OVDP Opt Out – Certified Tax Law Specialist Explains Opting Out
- 1 Sean M. Golding – Certified Tax Law Specialist
- 2 Less than 1% of Tax Attorneys Nationwide
- 3 OVDP Opt-Out Definitions
- 4 OVDP
- 5 OVDP Opt-Out
- 6 OVDP Opt-Out Summary
- 7 Opt-Out Procedure Basics
- 8 DOT and IRS Guidance on Opt-Out
- 9 OVDP Basics
- 10 Offshore
- 11 Voluntary
- 12 Disclosure
- 13 Program
- 14 How Does an OVDP Case Work?
- 15 Why OVDP?
- 16 OVDP Penalties
- 17 Golding & Golding, A PLC
OVDP Opt Out – Certified Tax Law Specialist Explains Opting Out
OVDP is the traditional IRS Offshore Voluntary Disclosure Program. The penalties for OVDP can be brutal. So much so, that even the IRS recognized that for some people the penalty was too lopsided.
As a result, the OVDP Opt-Out Procedures were born.
Sean M. Golding – Certified Tax Law Specialist
Our Managing Partner, Sean M. Golding, Board-Certified Tax Law Specialist is the only Attorney nationwide who has earned the Certified Tax Law Specialist credential and specializes in IRS Offshore Voluntary Disclosure Matters.
In addition to earning the Certified Tax Law Certification, Sean also holds an LL.M. (Master’s in Tax Law) from the University of Denver and is also an Enrolled Agent (the highest credential awarded by the IRS.)
He is frequently called upon to lecture and write on issues involving IRS Offshore Voluntary Disclosure.
Less than 1% of Tax Attorneys Nationwide
Out of more than 200,000 practicing attorneys in California, less than 400 attorneys have achieved this Certified Tax Law Specialist designation.
The exam is widely regarded as one of (if not) the hardest tax exam given in the United States for practicing Attorneys. It is a designation earned by less than 1% of attorneys.
OVDP Opt-Out Definitions
OVDP is the traditional IRS OVDP program. This summary does not apply to the “Streamlined Program.” There is no Opt-Out for the Streamlined Program, although Reasonable Cause with a Penalty Waiver might be an alternative to the 5% domestic penalty. There is also a possible Streamlined OVDP transition for people who applied to OVDP prior to July, 2014.
OVDP Penalty (FBAR & FATCA)
The OVDP Penalty referred to in the Opt-Out is the 27.5% or 50% willful penalty on FBAR and FATCA related penalties (other assets may also apply, such as Rental Real Estate — even though it is not reported on either the FBAR or 8938). This is different than then Unpaid Tax penalty of 20% on each year’s worth of tax money due.
Willful vs. Non-Willful
Willful vs. Non-Willful refers to the mental state of the taxpayer at the time of the non-compliance.
Closing Letter 906
Refers to the last step in the OVDP submission process. By “Opting-Out” a person foregoes the letter and instead seeks an Opt-Out.
OVDP is the IRS’ Offshore Voluntary Disclosure Program. It is a program designed to bring non-compliant taxpayers into U.S tax compliance by allowing applicants to retroactively file tax returns, and reporting forms (FBAR, 8938, 5471, 3520, etc.)
Still, even if a person was willful and selected to enter OVDP, the penalty may be too much to bear. Even the IRS acknowledges that sometimes the penalty is too high for certain individuals based on their own specific set of facts and circumstances.
Therefore, the IRS gives them the chance to “Opt-Out.”
The OVDP Opt-out is an approved method for trying to obtain a reduced OVDP Penalty if you are already within the IRS Offshore Voluntary Disclosure Program (especially if you do not qualify for Transitional Treatment).
Despite the fact that the IRS will not negotiate the value of the penalty if you are planning on signing the Closing Letter (906), if you decide to Opt-Out of the traditional OVDP Penalty Structure — you may be able to significantly reduce the IRS OVDP Penalty.
IRS OVDP Opt-Out Procedures for FBAR and/or FATCA Form 8938 Penalties can be a risky proposition – but for some people “Opting-Out” of the established OVDP penalty structure is the only way to get a fair penalty issued.
OVDP Opt-Out Summary
The opt-out procedure has become less common ever since the Internal Revenue Service and Department of Treasury introduced the modified Streamlined Offshore Disclosure Program for non-willful applicants. Nevertheless, for those who may have not heard of the streamlined program, do not qualify for the streamlined program, or did not transition into the streamlined program from OVDP — opting out is the only option to try to reduce penalties.
For some people, the Offshore Voluntary Disclosure Program is a get out of jail free card. It is an opportunity for individuals, estates, and businesses who knowingly/willfully failed to disclose and report foreign accounts and offshore income to come-clean, with little chance of IRS prosecution.
Nevertheless, the penalty structure behind OVDP is so intense that for individuals who may be on the cusp of willful or non-willful – but enter OVDP anyway – the OVDP penalty structure may prove to be too much.
For example, if a person had $1 million overseas that was unreported in a non-bad bank and only generated $10,000 a year in income, the person would still have a minimum FBAR penalty of $275,000; if it was in a “Bad Bank” the penalty would be $500,000.
Opt-Out Procedure Basics
OVDP FAQ 49 Question: If the taxpayer and the IRS cannot agree to the terms of the OVDP closing agreement, will mediation with Appeals be an option with respect to the terms of the closing agreement?
OVDP FAQ 49 Answer: No. The penalty framework for offshore voluntary disclosure and the agreement to limit tax exposure to an eight year period are nonnegotiable terms under the OVDP. If any part of the closing agreement is unacceptable to the taxpayer, the taxpayer may opt out and the case will be examined and all applicable penalties will be imposed (see FAQ 51). After a full examination, any tax and penalties imposed by the Service may be appealed, but the Service’s decision on the terms of the OVDP closing agreement may not be appealed.
DOT and IRS Guidance on Opt-Out
The Department of Treasury issued a memorandum a few years back detailing the concept of opt-out.
Essentially, once the opt-out occurs, the taxpayer cannot go back and re-enter the penalty structure. This is important, because for many taxpayers, they do not understand the ramifications of opting out, and the possible exposure they may face, such as failure-to-file penalties, failure-to-pay penalties, fraud penalties, and more.
When an applicant does not opt out, and basically goes along with the program – they resign themselves to paying the penalty and essentially purchasing a “Get out of Jail Free” card. They can sleep easy with the idea they have bought themselves out of a possible audit (involving foreign accounts and being subjected to penalties for FBAR, 8938, 3520, 5471, 5472 8621) or criminal investigation and prosecution.
For those that chance the opt-out, they will be subject to much more intense scrutiny for the offshore accounts and income. Moreover, it is impossible to know which particular agent you will be assigned, and what level of scrutiny the agent will enforce against you and your foreign accounts.
Offshore does not mean you should be conjuring up visions of resting easy in the Bahamas, or stashing millions in the Caymans. Essentially, from an international IRS tax perspective, it simply means you have money overseas. Whether the money is in a foreign account, overseas, or abroad — it is being held “offshore.”
Therefore, in order to qualify for OVDP you must have unreported assets, income or investments abroad. If you do have offshore assets, income or investments, then you can report them with OVDP — and you can include domestic undisclosed money as well.
But, it is important to keep in mind that you do not get the same protection for your domestic undisclosed money that you receive for your offshore undisclosed money. Moreover, if you do not have any undisclosed offshore money, and all of your unreported money is domestic (located in the United States), you can submit to the IRS Domestic Voluntary Disclosure Program, but not OVDP.
Unfortunately, the IRS Domestic Voluntary Disclosure Program does not provide the same protections and reduced penalty structure as the Offshore Voluntary Disclosure Program.
Voluntary means you are entering the program on your own volition.
Usually, it means that you are not under audit or under examination with the IRS. That is because if you are already under IRS audit or examination and then submit to the program, you are not technically doing so voluntarily. Rather, you are entering the program in response to being audited or examined.
The reason the IRS does not allow you to enter OVDP once you are under audit is because you have a proactive responsibility during an audit or examination to bring these issues to the forefront and explain them to the auditor — even if the auditor did not ask about offshore accounts specifically – but assuming he or she asks about additional income, assets, etc.
When you are under audit or examination you can be subject to excessively high fines and penalties which are mitigated through traditional OVDP. The IRS will not let you out of those penalties (if you are audited) by submitting to OVDP at that time.
By disclosure, the IRS is referring to full disclosure. If you want to voluntarily disclose offshore money, then you have to do a full disclosure and report all of the information you have regarding all of your offshore money abroad.
It does not matter if the money was held in an account within a branch or institution that went out of business. It also does not matter that your money is being held in an anonymous account that you firmly and wholeheartedly believe can never be discovered.
Rather, from the IRS’ perspective, when it is time to disclose – you must perform a full disclosure and report all of the information — no matter how low the chances that the IRS could ever discover the information, account information, investments or income otherwise.
OVDP is an approved IRS program. There are specific time requirements and reporting disclosures that must be done according to OVDP milestones. If you fail to meet these milestones timely, the IRS can remove you from the program, which now means the IRS has at least some specific information regarding your offshore finances, and can now enforce incredibly high fines and penalties against you.
Worse yet, you no longer have the protection of OVDP.
How Does an OVDP Case Work?
OVDP Phase 1
The person submits a preclearance letter. It typically takes the IRS 30 to 45 days to respond to the letter. After around 45 day you will learn whether you have been accepted or rejected into OVDP. Despite what some inexperienced attorneys will tell you online, not everyone gets accepted. And if an attorney has told you that everyone always gets accepted, than they have not been practicing in this area of law long enough – especially with the introduction of FATCA.
OVDP Phase 2
The applicant has 45 days to submit the initial disclosure to the IRS. It is a relatively detailed breakdown of the different accounts, transfers, opening and closing of the accounts, and related information. It is not as detailed as preparing and submitting IRS forms and schedules such as general FATCA Reporting, FBAR, 3520, 5471, 8621, 8865, 8938 — but it is still relatively comprehensive, and more detailed than it had been in years past, especially pre-FATCA.
OVDP Phase 3
Presuming that the applicant is accepted, the applicant then has 90 days to submit the full disclosure, including all necessary FBARs, schedules, penalty competitions, legal arguments for mitigation of penalties, etc. Depending on the specific facts and circumstances of your case (numerous PFICs, Foreign Mutual Funds, ETFs, etc.), it may take longer for you to compile the information or prepare the necessary documents. The IRS routinely grants extensions to file.
We know…it seems nuts to acquiesce to the IRS before they have even found you, audited you, or examined you — and allow the IRS to issue penalties against. You may instead also consider submitting an IRS Quiet Disclosure in hopes that you can fly below the radar without getting caught.
Quiet Disclosure is a horrible idea, and here’s why:
First, a quiet disclosure may lead you to jail or prison. For a comprehensive case study on how IRS required disclosure of offshore money can go wrong, please refer to our prior blog page on Quiet Disclosure, Criminal Investigations & Prison.
Second, if the IRS audits or examines you before you enter the program, you may be subject to incredibly high fines and penalties, which are detailed below:
The reason why it is so important to disclose before the IRS finds you, is because the IRS has taken to issuing gargantuan penalties against individuals whose issues seem relatively minor (Read: is the world going to explode because Marty didn’t report his foreign account?)
When it comes to penalties, the IRS has extreme leeway. On the one hand, if a person can show reasonable cause, then often times penalties will be waived. On the other hand, the IRS has the right to issue penalties which can reach 100% value of the foreign account in a multi-year audit scenario (noting, that up until recently the IRS issued 300% penalties for unreported FBARs, when a person was found to be willful and penalized at 50% within the 6-year SOL).
The following is a summary of penalties as published 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.
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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. He has also earned the prestigious IRS Enrolled Agent credential. Mr. Golding's articles have been referenced in such publications as the Washington Post, Forbes, Nolo, and various Law Journals nationwide.
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