be just what you’ve been holding out for. While you must pay three years of tax, interest, and penalties, the $1,500 limit has been eliminated. So long as you can show good cause why you did not file, and have been living and working outside the U.S. for several years, you should qualify for the 0% FBAR penalty.

What should I do?

If you are thinking about joining the 2014 OVDI, your first step is to have your last three years of tax returns prepared or amended. Once you know your amount due, you and your international tax person can assess your risk, costs, and benefits of falling in line.

Next, you or your representative should research the bank that holds your accounts. If they are under investigation, you are looking at a 50% penalty and have little hope of the 0%, 5%, or 27.5% offers.

Keep in mind that you must file AND pay your last three years of personal income tax returns. You are also required to file any offshore company or trust returns, if applicable. So, if your account was in a trust, you need to submit Forms 3520 and 3520-A with your application. If you had a corporation, you should include Form 5471 and all the schedules.

If the balances due from these filings are significant, be aware that interest and penalties apply. The reduced penalty offered through the OVDI is for the FBAR and not the taxes which result from filing your returns.

This means a 20% accuracy related penalty on the balance due will apply. A failure to file penalty of 25% will apply if you never filed the returns (not if you are amending your returns), and a failure to pay penalty of 25% is certain to come our way.

This means a 20% accuracy related penalty on the balance due will apply. A failure to file penalty of 25% will apply if you never filed the returns (not if you are amending your returns), and a failure to pay penalty of 25% is certain to come our way.