Volume 26 Issue 3 --May/June 2014
Much attention has been given to recent efforts by the government to catch and prosecute individuals who fail to report offshore accounts. In a well-publicized example, a widow inherited a Swiss bank account of approximately $45 million, which she failed to report on tax returns following her husband’s death. When discovered, she agreed to pay a penalty of $22 million to the government and still faced criminal prosecution.
For some time, US tax return filers have been required to answer a question about their foreign accounts. While having a foreign bank account is not illegal, failure to report them can be.
For many years, US persons with foreign financial accounts aggregating more than $10,000 in value have been required to file a Foreign Bank Account Report (FBAR). More recently, an additional set of reporting requirements using Form 8938 have come into play. The potential penalties for failing to file either form can be enormous.
In an effort to encourage non-compliant taxpayers to come forward, the IRS created a series of Offshore Voluntary Disclosure Initiatives or Programs (OVDP). Because of the potentially large penalties for failing to report foreign accounts and income, many taxpayers came forward. According to the June 26, 2014, IRS release, 45,000 taxpayers have come into voluntary compliance and have paid $6.5 billion in taxes, interest, and penalties.
Under these programs, taxpayers could pay a special fixed penalty in addition to any regular tax, interest, and late filing or late payment penalties due. The amount of this special penalty, called an “Offshore Penalty” by the IRS was smaller than the maximum penalties that could have been assessed. Most recently, the Offshore Penalty was 27.5% of the highest value of unreported assets during a six-year period. The amount of the Offshore Penalty was not negotiable or subject to reduction except in certain very limited situations.
In many situations, individuals who failed to report foreign accounts solely because they were unaware of the reporting obligations were effectively treated the same way as others who were effectively using the foreign accounts for tax evasion.
Eligibility for these programs was dependent upon first receiving a letter from the criminal division of the Justice Department stating that criminal prosecution was not going to be pursued. For taxpayers, satisfying the requirements of the programs was difficult and the IRS was apparently having a hard time processing the requests.
Recently, the IRS announced a number of significant changes to streamline the offshore disclosure program for those whose failures to comply are “non-willful.” Taxpayers must show that their conduct in failing to report foreign income or accounts was due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.
For example, suppose Miya was given stock in her father’s company in Asia and had a bank account created for her in her home country. Miya went to a return preparer who did not ask questions about foreign assets so the existence of the foreign stock and foreign bank accounts was unreported. Miya had no idea that she needed to report the foreign account or stock.
For such individuals whose failures were non-willful, effective July 1, 2014, the IRS had created a new “streamlined” approach with a lower 5% offshore penalty, in lieu of the 27.5% penalty. There are still a number of requirements that must be met for participation in the program, but in many cases for taxpayers that were unaware of their filing requirements, the changes can be beneficial.
In addition to a reduced offshore penalty, the streamlined program typically requires filing fewer amended tax returns, but payment of all taxes, interest and penalties, including the 5% offshore penalty is required at the time of application for the program. While applying for the program is not for the faint of heart, it can be better than the alternatives.
In addition to the new streamlined procedures for some non-willful violators, the IRS has also upped the ante for some violators. For those that have unreported accounts with one of a number of overseas institutions that are currently cooperating with the IRS, the penalties got worse. For such persons, the offshore penalty has been increased from 27.5% to 50%. Clearly, the IRS is trying to encourage violators to come forward before the IRS finds about the accounts from other sources.
There are transitional rules for those who have unresolved applications submitted under the prior versions of the program.
If you have questions about this, please call the Tax & Business Professionals.
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