In recent years, the Internal Revenue Service has amped up enforcement of rules regarding offshore accounts held by United States residents. In many situations, parties who were unaware of reporting requirements can be assessed a crippling combination of back taxes owed, interest, and penalties. In certain circumstances, criminal prosecution for nondisclosure can also occur. Fortunately, the IRS offers the Offshore Voluntary Disclosure Program (“OVDP”) to mitigate the consequences associated with retroactive reporting.
United States persons with financial interests in or signature authority over foreign financial accounts must disclose their foreign holdings on Form TD F 90-22.1, if the aggregate value of such accounts exceeds $10,000 during the calendar year. Reporting requirements exist for United States citizens, residents, entities (corporations, partnerships, and limited liability companies), trusts and estates. “Foreign financial accounts” include a wide assortment of accounts, including some insurance policies and mutual funds.
Based on the assortment of parties and accounts covered, persons with a reporting requirement may be unaware of the need to file. Where filing for previous years has not occurred, penalties can be devastating. Willful failures to file Form TD F 90-22.1 cause an annual penalty of the greater of $100,000 or 50% of the total balance of the foreign account per violation. The IRS can assess penalties for six years for FBAR violations. Under this structure, penalties can easily exceed the value of the overseas accounts in question. Nonwillful failures to file carry a penalty of $10,000 per violation. Additional penalties of up to 25% on amounts owed can be imposed for failure to file returns and failure to pay amounts owed where the failure is nonfraudulent. For fraudulent failures, penalties can reach 75%. An accuracy-related penalty of 20% may also be assessed.
Criminal charges can also be pursued against nonfilers. Failure to file an FBAR can carry a sentence of up to ten years, and criminal fines of up to $500,000. While criminal penalties are not universally pursued, the mere threat of such penalties can cause significant distress for all parties involved.
To encourage taxpayers to become current with these foreign reporting requirements, the IRS has instituted the OVDP. To enter the program, taxpayers agree to pay the 20% accuracy-related penalty mentioned above, and any other applicable penalties (aside from the fraud penalty, which is not assessed). In place of the 50% annual penalty that could otherwise apply, those in the program pay only 27.5% (or, in certain instances, 12.5% or 5%) of the highest aggregate balance in foreign accounts during the disclosure period (2005-2012 for 2013 disclosures).
As an example, if a taxpayer maintained an account worth $1 million for all years during the disclosure program (2005-2012), accuracy-related penalties and any failure to file or pay penalties would be the same whether the IRS discovers the account or the taxpayer voluntarily discloses (except, as noted above, for the fraud penalty). However, if not filing through the OVDP, the taxpayer faces additional penalties of $500,000 per year (or $3 million total, given the six-year limitations period) if the IRS alleges their violations were wilful. Conversely, through the OVDP program, the additional penalty would be $275,000 total, saving the taxpayer $2,725,000. Disclosing parties thus receive potentially enormous savings in amounts owed.
Parties who abide by the OVDP program’s terms will also avoid criminal prosecution. The IRS states it will not recommend criminal charges for any disclosing party if they comply with all OVDP requirements, providing additional motivation for disclosure.
Disclosing parties can benefit from retaining counsel experienced with the program. Experienced practitioners can advise the proper course of action under the facts involved, and ensure that all portions of the process are handled appropriately.
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