By Christopher M. Ferguson
NYSSCPA Tax Stringer
April 1, 2020
On Sep. 28, 2018, the IRS’s Offshore Voluntary Disclosure Program (OVDP) came to an end; however, offshore tax and reporting noncompliance persists in today’s increasingly global economy. Tax advisors are still helping clients who have been—or continue to be—noncompliant with their offshore tax and reporting obligations. This Q&A addresses some of the common issues that taxpayers and their advisors are dealing with in a post-OVDP world.
Why Did the Program End?
From the inception of the OVDP in 2009 and throughout its various iterations over the years, the IRS has always indicated it would have a finite lifespan and that it could be terminated at any time. In a release published on Sep. 4, 2018, the IRS cited several factors that contributed to the program’s termination:
- The success in achieving its goal of increased compliance and awareness (some 56,000 disclosures, raising $11.1 billion in revenue).
- Diminishing returns in more recent years (e.g., a drop from 18,000 disclosures in 2011 to 600 in 2017).
- Advances in third-party reporting in recent years (e.g., FATCA).
The IRS also noted that since its March 2018 announcement that the program would end, it had not “received any public comments addressing a continued need for the OVDP.”
Can Taxpayers Still Make Voluntary Disclosures?
Yes. The IRS has had in place a voluntary disclosure practice that long pre-dates the OVDP and that will continue, albeit in a different form than the OVDP. Its parameters and criteria are detailed in the IRS’s Internal Revenue Manual (IRM). In addition, in November, the IRS issued Interim Guidelines intended to provide guidance on how voluntary disclosures will be handled going forward. The Interim Guidelines discuss the procedures for making a voluntary disclosure and how voluntary disclosures will be processed, as well as providing information on to the civil penalty framework facing taxpayers.
How Does a Taxpayer Make a Voluntary Disclosure?
Taxpayers initiate a voluntary disclosure by filing Form 14457, which has two parts. The first section is for the purpose of pre-clearing the taxpayer as eligible to make a voluntary disclosure. The second section, which should be completed only after the taxpayer receives pre-clearance, requires that the taxpayer provide detailed information with respect to noncompliance, including all undisclosed assets, all facts related to the noncompliance, and all advisors or professionals who aided the taxpayer’s noncompliance. A taxpayer contemplating a voluntary disclosure should be aware going into the process that it will be necessary to provide such information. The voluntary disclosure practice is centralized with the Criminal Investigation Division (CID) in Philadelphia, PA. Once voluntary disclosures are accepted for processing, they are assigned to the Examination Division, where they follow standard examination procedures.
What Are the Criteria for a Voluntary Disclosure?
A successful voluntary disclosure must be truthful, timely, and complete. In addition, taxpayers must show a willingness to cooperate (and must, in fact, cooperate) with the IRS in determining their correct tax liability. They must also make good-faith arrangements to pay the full amount of tax, penalties, and interest determined to be applicable. Furthermore, the income disclosed as part of the voluntary disclosure must be legal source income.
The timeliness of a voluntary disclosure can sometimes present an issue. In general, a disclosure is timely if it is received before the IRS has initiated a civil examination or criminal investigation of the taxpayer (or has notified taxpayer of same), or has obtained information or initiated an examination or investigation related to the taxpayer’s specific tax liabilities.
Does a Successful Voluntary Disclosure Provide Immunity from Prosecution?
A voluntary disclosure does not confer immunity from prosecution. The IRM states that “[i]t is currently the practice of the IRS that a voluntary disclosure will be considered along with all other factors in the investigation in determining whether criminal prosecution will be recommended.” In practice, the success of the voluntary disclosure practice depends on taxpayers trusting that they will not be prosecuted when making a successful voluntary disclosure. Therefore, taxpayers who successfully complete a voluntary disclosure and have been truthful throughout the process can safely presume that they will not be recommended for criminal prosecution.
What Civil Consequences or Penalties Exist?
According to the Interim Guidelines, voluntary disclosures will generally include a six-year disclosure period. Taxpayers must submit all required returns and reports for the disclosure period. The Interim Guidelines direct examiners to apply a one-time civil fraud penalty under IRC section 6663 [or IRC section 6651(f)], which is equal to 75% of the underpaid tax to the year with the highest amount of tax owed. Importantly, this is in lieu of accuracy-related penalties in the other (typically five) years covered by the disclosure (which had been imposed under the OVDP).
Willful foreign bank and financial accounts (FBAR) penalties will apply to all cases involving FBAR noncompliance and will be computed under the penalty guidelines in IRM 4.26.16 and 4.26.17. In most cases, this will result in the imposition of a 50% penalty on the year with the highest aggregate account balances. Although the Interim Guidelines do no foreclose the possibility of imposing other information return penalties, they suggest that, where the one-time 50% FBAR penalty is imposed, it will substitute for other information return penalties that could apply.
Although taxpayers “are not precluded” from requesting accuracy-related penalties instead of fraud penalties, or non-willful instead of willful FBAR penalties, deviations from the penalty structure set forth in the Interim Guidelines will be “exceptional” and a taxpayer must provide “convincing evidence” to justify why the civil fraud penalty or willful FBAR penalty should not be imposed.
Can Taxpayers Opt Out of the Civil Framework?
The Interim Guidelines do not foreclose the possibility of taxpayers disputing the civil resolution imposed by examiners or from arguing for reduced penalties. Nevertheless, they do make several things abundantly clear:
- The voluntary disclosure practice is for taxpayers whose noncompliance is willful.
- There is an express expectation that voluntary disclosure will end in a closing agreement.
- Deviations from the penalty structure laid out in the Interim Guidelines will be rare.
- Examiners have discretion to impose greater penalties or extend the years under examination in unagreed cases.
The takeaway from this is clear: 1) Taxpayers who believe they are non-willful should exercise options other than making a voluntary disclosure under the Interim Guidelines (see below), and 2) though they may still argue for better treatment, taxpayers who make a voluntary disclosure should be prepared to accept the penalty framework set forth in the Interim Guidelines.
Are Other Options Available?
In cases where a taxpayer’s offshore noncompliance was due to non-willful conduct, such as inadvertence or negligence, the IRS continues to offer options for qualifying taxpayers that are far more lenient than those available under the Interim Guidelines. These include the following:
- The IRS’s foreign and domestic streamlined filing procedures.
- Delinquent FBAR submission procedures.
- Delinquent international information return submission procedures.
Information concerning these alternative filing procedures can be found on the IRS’s website.
An important feature that each of these alternative procedures share is that they assume that a taxpayer has acted non-willfully. Unlike voluntary disclosure submissions, these submissions are not vetted by CID, and taxpayers who utilize these procedures do not receive protection from criminal prosecution. The streamlined filing procedures in particular require that applicants certify that their conduct was non-willful and provide a detailed account of the facts and circumstances surrounding their noncompliance.
Taxpayers should not take such procedures lightly. False submissions may be grounds for prosecution and result in criminal prosecution for the underlying noncompliance being reported. Thus, while taxpayers may be greatly tempted to avail of themselves of these alternatives to a full voluntary disclosure, given the significantly reduced penalties and potentially better economic outcome, it’s a huge risk. It bears repeating that the only option that provides protection from criminal prosecution to a taxpayer whose noncompliance was willful is the voluntary disclosure practice described in the Interim Guidelines.
Where Can Taxpayers Get More Information?
The Interim Guidelines and other policies and procedures constituting the IRS’s voluntary disclosure practice, as well as the alternatives described above for non-willful taxpayers, all can be found on the IRS’s website. But remember that every case is fact-specific, and it is not always obvious which alternative is best for each taxpayer. Taxpayers or preparers with questions about correcting past offshore noncompliance would be wise to consult a tax professional.