Offshore account compliance: the evolution of a revolution.

• Author: Dorot, Datan Z.
• Position: Tax Law

On June 18, 2014, the commissioner of the Internal Revenue Service, John Koskinen, announced major revisions to the Offshore Voluntary Disclosure Program (OVDP), bringing it into its fourth metamorphosis. The changes, although good and bad, were certainly necessary for a more equitable and fluid administration of the highly successful amnesty program.

FBAR FinCEN Form 114

U.S. persons are required to annually declare their financial interest in or signature authority over foreign financial accounts on the Report of Foreign Bank and Financial Accounts (FBAR), FinCEN Form 114 (formerly IRS Form TD F 90-22.1), if the aggregate value of the accounts exceeds $10,000 during the calendar year. (1) Failure to properly disclose such interest may potentially result in severe civil and criminal liability. (2) In 2008, the U.S. Department of Justice (DOJ) investigated Swiss bank UBS AG after learning that UBS conspired to defraud the U.S. government. UBS ultimately entered into a deferred prosecution agreement with the DOJ, stipulating that bank representatives facilitated tax evasion by concealing U.S. taxpayers' interests in order to evade reporting requirements. (3) While UBS was the first bank to be pursued, the DOJ recognized that these fraudulent and illegal activities were widespread. The UBS spark ignited a worldwide effort to combat the facilitation of international tax evasion and money laundering by financial institutions. (4)

Evolution of Amnesty

* OVDP 1.0--The IRS has historically allowed taxpayers to voluntarily disclose any violations or oversights, regardless of intent, before the IRS identifies such violations, in exchange for reduced or at least mitigated civil and/or criminal consequences. In 2009, the IRS introduced the first OVDP, designed specifically for taxpayers who willfully failed to report offshore income and file FBARs. (5) The 2009 OVDP provided that, in exchange for willful violators' submission of amended returns and delinquent FBARs for a six-year period, such taxpayers could avoid criminal prosecution and would only be subject to a reduced penalty for failing to file FBARs, in lieu of "all other penalties," equal to 20 percent of the highest aggregate account balance at any time during the covered period. (6) The 2009 program was highly successful; however, it expired on October 15, 2009. (7)

* OVDP 2.0--On February 8, 2011, the IRS introduced the 2011 Offshore Voluntary Disclosure Initiative (OVDI). While fundamentally the same, the IRS penalized taxpayers who opted not to participate in the 2009 OVDP by increasing the offshore penalty from 20 percent to 25 percent. Additionally, the disclosure period was extended from six years to eight. During the administration of the 2009 OVDP, the IRS recognized that some taxpayers' inability to present mitigating factors resulted in inequitable outcomes for many taxpayers. In response, the IRS introduced the opt-out procedure, whereby taxpayers, after fully complying with the OVDP requirements, but before they sign a closing agreement, can elect to opt out of the OVDP. They could subject themselves to standard audit procedures and could introduce relevant mitigating factors. While an opting-out taxpayer still avoids criminal prosecution, the taxpayer is exposed to the full range of penalties otherwise mitigated through the 2011 OVDI if the IRS proves the taxpayer's willfulness. (8)

Additionally, the IRS clarified the offshore penalty calculation to include the value of foreign income-producing property if the income from such property was not properly reported on the taxpayer's income tax return for such year. (9) The 2011 OVDI had an expiration date of September 9, 2011.

* OVDP 3.0--In January 2012, the IRS introduced the 2012 OVDP in which certain aspects of the 2011 OVDI were clarified and in which the offshore penalty was increased to 27.5 percent. (10) Later that year, on June 26, 2012, the IRS announced its efforts to "help U.S. citizens overseas, including dual citizens and those with foreign retirement plans." (11) This alternate procedure, referred to as the streamlined filing compliance procedure, allowed nonresident U.S. taxpayers to become compliant if they owed little or no back taxes and met certain requirements so as to be considered as presenting a low level of compliance risk. This alternative, although limited to nonresidents who did not originally file a return, gained significant traction with U.S. taxpayers around the world.

Compliance Outside the OVDP

Since its inception, the OVDP rules allowed for disclosure outside the OVDP for taxpayers who failed to file an FBAR, but otherwise paid tax on and reported all income. In such instances, U.S. taxpayers could prepare and file delinquent FBARs and attach a statement explaining the delinquency (referred to as a Question 17 Submission). (12) As a corollary, the OVDP Frequently Asked Questions and Answers (FAQs) provided that if a taxpayer qualifies for and makes a Question 17 Submission, then no penalties would be assessed for the late filing of informational returns, such as Forms 3520 and 5471. (13)

OVDP 4.0: New Rules, New Tools

The OVDI/OVDP in its various mutations has yielded significant success both in the IRS's and DOJ's efforts to combat tax evasion and generate revenues for the government. (14) Through the OVDP, the IRS and DOJ have been able to collect tremendous amounts of information and documentation--in searchable databases--and directly pursue foreign financial institutions and U.S. taxpayers.

Despite its success, the most significant limitation of the OVDP has always been its lack of discretion. Except for the opt-out procedure, taxpayers were forced to enter into a program that disregarded any mitigating circumstances of their noncompliance. Take the Miami businessman who deliberately excludes cash transactions on his tax return and hands over $1 million in cash to his Swiss private banker for the purpose of evading tax. In the program, he will be subject to the same penalty structure as the Boca retiree who spends her days playing shuffleboard and mahjong, and who holds a $1 million bank account in Germany (earning less than 1 percent) that she inherited from her German mother and from which she draws $500 monthly for her medical bills. Both had a financial interest in a foreign account; both failed to report their ownership interest; both did not disclose their income--both are subject to the same exact offshore penalty under the OVDP. With these scenarios in mind, on June 18, 2014, the IRS announced its latest rendition of the OVDP with much anticipated changes and improvements. The following is a summary and analysis of the major changes. 15

Offshore Penalty

Since early this year, in an effort to comply with the Foreign Account Tax Compliance Act, banks and financial institutions around the world have been working to identify account holders with connections to the United States. These institutions issued letters to each of their account holders (who are or are suspected to be U.S. taxpayers) informing them of the current efforts of the IRS and DOJ and requiring that the account holders confirm that they are either currently compliant or are in the process of becoming compliant with their U.S. tax and information reporting obligations in connection with their accounts. Some banks have gone so far as to restrict access to clients' accounts until such...