- 1 Understanding OVDP
- 2 Entering OVDP Does Not Make You Criminal
- 3 You Cannot Be “A Little Willful”
- 4 You Are Not Entering a Plea Deal
- 5 You Can Disclose Domestic Income As Well
- 6 The Income Must be Legally Sourced Money
- 7 Additional Information About OVDP
- 8 OVDP Basics
- 9 Preclearance Letter
- 10 Penalties
- 11 Closing Letter (906 Letter)
- 12 Opt-Out
- 13 OVDP and IRS Offshore Voluntary Disclosure
OVDP and the IRS Streamlined Filing Compliance Procedures are the two primary areas of law we concentrate on at Golding & Golding.
We have found that one of the major concerns individuals have when considering entering OVDP is simply understanding the OVDP process. Key questions we receive are:
– What the OVDP process is;
– Whether OVDP is the proper program for them to enter; and
– The important steps in moving forward with the process.
As you can imagine, there is a bunch of horrible misinformation online designed to unnecessarily scare unsuspecting OVDP applicants.
Inexperienced attorneys will make you feel as if entering this program is only for criminals, and even if you were willful you should still enter the Streamlined Program — for any number of foolish reasons.
To that end, we will provide you with the key basics necessary to understanding OVDP, in order to help those of you who may be considering the program — but have received bad legal advice from other attorneys — to make an informed and rational decision.
Entering OVDP Does Not Make You Criminal
Entering OVDP does not make you a criminal. Technically, there is a “quasi-criminal” aspect to it because you are inherently acknowledging that you are “willful,” but you are not doing so in any criminal context. Rather, you are agreeing to proactively pay a penalty to resolve the matter.
In fact, there are numerous reasons why a non-willful individual would still enter traditional OVDP, such as: Mark-To-Mark Elections, or because the person is very risk averse, and the IRS refuses to provide a concrete definition/analysis of willful versus non-willful — which may leave some people a bit too queasy to enter the Streamlined Program.
You Cannot Be “A Little Willful”
There are numerous inexperienced and unethical attorneys who are actually directing willful individuals into the streamlined program to make a quick buck off of them. These clients often contact us thereafter, unsure and scared why an Attorney would actually do this.
These Attorneys tell the individuals that the risk of being audited under the streamlined program is low, or that it’s only a little bit of income, so the IRS is not interested in pursuing any action agains them; this advice is foolish at best.
Why? If you were willful then you cannot enter the streamlined program, end of story. And, even though willful vs. non-willful can be a bit of a gray area, 99% of the time you know if you were willful.
And, if you know you are willful, you cannot go streamlined.
Common Example of Willfulness — Michelle
Michelle has a CPA. The CPA sends Michelle a questionnaire/binder each year asking Michelle certain questions about her financial status. Michelle speaks English and the questionnaire/binder is in English. There are two questions in the binder regarding foreign accounts:
- Do You have any bank accounts or other accounts located outside of the United States?
- Do you have any income that is generated outside of the United States?
Michelle answers no, and continues on with the questionnaire even though she knew she had accounts located outside of the United States.
Therefore, Michelle is willful.
Any recommendation from an attorney for Michelle to enter the streamlined program is foolish at best. Any attorney who knowingly recommends Michelle to proactively misrepresent her non-willfulness to the IRS by filing under the Streamlined Program, thereby making an intentional misrepresentation to the IRS, in writing – and under penalty of perjury – should reconsider their career choices.
*If you want to learn more about this issue, you can click here for a comprehensive blog posts we prepared regarding being Willful and entering the Streamlined Program, or another article we prepared summarizing the government’s indictment against Manafort & Gates and the 3 key issues which may lead to them being found guilty.
You Are Not Entering a Plea Deal
Oftentimes, individuals let artificial fear (or the fear of the worst, even if it does not involve them based on their own set of facts) get the best of them. When a person enters into traditional OVDP, they are acknowledging that they did something wrong and they want to proactively fix it.
At the end of the process, a person signs a closing letter (906) and the matter is over – at least as to international related issues. The individual is not signing a plea deal; there is no criminal aspect to the program. In other words, a person is entering into a civil agreement with the Internal Revenue Service to pay a comprehensive penalty to make this matter go away.
They are not being indicted, nor entering into any criminal settlement agreement.
You Can Disclose Domestic Income As Well
For individuals who owe the government taxes for income earned both in the United States and abroad can enter traditional OVDP and disclose both sources of income.
There is a caveat: when it involves the international/offshore income or accounts the IRS has confirmed that as long as the person makes a full disclosure, and fully cooperates with the IRS, there would not be any audit or criminal investigation.
These rules do not apply for the domestic related income. In other words, feasibly, the IRS could still audit or examine (even formally investigate) a person regarding their domestic unreported income — even if the IRS accepts the offshore portion of the disclosure.
**If a person has only unreported domestic income, there is a separate program called the IRS Domestic Voluntary Disclosure Program.
The Income Must be Legally Sourced Money
The IRS is not going to allow itself to be used to launder money. Offshore money laundering is a key enforcement priority for the IRS. If any of the money is illegally sourced, you may want to reconsider entering traditional OVDP.
The OVDP FAQ as provided by the IRS make it clear that the money must be “Legally Sourced.”
The idea behind OVDP is you may have some income or other gift or investment money overseas that you did not report, for one reason or another. On the other hand, if you have been partaking in illegal activities or laundering money offshore, traditional OVDP is not the proper program for you.
Additional Information About OVDP
For those of you still interested, we are also including a few key tips in common questions we received from clients who we have represented in OVDP:
Understanding how the OVDP process works is important to effectively navigating the pitfalls and landmines of the submission process.
In fact, when it comes to OVDP, one of the hardest parts about moving forward is just understanding the process itself, and being able to distinguish fiction from reality.
As such, the four most important aspects of understanding OVDP for our clients are the following:
- What is a preclearance letter?
- What are the penalties associated with OVDP?
- What is a closing letter?
- What is opting out?
In this article, we will provide a summary about the different aspects of OVDP as they relate to these four main issues.
The preclearance letter is the initial submission made on behalf of an applicant considering OVDP. While a person is not guaranteed entrance into OVDP, by submitting the preclearance letter, the IRS Criminal Investigation Department takes the opportunity to run a background check on the individual, estate or business.
What is the Purpose of the Background Check
The main purpose of the background check is to make sure that the individual is not already in tax trouble, or other trouble with the law. Even though the penalties associated with OVDP are high, relative to what could happen if a person was to get examined or indicted on criminal tax related issues involving offshore and foreign income, OVDP is a great deal.
A Preclearance Letter is not technically part of OVDP
This is a bit of a nuance. On the one hand, by submitting the preclearance letter you are opening yourself up to the IRS regarding your foreign accounts, assets, investments, etc. so that they can inspect, research and do their due diligence to determine whether you are authorized to apply.
On the other hand, technically, the preclearance letter is not part of the submission. In other words, feasibly you could submit an OVDP letter and then not move forward with submitting to the formal program, which is the the next step and involves submitting forms 14454 and 14457. Alternatively, if you were to submit the 14454 and 14457 and then discontinue the process, it would be considered a breach of the program and you can find yourself in some serious trouble.
OVDP penalties are broken down as follows:
Penalty on the Assets & Accounts
The penalties are relatively straightforward as follows:
– The applicant will categorize their submission down per year, within the 8-year compliance Period.
– For example, if a person is submitting for 2016 and already submitted their 2016 tax return incorrectly, they will need to amend for eight years-which would mean 2009 through 2016.
– Thereafter, the person will look at each year independently. For example, a person will look at year 2012 and assess which foreign accounts, specified foreign assets or income generating real estate they have for that year.
– Then, for that specific year only, and using the exchange rates for that particular year, the applicant will figure out the maximum balance of each account within that year. The applicant will then aggregate or add the maximum account balances together to calculate the annual aggregate total for that particular year.
– Next, the individual or other applicant will prepare the same analysis for each year within the compliance. Then, the applicant will take only the year that has the highest value and multiply it by one of two numbers:
Account and Asset (FBAR & FATCA) 27.5% Penalty
27.5% penalty is the general penalty amount. For example, as long as the individual was not associated, at all, with a “bad bank” or investor, the individual would multiply the highest balance by 27.5%. So David’s highest year had $500,000 of unreported accounts and assets, his penalty amount would be $137,500.
Account and Asset (FBAR & FATCA) 50% Penalty
The IRS publishes a list (updated periodically) of foreign financial facilitators, which includes individual investor “professionals” and foreign financial institutions. If any of the applicant’s money (even minimal) is invested with one of these “bad banks,” then the entire amount of unreported money (for all institutions, assets, etc.) is multiplied by 50% instead of 27.5%.
Therefore, continuing the example from above, if David had any money in one of these bad banks, and the penalty jumps to 50% for $250,000. It should be noted, that the IRS does not parse out the funds that are in that that bank and only expose those to the heightened penalties – rather, the full amount of unreported money is subject to the 50%.
Penalties on Taxes
Beyond the penalties associated with the undisclosed assets, accounts or investments — are the penalties on the taxes that are due. For example, let’s say David had $10,000 of unreported income in year 2012 and was subject to a nearly 40% tax rate.
In that year, in addition to the penalties identified above, David would also have to pay $4000 in taxes that are due, as well as a 20% penalty on the $4000, which is an $800 penalty. In addition, David also has to pay interest.
So if David has significant unreported income for each year and a compliance, David may have significant taxes, penalties, and interest amount due.
**In addition, if David did not file or pay his regular taxes (for example, David was required to but never filed a tax return for year 2012), David would also have to be subject to a possible failure to file and failure to pay penalty.
Closing Letter (906 Letter)
Typically, within one to three years from the beginning of the submission, this monstrosity comes to an end. As a result, the Internal Revenue Service will send the applicant a 906 closing letter.
By submitting a signed closing letter back to the Internal Revenue Service, the applicant has acknowledged the penalty, and agrees to everything the IRS has required from him or her in the submission.
Presumably, once the closing letter is signed, the IRS puts the matter to rest. This has many benefits for our clients who might’ve waffled between the streamlined program and OVDP, but had the following issues:
- Avoiding a criminal investigation
- Avoiding further audits or examinations on these international related issues
- Usually avoiding a future audit on tax matters involving the same unreported money for years prior to the year compliance period.
- IRS Acceptance of the Mark-to-Market election
- Much smaller likelihood that the IRS will contact any other foreign countries in which the taxpayer may have also failed to pay tax.
In other words, for all intents and purposes — the matter is over.
For some people, the chances of going streamlined and being taken to task on willful versus non-willful is too much to bear. At the same time, the thought of paying a 27.5% penalty or 50% penalty solely because they were risk-averse against submitting a streamlined application when the IRS still refuses to publish a clear-cut definition of the term willful is absurd.
As a result, instead of signing the closing letter the applicant agrees to opt-out. In an opt-out situation, the applicant still maintains the opportunity to stay “protected” under the program. At the same time, the taxpayer disagrees with the penalty amount and would rather allow the Internal Revenue Service to audit him or her in order to try to get the penalty reduced.
Oftentimes, the IRS may reduce the penalty depending on the facts and circumstances presented by the taxpayer. But, it has to be noted and considered that the IRS can also increase the penalty.
Nevertheless, the mere fact that the IRS may issue higher penalties (which is not common when the facts support the taxpayer’s opt out position) should not be enough to dissuade the taxpayer from an opt out when they firmly believe they can achieve a better result.
Even the IRS has published memoranda wherein the IRS provides that for some individuals the penalties are absolutely lopsided and and opt-out should not be held negatively against taxpayer.
OVDP and IRS Offshore Voluntary Disclosure
We hope this helped summarize the more pressing questions we get from new clients.
Please feel free to visit our International Tax Library to research other topics we have written about.
In addition, if you’d like to read a more comprehensive summary regarding the different programs you may find our IRS offshore voluntary disclosure program options summary helpful to you.