Tax Law Insights

A bedrock of IRS administrative practice has been the voluntary disclosure.   Where an individual or business has not filed tax returns or believes they may have criminal tax exposure for prior actions, IRS procedures have long-sanctioned a form of  “criminal tax amnesty” if the taxpayer voluntarily comes forward before being contacted by the IRS, discloses his tax misdeeds, fully cooperates to correct the back tax issues, and then becomes compliant going forward.  In exchange for this “voluntary disclosure”, while criminal tax prosecution may not be recommended, the taxpayer will certainly be expected to pay required back taxes, interest, and often hefty civil penalties.  Where a taxpayer has real concerns above criminal exposure, however, the civil payment of back taxes, penalties and interest essentially in exchange for “criminal tax amnesty” is often a wise path.

Beginning in 2009, the IRS also adopted a series of specific disclosure programs for individuals with unreported foreign bank accounts and income.  These disclosure programs provided  guidelines and clear directions to individuals who wish to qualify. The most recent program – the “Offshore Voluntary Disclosure Program” (2014 OVDP) – was closed by the IRS, however, as of September 28, 2018.  There is a remaining program for individuals with unreported foreign bank accounts and/or income, known as the “Streamlined Filing Compliance Initiative”, but the “Streamlined” program is only available to individuals who were “non-willful” – i.e. negligent.    For individuals who were aware of their foreign income and/or bank accounts, and US requirements to report this income and accounts, the “Streamlined” program is not available.  Thus, as of September 28, 2018, there was no announced program of the IRS specifically applicable to individuals knowledgeable about their foreign income and accounts who may wish to come forward and make a voluntary disclosure with the IRS.  This changed as of November 29, 2018.

On November 29, 2018, the IRS released an internal memorandum dated November 20, 2018 from the Deputy Commissioner of Services and Enforcement to all IRS criminal law enforcement personnel.   In this memorandum, the IRS released new and updated procedures for accepting and reviewing voluntary disclosures by taxpayers, whether involving foreign assets or income, or not.   The new IRS voluntary disclosure procedures are applicable beginning as of September 29, 2018, and generally apply to taxpayers who perceive they may be “willful” – i.e., where a taxpayer believes he or she may have committed criminal tax acts in the past.

Under the new voluntary disclosure procedures, where an individual has not been contacted by the IRS and comes forward with a potential voluntary disclosure, the taxpayer must initially apply through the IRS Criminal Investigation Division in Philadelphia for “pre-clearance”.  If pre-clearance is granted, the taxpayer must then provide additional documents and information requested by the IRS Criminal Investigative Division and including a narrative from the taxpayer concerning his prior tax actions.  If the IRS Criminal Investigative Division then accepts this additional information from the taxpayer, the Criminal Investigative Division will issue a “preliminary acceptance” letter to the taxpayer, and the taxpayer will then be referred to an IRS Office in Austin, Texas for civil processing.

Once the IRS Office in Austin, Texas receives the file, a civil examiner will be assigned, and the taxpayer will be required to file required returns, amended returns, and other information with the civil tax examiner.    Under the new disclosure program, the taxpayer must provide a tax disclosure for at least a 6-year period going back.   A period of less than 6 years can be used if the actions involved were for a lesser period.  At the conclusion of this examination, the taxpayer will be expected to pay any resulting federal taxes due for the disclosure period, including interest, and also a 75% civil fraud penalty for the one year with the highest tax liability within the disclosure period.  Other civil penalties may apply as well (e.g. failure to file).  If the taxpayer disagrees with the proposed taxes and penalties determined by the civil examiner, the taxpayer has the right to challenge these liabilities administratively through the IRS Office of Appeals.

If the taxpayer has unreported foreign bank accounts and wishes to come forward now under the new disclosure program, in addition to potential income taxes and related penalties and interest that may be due if foreign income in the accounts was not reported, an additional foreign bank account penalty is due, and which potentially may be equal to the greater of $100,000 or 50% of the aggregate foreign bank account balances for each year of the disclosure period.  However, IRS examiners do have discretion here to potentially reduce this penalty amount.

With the release of this memorandum, taxpayers and tax practitioners now have guidance from the IRS concerning voluntary tax disclosures after September 28, 2018.  The guidance and procedures provide a path for taxpayers with potential criminal exposure to come into compliance and move forward without fear of criminal retribution.