Tax Law Insights

The IRS recently announced it will be shutting down its successful Offshore Voluntary Disclosure Program (OVDP) for unreported foreign bank accounts and income. The program will end September 28, 2018. Under the OVDP, first started in 2009, over 50,000 individuals have come forward to report previously unreported foreign bank accounts and income. The IRS reports it has raised over $11 billion in taxes, penalties and interest through the OVDP.

The U.S. income tax system is perhaps the most expansive in the world. U.S. citizens and permanent residents must report their worldwide income from all sources to the IRS and pay U.S. income taxes on this foreign income. The U.S. does allow an offsetting credit against the reported U.S. income tax liability for foreign income taxes paid on the income, but many countries have lower tax rates that the U.S. (resulting in additional U.S. taxes due) or individuals do not pay foreign income taxes on this income resulting in full U.S. income taxes being due.

The U.S. also has a separate reporting system for foreign bank and financial accounts, in addition to U.S. income tax reporting and filing requirements, and these foreign bank account reports (FBARs) must annually be filed with the U.S. Treasury Department.

For individuals who do not report their foreign income and bank accounts as required under U.S. law, U.S. taxes, substantial penalties, and interest are due on the unreported income, and separate and substantial civil penalties are due for not filing the required and separate foreign bank account reports. The IRS will also criminally prosecute individuals who do not abide by these rules.

To encourage individuals with unreported foreign bank accounts and income to come forward, the IRS adopted the OVDP. For qualifying individuals, the program offered amnesty from criminal prosecution - but at a price. Eight (8) years of back income tax returns and foreign bank account reports were due under the program, and the taxpayer had to pay all income taxes on the unreported foreign income for this 8-year period, including income tax penalties and interest. An additional and substantial penalty for failing to file foreign bank account reports was also due, ranging initially from 20% of the highest foreign bank account balances during the 8-year disclosure period but then up to 50% of the bank account balances if an individual had one or more foreign bank accounts at a bank listed on the IRS's published "Black List" (e.g. UBS and Credit Suisse).

Congress in 2010 adopted The Foreign Account Tax Compliance Act (FATCA), and which required additional and further disclosures of foreign bank account information, not only from U.S. taxpayers but from the foreign banks and financial institutions as well. The IRS also aggressively moved against foreign-based banks with branches in the U.S. threatening criminal prosecution and heavy fines against them, and to cut off these foreign banks from access to the U.S. banking system for their clients. Many of these foreign-based banks "rolled over" and began providing the IRS with the names of their U.S. bank account customers. As a result of FATCA and IRS enforcement efforts against foreign banks, the IRS has developed a treasure trove of information on non-compliant U.S. taxpayers. Armed with this foreign bank information now, the IRS believes it no longer needs to have the OVDP and has ended the program.

While many individuals have filed under the OVDP, paid their foreign taxes, and are now going forward as compliant U.S. taxpayers, there are still many individuals who have not. For these remaining individuals with unreported foreign income and bank accounts, now that the ODVP has ended, what are their options?

1. File under the IRS Streamlined Filing Compliance Procedures

In 2014, as a result of taxpayer and practitioner complaints, the IRS adopted a separate foreign income and bank account disclosure program for individuals who were "non-willful". Referred to as the "Streamlined Filing Compliance Procedures" (Streamlined) by the IRS, this new and additional program is an abbreviated disclosure program designed for individuals with foreign bank accounts and income, but who, through negligence, mistake, reliance on an accountant, or other justifiable reasons, were determined to be "non-willful". For individuals who were "willful" - i.e. they knew they were required to report their foreign income and bank accounts but did not - the OVDP was the required disclosure program; for eligible "non-willful" individuals, however, the abbreviated Streamlined disclosure program potentially offered far better results.

Under the Streamlined program, an individual is required to file only three (3) years of back income tax returns reporting their foreign income. Taxes and interest are due for this 3-year period, but no income tax penalty is due. For the foreign bank account reports, six (6) years of FBARs must be filed, but, for U.S. residents filing under the program a substantially reduced 5% bank account penalty is due based on the highest foreign bank account balances over the 6-year FBAR compliance period. Moreover, for filers who were not U.S. residents, no bank account penalty is due.

Filing under the Streamlined program has different consequences than filing under the OVDP. Filing under the OVDP provided taxpayers with criminal amnesty and certainty of a tax payment and a result. Where a taxpayer files under the Streamlined program, however, this filing is made directly with a separate IRS office and the filing taxpayer may never even hear from the IRS. The taxpayer will then simply move on and compliantly file with the IRS going forward; however, the IRS reserves the right to audit Streamlined submissions, and, if a Streamlined submission is not accurate, the IRS can reject the submission, and even refer the taxpayer for criminal investigation.

Because of the beneficial terms under the Streamlined program, as compared to the OVDP, over 65,000 individuals have filed to-date with the IRS under the Streamlined program. While the IRS has announced the end of the OVDP, the IRS has announced that the Streamlined program will continue, although the IRS has indicated it reserves the right to end the Streamlined program at some future date.

Filing under the Streamlined program must be done carefully and in consultation with experienced tax counsel. While many individuals believe they may be "non-willful", a review of the facts and information may prove otherwise.

1. File a Traditional "Voluntary Disclosure" with the IRS

With the end of the OVDP, for those individuals who do not qualify to make a Streamlined disclosure because they may have been "willful", pre-OVDP IRS procedures still remain to allow a taxpayer to make a "voluntary disclosure" of their foreign bank accounts and income to the IRS. If this voluntary disclosure is accepted by the IRS, the IRS will not recommend criminal prosecution, but the individual will be referred civilly to the IRS for audit/examination. There is no specific number of tax years for which tax returns and foreign bank account reports must be reported through this more "traditional voluntary disclosure", and this is determined through the civil audit/examination process. To qualify, an individual must make a complete and full disclosure of all foreign income and bank accounts, and before the individual has been identified by the IRS. The individual must also, of course, fully cooperate with the IRS through this disclosure process.

1. File a "Quiet Disclosure" with the IRS

If an individual does not qualify for the OVDP or Streamlined disclosure programs, but the individual does wish to report his/her unreported foreign income and bank accounts, the individual may simply file his/her back tax returns and foreign bank account reports with the IRS and the U.S. Treasury Department, respectively, and not through any form of formal disclosure. The IRS strongly discourages this method of "quietly reporting" undisclosed foreign income and/or bank accounts, but, for certain individuals who seek to be compliant and who otherwise may not qualify under the OVDP or Streamlined disclosure programs, a "quiet disclosure" may be a viable option. Filing through a "quiet disclosure" has many uncertainties, including the number of tax years for which to file back tax returns and bank account reports. Individuals considering a "quiet disclosure" must also be advised that these types of filings are subject to a high risk of audit/investigation by the IRS.