Offshore Voluntary Compliance (2018) – IRS Common Questions & Answers
- 1 Offshore Voluntary Compliance
- 2 Offshore Voluntary Disclosure Program (OVDP)
- 3 OVDP Penalty Amount
- 4 Penalty Opt-Out
- 5 Streamlined Filing Compliance Procedures
- 6 Streamlined Domestic Offshore Procedures (SDOP)
- 7 Streamlined Foreign Offshore Procedures (SDOP)
- 8 Conclusion
- 9 Get Into Compliance with IRS Offshore Disclosure
- 10 When Do I Need to Use Voluntary Disclosure?
Offshore Voluntary Compliance
IRS Offshore Voluntary Compliance has become a critical issue for millions of individuals worldwide who have a U.S. tax reporting requirement but have not properly filed the necessary documents with the Internal Revenue Service.
The reason why Offshore Disclosure has become so important is because the Internal Revenue Service and U.S. Government as a whole has made enforcement of Offshore Compliance a key priority.
Moreover, the IRS can issue excessively high fines and penalties against an individual, business or estate for failing to get into compliance, and enforce collection through the following common methods:
The following is a brief summary of the differences between some of the key programs that applicants may use to get themselves into compliance before it is too late.
Offshore Voluntary Disclosure Program (OVDP)
The Offshore Voluntary Disclosure Program (aka OVDP) is the traditional program used for individuals who are looking for the most protection – and are willing to pay the most money to get that protection.
Unlike some of the other IRS programs, the traditional Offshore Voluntary Disclosure Program provides for as close to Offshore Amnesty as a person can achieve when it involves offshore disclosure.
Reduced Chance of IRS Audit or Examination
In 99% of the cases, Internal Revenue Service will not pursue an audit involving any issues regarding the international tax related matters of the OVDP submission. It is important to note that when a person makes an offshore voluntary disclosure program submission, it may also include domestic issues as well. But, when a person has unreported domestic income or another related domestic issue (over-embellished deductions, false businesses), they are not provided the same protection against audit as they are with the traditional OVDP for Foreign or Offshore Income.
Reduced Chance of Criminal Investigation or Prosecution
One of the nicest benefits of the traditional OVDP is almost nobody is ever prosecuted under this program. While the IRS will not guarantee amnesty against prosecution, even on the IRS ‘website they have all but said as long as a person makes a full disclosure — they will not recommend prosecution.
So, for all you who were addicted to television shows such as HBO’s OZ, and worry that you too could find yourself in that situation, traditional OVDP may be a good option for you, if you were willful.
**For some reason, attorneys, CPAs and other tax professionals like to scare individuals into OVDP, by telling them the IRS will put them in prison for upwards of five years for tax related crimes. While this is true that the IRS could do this, the chances are relatively slim. So, before you decide to submit to OVDP, you should really speak with a few different offshore disclosure lawyers to get a baseline idea of how bad your tax really are vs. your fear of the unknown.
OVDP Penalty Amount
When it comes to the penalty, if you choose not to opt out, the penalties are tough – if not excessive.
– A person has to pay any outstanding tax liability they may have had on unreported income in prior year.
– A person must pay 20% penalty for each year’s unreported tax.
– A person must pay interest on the unreported money for each year.
– A person must pay either a 27.5% or 50% penalty on the highest annual aggregate maximum balance during the eight-year compliance period, depending if their money is located in a bad bank.
Three (3) Common Questions Regarding the OVDP Penalty
– The value real estate is included in the penalty if the real estate is used to generate income.
– If a portion of the money does not belong to you, that portion is excluded from the penalty.
– There is no double counting of the balances, so if you had $2 million that was transferred five times, into five different accounts – you still pay the penalty on the $2 million, not $10 million.
If you believe the penalty too high, and often times it is – you have the option to opt out to try to reduce the penalty. Opting out comes with various risks, and the biggest risk being that the IRS has the right to penalize you even more than you would have been penalized under the traditional OVDP penalty.
The penalty off without is not for the faint of heart, and you should be represented by an Attorney (not a CPA) for an Opt-Out.
Streamlined Filing Compliance Procedures
Even the IRS determines that the above referenced reporting and penalty structure is ridiculous for an individual who was non-willful.
Example: David is originally from Hong Kong and relocated to the United States in 2008. He is a legal permanent resident who was told by his tax preparer that he did not need to report the income he earned from Hong Kong because it was tax-free in Hong Kong and the accounts were opened before he became a U.S. Person. Of course, none of that ‘advice” is true and the United States taxes individuals on their worldwide income. Thus, David must go back and report the income and the accounts.
Prior to the introduction to formalized streamlined program, David would have to submit through traditional OVDP and then be forced to opt out. To avoid this outcome, in 2014 the IRS introduced formalizes streamlined program options.
Streamlined Domestic Offshore Procedures (SDOP)
The Streamlined Domestic Offshore Procedures (SDOP) is designed for individuals who are non-willful, but do not qualify as a foreign resident. Instead of going through the traditional OVDP, these individuals have another option which is to submit under the streamlined filing compliance procedures (SFCP).
The Streamlined Filing Compliance Procedures have a significantly reduce reporting a penalty structure as follows:
- Three (3) years of amended returns
- Six (6) years of FBAR (Report of Foreign Bank and Financial Accounts)
- No penalty on unreported tax due each year
- A 5% penalty on the highest year-end balance
It should be noted, that for OVDP, the penalty is on the maximum aggregate balance during the year that has the highest aggregate balance within the compliance period. Conversely, the streamlined program the penalties on the highest “year-end” balance.
The purpose of using the Highest Year-End balance vs. Account Maximum Balance is because under the streamlined program a person is considered non-willful. Therefore, to try to avoid any artificial increases in an account balance that may have occurred throughout the year (aka sale of a home and funds deposited into the account), the IRS limits the balance of December 31 aggregate total.
Streamlined Foreign Offshore Procedures (SDOP)
The Streamlined Foreign Offshore Procedures (SFOP) is nearly identical to the streamlined domestic, aside from a few exceptions — which makes it even more forgiving and beneficial to the applicant:
- A person can file original returns through SFOP
- The 5% penalty is waived
If you are out of US tax compliance, and you have unreported foreign income, accounts, investments, real estate, life insurance, pensions, foreign business ownership, provident funds, etc. you should consider submitting to one of Offshore Voluntary Compliance programs.
The IRS has the right to issue excessive fines and penalties against you for failing to report. We have provided a summary of those penalties for you below as provided by the IRS:
A penalty for failing to file FBARs. United States citizens, residents and certain other persons must annually report their direct or indirect financial interest in, or signature authority (or other authority that is comparable to signature authority) over, a financial account that is maintained with a financial institution located in a foreign country if, for any calendar year, the aggregate value of all foreign financial accounts exceeded $10,000 at any time during the year. The civil penalty for willfully failing to file an FBAR can be as high as the greater of $100,000 or 50 percent of the total balance of the foreign financial account per violation. See 31 U.S.C. § 5321(a)(5). Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation.
Beginning with the 2011 tax year, a penalty for failing to file Form 8938 reporting the taxpayer’s interest in certain foreign financial assets, including financial accounts, certain foreign securities, and interests in foreign entities, as required by IRC § 6038D. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. Taxpayers must also report various transactions involving foreign trusts, including creation of a foreign trust by a United States person, transfers of property from a United States person to a foreign trust and receipt of distributions from foreign trusts under IRC § 6048. This return also reports the receipt of gifts from foreign entities under IRC § 6039F. The penalty for failing to file each one of these information returns, or for filing an incomplete return, is the greater of $10,000 or 35 percent of the gross reportable amount, except for returns reporting gifts, where the penalty is five percent of the gift per month, up to a maximum penalty of 25 percent of the gift.
A penalty for failing to file Form 3520-A, Information Return of Foreign Trust With a U.S. Owner. Taxpayers must also report ownership interests in foreign trusts, by United States persons with various interests in and powers over those trusts under IRC § 6048(b). The penalty for failing to file each one of these information returns or for filing an incomplete return, is the greater of $10,000 or 5 percent of the gross value of trust assets determined to be owned by the United States person.
A penalty for failing to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Certain United States persons who are officers, directors or shareholders in certain foreign corporations (including International Business Corporations) are required to report information under IRC §§ 6035, 6038 and 6046. The penalty for failing to file each one of these information returns is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return.
A penalty for failing to file Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business. Taxpayers may be required to report transactions between a 25 percent foreign-owned domestic corporation or a foreign corporation engaged in a trade or business in the United States and a related party as required by IRC §§ 6038A and 6038C. The penalty for failing to file each one of these information returns, or to keep certain records regarding reportable transactions, is $10,000, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency.
A penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation. Taxpayers are required to report transfers of property to foreign corporations and other information under IRC § 6038B. The penalty for failing to file each one of these information returns is ten percent of the value of the property transferred, up to a maximum of $100,000 per return, with no limit if the failure to report the transfer was intentional.
A penalty for failing to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. United States persons with certain interests in foreign partnerships use this form to report interests in and transactions of the foreign partnerships, transfers of property to the foreign partnerships, and acquisitions, dispositions and changes in foreign partnership interests under IRC §§ 6038, 6038B, and 6046A. Penalties include $10,000 for failure to file each return, with an additional $10,000 added for each month the failure continues beginning 90 days after the taxpayer is notified of the delinquency, up to a maximum of $50,000 per return, and ten percent of the value of any transferred property that is not reported, subject to a $100,000 limit.
Underpayment & Fraud Penalties
Fraud penalties imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that, although calculated differently, essentially amount to 75 percent of the unpaid tax.
A penalty for failing to file a tax return imposed under IRC § 6651(a)(1). Generally, taxpayers are required to file income tax returns. If a taxpayer fails to do so, a penalty of 5 percent of the balance due, plus an additional 5 percent for each month or fraction thereof during which the failure continues may be imposed. The penalty shall not exceed 25 percent.
A penalty for failing to pay the amount of tax shown on the return under IRC § 6651(a)(2). If a taxpayer fails to pay the amount of tax shown on the return, he or she may be liable for a penalty of .5 percent of the amount of tax shown on the return, plus an additional .5 percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding 25 percent.
An accuracy-related penalty on underpayments imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.
Even Criminal Charges are Possible…
Possible criminal charges related to tax matters include tax evasion (IRC § 7201), filing a false return (IRC § 7206(1)) and failure to file an income tax return (IRC § 7203). Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. § 5322. Additional possible criminal charges include conspiracy to defraud the government with respect to claims (18 U.S.C. § 286) and conspiracy to commit offense or to defraud the United States (18 U.S.C. § 371).
A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000. A person convicted of conspiracy to defraud the government with respect to claims is subject to a prison term of up to not more than 10 years or a fine of up to $250,000. A person convicted of conspiracy to commit offense or to defraud the United States is subject to a prison term of not more than five years and a fine of up to $250,000.
Get Into Compliance with IRS Offshore Disclosure
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
We Can Help.
Sean holds a Master's in Tax Law from one of the top Tax LL.M. programs in the country at the University of Denver, and has also earned the prestigious Enrolled Agent credential. Mr. Golding is also a Board Certified Tax Law Specialist Attorney (A designation earned by Less than 1% of Attorneys nationwide.)