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OVDP – When Can the IRS Issue a 50% Penalty for Tax Fraud or Evasion?

Golding & Golding - International Business Tax Lawyers

Golding & Golding – U.S. and International Tax Lawyers

Offshore disclosure can be a very scary and intimidating process – even more so if you are not properly informed!

Trying to determine if you are willful or non-willful is a headache in and of itself. In addition, there is so much misinformation online regarding offshore disclosure (by unscrupulous Attorneys, CPAs and Accountants) that is intended to scare taxpayers, it is no wonder that many people get scared and lose sleep when faced with the dilemma of offshore disclosure.

With that said, one of the scariest moments in the offshore disclosure lifecycle is learning that some of your money was in a “Bad Bank”. Click Here for the current list of Bad Banks.

A key factor regarding Bad Banks (Foreign Financial Institutions or Facilitators) that many inexperienced Attorneys, CPAs, and Accountants neglect to tell their clients, is that the exorbitant 50% Penalty for bad banks is only applicable to people who were willful!

What is a Bad Bank?

A “Bad Bank” is a bank that is been identified by the US government as a foreign financial institution that facilitated tax evasion and the hiding of foreign money in secret accounts of US taxpayers.

The list of bad banks continues to grow. What makes having your money in a bad bank so intimidating, is that if you have any money in a bad bank then all of your OVDP penalty is increased from 27.5% to 50%.

Nevertheless, the most important thing to keep in mind is you have to be willful in order to have your penalty amount increase. In other words, simply because you have money in an account within a bank that has been identified as a bad bank does not mean you are willful.

Rather, it means if you are willful and you have your money in a bad bank, then you have to pay the increased penalty amount.

Willful vs. Non-Willful

There is no concrete definition of the terms willful or non-willful in the context of offshore disclosure – rather, it is a totality of the circumstances test based on the specific facts and circumstances of each taxpayer’s situation.

To that end, below please find a recent article we authored regarding the distinction between willful and non-willful, followed by a summary of the difference between OVDP and Streamlined Program:

                   

Willful or Non-Willful (OVDP) – Offshore Disclosure is the process of coming forward and disclosing overseas assets and foreign income to the IRS in exchange for a waiver of prosecution by the Internal Revenue Service. Whether a Taxpayer is Willful or Non-Willful will determine which OVDP offshore disclosure program the taxpayer should enter — and what their penalty will be.

Whether or not you will have to pay an OVDP penalty (and if so, how much you will have to pay) will depend on a few different factors – with the most important factor being whether you acted willful or not willful.

                                

The Willful Taxpayer – What if I Knew I was Required to Disclose but Did Not Disclose?

If you knew you were supposed to report and disclose your foreign income and assets but chose not to, chances are your actions were willful under OVDP. In other words, if you knew you had a duty to report, but intentionally did not report your accounts, then you acted “willfully.”

While there is no strict definition of the word willful, it generally boils down to knowledge of the requirement to disclose. Alternatively, if you did not know that you were required to report your foreign accounts, then you could not have “willfully” failed to report the accounts, because you did not know about the requirement to do so.

– If you were willful then you should be careful not to enter the IRS Streamlined Program, because if you are “caught” entering Streamlined when you were actually willful, there can be very stiff penalties. Rather, you should enter the Offshore Voluntary Disclosure Program – because you were willful and require IRS Tax protection from criminal prosecution – and consider “Opting-Out”

– While the penalty for OVDP is higher, consider the alternatives: would you rather admit willfulness, pay a 27.5% penalty for one-year’s worth of high-balance and both prevent a future audit and almost always prevent criminal prosecution, or live in constant fear of  being audited, pay upwards of $1 million in penalties and do 5 to 20 years in federal prison if you are caught? When compared to the latter option, 27.5% for one year is not such a big deal.

Non-Willful – I was unaware that I was required to Disclose my Foreign Income and Assets?

The IRS is aware that many people simply did not know of the requirement to report. Unlike OVDP, where generally individuals are earning active income overseas or are intentionally placing money overseas, if a person is Non-Willful, they qualify for the Modified Streamlined Program – which has a significantly reduced penalty structure. There are plenty of people who have overseas accounts because they immigrated or relocated to the United States from another country or might’ve received an inheritance. These are not the people the IRS is seeking to prosecute, since they were “Non-Willful”.

  • Therefore, the IRS modified a small streamlined program that now allows pretty much anyone who was non-willful to enter this program. There are several benefits of this program, including a reduced if not forgiven penalty and strict limitations as to what items can be penalized and which items cannot.
  • Under the traditional OVDP program pretty much any type of asset that earns income is subject to the penalty; under the modified streamlined program only items that are included on an 8938 are generally included in the penalty computation. For example, income generating real estate is excluded from the penalty computation

What is the First Step in Resolving my Foreign Account Issues with the IRS?

Deciding whether to disclose your foreign income and assets is a big decision but a decision which overall is beneficial to you and your family. Why? Because with the new FATCA laws (Foreign Account Tax Compliance Act) several foreign countries and foreign financial institutions have agreed to report US taxpayer information to the IRS – whether they were willful or non-willful. In fact, foreign banks are pretty much reporting everybody who they have in their records to maintain a US address.

  • That means that even if you’re only living in the US temporarily there is a good chance your foreign financial institution will report you to the IRS. And, if it turns out that you are required to file a W-9 instead of a W-8 BEN, this can cause a major problem for you down the line, as well as an issue if you are seeking legal permanent residency or naturalization.
  • It is important to note that if the IRS contacts you first, then you are disqualified from the program (whether you were willful or non-willful) Moreover, if you are under audit from the IRS for any reason involving foreign or domestic tax issues you’re disqualified from the program as well. In addition, the IRS can stop the program at any time, and history has shown that the penalty amount increases almost every year.
  • Further, the Department of Justice recently issued a bulletin letting individuals know that they will be seeking strict enforcement against anybody who is found entering into the streamlined program when they should’ve entered into the traditional OVDP.

We can assist you with all of your OVDP and International tax law questions!

                                            

OVDP VS. STREAMLINED PROGRAM

At Golding & Golding, we have successfully handled numerous OVDP (Offshore Voluntary Disclosure Program) and IRS Streamlined Program applications for individuals and businesses around the globe with outstanding unreported foreign accounts ranging from $50,000.00 to over $30,000,000.00

Click Here to learn about some of our more recent OVDP and Streamlined accomplishments.

In order to assist you better understand the distinction between the two different IRS foreign account disclosure programs, we are providing the following summary for your reference:

If you or your business has unreported or undisclosed foreign accounts, offshore assets, or foreign income, then you may be considering whether you should enter the Offshore Voluntary Disclosure Program (OVDP) or the IRS Streamlined Offshore Disclosure Program, and what the definition of “Willful” is.

Whether or not a person enters Offshore Voluntary Disclosure Program (OVDP) or the IRS Streamlined Offshore Disclosure Program will depend on the facts and circumstances of each taxpayer’s situation. No two tax situations are identical, and the failure to properly submit to the correct program can have serious consequences for the unsuspecting taxpayer.

                                    

Why Comply with IRS Foreign Disclosure Laws?

Because if you fail to comply with FATCA (Foreign Account Tax Compliance Act) as well as general IRS Foreign Disclosure Laws, the IRS has the authority to penalize you upwards of 100% of the value of your offshore assets and accounts as well as:

  • Collect Taxes for prior tax years
  • Collect Interest on outstanding tax liability for prior years
  • Penalize you for the failure to report foreign accounts on the tax return (Schedule B and 8938)
  • Penalize you for the failure to report foreign gifts (3520)
  • Penalize you for the failure to report foreign Trusts (3520 and 3520A)
  • Penalize you for the failure to report ownership in Foreign Corporations (5471 and 5472)
  • Penalize you for the failure to report ownership in a PFIC (8621)
  • Genera Negligence and Fraud Penalties
  • Investigate you for Criminal Tax Fraud & Criminal Tax Evasion if you willfully failed to report your assets & foreign income.

The reason why international tax law compliance has taken center stage is because under the new FATCA (Foreign Account Tax Compliance Act) laws, foreign countries are actively reporting the bank and financial accounts of US citizens and US legal permanent residents to the IRS and U.S. Government.

If a foreign country is interested in working with the United States, the foreign country will enter into an “ Intergovernmental Agreement” (IGA) with the United States. These agreements are reciprocity agreements, which means that not only will the foreign country report the information to the IRS, but the IRS will also reciprocate by providing the same information to foreign country tax authorities.

                                       

Why Enter either OVDP or the Modified Streamlined Program?

Individuals and businesses who are trying to avoid 100% FBAR penalties and/or Criminal Prosecution may seek to voluntary disclose, pay a penalty (unless abated), and avoid criminal prosecution.

There are the only two approved programs by the Internal Revenue Service that can bring a taxpayer into compliance. Instead of entering the programs, a taxpayer may qualify to directly report under the reasonable cause exception, in which the taxpayer directly submits the forms with a statement explaining why they were not properly filed instead of paying a penalty.

*The IRS is not known to be sympathetic, and if you choose the “Reasonable Cause/Delinquency FBAR Submission” option and the IRS does not believe you, you may be subject to IRS Audit and/or examination, as well as being disqualified from entering either the OVDP or Streamlined Program. Worse yet, the IRS has all of your unreported and undisclosed foreign account and foreign income information – which can lead to serious fines and penalties.

**If the taxpayer submits the forms to the IRS without submitting to the FBAR Delinquency/Reasonable Cause or IRS Disclosure Programs, it can be considered a “silent disclosure” or “quiet disclosure.” If the IRS learns of the Quiet or Silent Disclosure, the IRS will penalize you heavily as well as consider initiating criminal proceedings against you. In this scenario, not only will the IRS seek to take all of your money and assets through the implementation of penalties and levies, but you may be spending the next 2 to 20 years in prison for tax evasion or tax fraud.

                                 

What is the Difference between OVDP and the Streamlined Program?

Before making a decision regarding voluntary disclosure, it is important to understand the difference between the two main programs.

OVDP (Offshore Voluntary Disclosure Program Requirements)

In accordance with OVDP filing requirements, The Applicant will then be required to pay the outstanding tax, along with estimated interest, a 20% penalty on the outstanding tax, as well as an “FBAR” Penalty. The Penalty is 27.5% (or 50% if any of the foreign accounts are held at an IRS “Bad Bank”) on the highest year’s “annual aggregate total” of unreported accounts (Accounts which were previously reported are not calculated into the penalty amount).

For OVDP, the annual aggregate total is determined by adding the “maximum value” of each unreported account for each year, in each of the last 8 years. To determine what the maximum value is, the taxpayer will add up the highest balances of all their accounts for each year. In other words, for each tax year within the compliance period, the application will locate the highest balance for each account for each year, and total up the values to determine the maximum value for each year.

Thereafter, the OVDP applicant selects the highest year’s value, and multiplies it by either 27.5%, or possibly 50% if any of the money was being held in what the IRS considers to be one of the “bad banks.” When a person is completing the penalty portion of the application, the two most important things are to breathe, and remember that by entering the program the applicant is seeking to avoid CRIMINAL PROSECUTION!

When it comes to the Streamlined Program, the penalty is limited to 5% on the highest “year-end” balance for the last 6-years. The reason is that if the person was non-willful, they should not be overly-penalized if there was an artificial increase in the value of the bank accounts – such as from the sale of a home during the tax year.

(A complete breakdown of OVDP requirements can be found on our OVDP Page, by Clicking Here)

                                       

OVDP is Unfair for Non-Willful Taxpayers

Before the implementation of the modified streamlined program, it was difficult for individuals who were non-willful (no specific definition, but generally “without intent to deceive or defraud”) to become compliant. Why? Because if you are non-willful, you still had to go through the filing procedures as if you were willful, and then opt out of the penalty structure and open yourself up for audit.

Not such a big deal, except for the fact that you also had to pay 20% penalty on the outstanding taxes that you owed along with a 27.5% penalty on the highest year’s annual aggregate (unless you successfully “opted out” from the penalty structure – which came with a whole other set of headaches). As you can imagine, for individuals who simply inherited some money overseas, had no international dealings, and had no idea that they were required to report foreign passive income (Interest income) in a country that does not tax its own citizens on passive income earnings — providing this information to the IRS was a huge burden.

                                       

What is the Modified Streamlined Program?

In order to avoid “non-willful” applicants from having to go through the entire OVDP process before opting out, the IRS and Department of the Treasury modified a small program in existence, called the streamlined program, which was very limited. The IRS expanded the program to basically allow anyone who was non-willful to enter the program.

The program reduced the amount of documentation that applicants were required to file to only three years of amended tax returns and six years of FBAR (Foreign Account Reporting Statements). In addition, there was no penalty on the tax amount that was due and no penalty on the value of income generating foreign real estate that was not previously disclosed. Moreover, the  27.5% penalty was reduced down to 5%, or completely waived if the foreign residence requirements were met.

Penalty Waiver: there is a small facet of the modified streamlined program called the Modified Foreign Offshore Program.  If a person qualifies for the modified stream of program (which means they acted non willfully) and they can prove they lived overseas for a total of 330 days out of the tax year in any year within the last three years, then they may qualify to have the penalty waived.

The Streamlined Programs sounds great, right? Well it is, unless you are attempting to wrongfully evade the 27.5% penalty by entering the program when you knew you were willful.

                                       

What if you are caught trying to sneak into the Streamlined Program?

I cannot stress to you enough to not try and enter the Streamlined Program if you were willful. If you knowingly enter the streamlined program and it is found that you acted willfully in your failure to disclose and report your overseas and foreign assets and income you will most likely be prosecuted by the IRS.

The IRS made this fact known in a recent public relations statement. From the IRS’ perspective, if you wrongfully enter this program in order to avoid paying the full penalty amount what you have done is stolen 27.5% or 50% of the penalty amount due to the IRS – and this does not make the IRS very happy.

Even worse is that you may be subject to criminal prosecution. And, since you have already disclosed all the foreign financial information in your Streamlined Program application, you will be in a tough position to try and defend yourself

                                        

Why is the Modified Streamlined program in Jeopardy?

Just like in everything in life, a few bad apples spoil the whole bunch. The IRS has learned that several individuals who were willful in their failure to report undisclosed foreign tax and bank information have been caught trying to sneak into the modified streamlined program in order to pay a reduced penalty – or avoid the penalty altogether  This contradicts the IRS’ intention which was to modify and expand the Streamlined Offshore Disclosure Program to assist taxpayers who otherwise would be overburdened by having to enter the OVDP and opt out of the penalty structure.

                                       

There is No Reason to be Scared of the OVDP or the Streamlined Programs

The goal of this article is not to scare you. Rather, it is to warn you to just be cautious if you are entering into these programs. Way too many inexperienced and unscrupulous attorneys, CPAs and enrolled agents see these programs as a way to scare individuals.

                                     

If You are going to enter a Foreign Disclosure Program, use an Attorney

While CPAs and enrolled agents (who are not also attorneys) may charge less than an attorney is important to note that you do not have an attorney client privilege with CPAs and enrolled agents. What that means, is that if it turns out you wrongfully entered the streamlined program and the IRS wants to speak with your representative, unless your representative is an attorney, there is no privilege between a CPA and Taxpayer when a Criminal Matter is at issue. 

Here is a link to recent article we authored “OVDP – Frequently Asked QuestionsorStreamlined Program – Frequently Asked Questions”