International Tax Compliance After the End of the Offshore Voluntary Disclosure Program
For the last several years, retroactive offshore disclosures have been the method of the IRS’ efforts to ensure that US taxpayers were reporting their foreign assets and foreign income. Curative programs for prior reporting failures have been seen as appropriate given the IRS’ past lack of emphasis on international requirements. The most expansive disclosure program is the offshore voluntary disclosure program (“OVDP”).
The IRS’ recent focus in the international area and time establishing reporting under the Foreign Account Tax Compliance Act (“FATCA”) has presumably made retroactive disclosure programs less appropriate. There has been an increased emphasis on international reporting in the recent years. As the world becomes more global, the reporting requirements apply to a far greater scope and variety of individuals. The IRS announced that the OVDP will close on September 28, 2018.
Alternative disclosure options will exist after the closing of the OVDP, however, these options will have a narrower focus. Many taxpayers will be left with less than great options for disclosures. Taxpayers who cannot comfortably certify non-willfulness, which is an increasing proportion of the noncompliant taxpayers, will be affected. Practitioners expect the IRS’ future approach in the international compliance area will shift from disclosures to assessments.
The OVDP has been a key disclosure method for taxpayers who could not certify non-willfulness in the nondisclosure of their foreign assets and foreign income. In lieu of the penalties that were otherwise assessed for failure to report foreign assets, the taxpayers in the OVDP pay a 20 percent accuracy related penalty (and pay failure-to-file and failure-to-pay penalties where applicable). The disclosing taxpayer also agreed to pay the miscellaneous Title 26 offshore penalty, a one-time penalty that was 27.5 percent or 50 percent of the highest value for foreign income-generating assets during the eight-year disclosure period. The OVDP process is lengthy but offers taxpayers in this position certain assurances: (1) participating taxpayers would not be recommended to face criminal penalties, and (2) a closing letter upon completion of the OVDP indicating that all prior failures to properly report foreign assets have been resolved.
On March 13, 2018, the IRS issued IR-2018-52 providing its intention to close the OVDP effective as of September 28, 2018. If a taxpayer has unreported foreign assets or income, they should review their options quickly before the OVDP is no longer an option. The release stated that part of the IRS’ rationale was based on advances in third party reporting. Two primary mechanisms provide for these advances: (1) FATCA, which essentially requires foreign financial institutions to disclose specific foreign assets held by US taxpayers and (2) settlements between the IRS and foreign financial institutions who agree to turn over US account owner information. These two methods allow the IRS to more easily access information on overseas assets of US taxpayers. This reduces the IRS reliance for taxpayers to voluntarily disclose their foreign assets and income.
Alternative Disclosure Options
Even with the OVDP’s end, there are other options for offshore disclosures depending on the circumstances. The delinquent FBAR submission procedures and the delinquent international information return procedures are appropriate for taxpayers whose failure to report foreign assets do not create reportable income or additional taxes due. These two procedures have a narrow application, if there is additional tax due connected to undisclosed foreign assets, then these procedures are not available. The most expansive remaining program is the streamlined filing compliance procedures (“SFCP”). There are two versions of the SFCP, one for taxpayers residing in the US and the other for taxpayers residing outside the US.
Under the SFCP for taxpayers residing in the US, a five percent penalty is imposed on the highest end of year balance of a taxpayer’s foreign assets subject to penalty over the six year covered period, along with tax and interest on tax amounts. Under the SFCP for taxpayers residing outside the US, there is no base penalty on foreign assets; the taxpayer pays the additional tax and interest on tax due. Under the SFCP there is no accuracy related penalties. As compared with the OVDP, the SFCP has fewer submission obligations, but receives fewer assurances: the taxpayer will receive no closing letter from the IRS or any type of statement from the IRS.
The SFCP requires that a taxpayer’s prior failure to file FBARs or include income from foreign assets on their tax returns were non-willful. The non-willfulness standard must apply to all aspects of the prior reporting failures. If the failure to report the assets was non-willful, but the failure to report the income connected with the foreign assets was willful, the taxpayer will not qualify to file under the SFCP.
The IRS defines non-willful as conduct:
Due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law (Internal Revenue Manual section 188.8.131.52.5.3).
Determinations of willfulness are made at the IRS’ discretion, based primarily on a statement with relevant facts submitted with the taxpayer’s SFCP certification. If a submission is denied based on a failure to meet the non-willfulness standard, the taxpayer is subject to all applicable penalties.
As awareness of international reporting requirements increase, the ability for a taxpayer to certify and for the IRS to accept non-willfulness decreases. Prior to the IRS increasing its efforts to educate taxpayers on international reporting, it was easier for taxpayers to claim ignorance of the requirements.
In IR-2018-52 the IRS mentions that the voluntary disclosure program maintained by the IRS criminal division will remain open after the end of the OVDP. There are fewer assurances offered through this program as compared to the OVDP.
Assessments for FBAR Failures
The IRS is now more able to identify unreported foreign assets and unreported foreign income. However, the FBAR penalties are generally the highest and allows the IRS huge discretion in assessing penalties.
The IRS has the authority to enforce civil FBAR matters. This authority generally does not extend to the collection of assessed penalties. Assessable FBAR penalties depend on whether the failure is determined to be willful or non-willful. There is a six-year statute of limitations for failure to file FBARs.
For non-willful failure to file FBARs, the IRS can assess penalties up to $10,000 per account per year. Taxpayers who hold numerous accounts overseas, especially taxpayers residing overseas, can face significant penalties regardless of the accounts aggregate value. However, the Internal Revenue Manual (“IRM”), incorporating SBSE-04-0515-0025 (IRS Memorandum), generally limits the assessment to one non-willful penalty per open year, with the penalty not to exceed $10,000. The IRM provides that in no case should the non-willful penalty exceed 50 percent of the highest aggregated balance of all accounts to which the violations relate during the years at issue.
For willful FBAR violations, the penalties permissible are an annual penalty of the greater of $100,000 or 50 percent of the amount of the balance of unreported accounts at the time of the violation, for each year a failure occurs. The IRS typically will limit the penalty amount for all years to no more than 50 percent of the highest aggregated account balance, and the IRM provides that in no case should the penalty exceed 100 percent of the highest balance.
The IRM provides the examiners with discretion in imposing the penalties, so the examiner can impose lower penalties when appropriate. The IRM provides that the examiner should ensure that the amount of the penalty is commensurate to the harm caused by the FBAR violation.
The penalties for willful violation of the FBAR are significantly higher than non-willfulness. It is therefore important to understand what constitutes a willful violation. Willfulness for FBAR violations mirrors the willfulness concept under criminal tax law: a voluntary, intentional violation of a known legal duty. The IRM provides that willfulness for FBAR filing is:
Willfulness is shown by the person’s knowledge of the reporting requirements and the person’s conscious choice not to comply with the requirements. In the FBAR situation, the person only need to know that a reporting requirement exists. If a person has that knowledge, the only intent needed to constitute a willful violation is a conscious choice not to file the FBAR.
Willful blindness is when a taxpayer makes a conscious effort to avoid learning of the FBAR requirements, which also constitutes willfulness for these purposes.
Enforcement of FBAR Assessments
The FBAR penalties are enforced under Title 31 rather than Title 26 (Internal Revenue Code) of the United States Code, which is significant in the collection context. FBAR penalties are debts owed to the US government and the standards for the collection of FBAR penalties are provided by regulations under Title 31.
For FBAR penalties, notice of penalties are sent prior to collection activities. Installment options for payment are available, and the debts can be deemed uncollectible. When a taxpayer has debts with a principal balance exceeding $100,000, the Justice Department must approve any compromise or a suspension or termination of collection activity.
FBAR penalties are enforced through government offsets and the commencement of civil actions to collect assessed penalties. The government’s collection options through offset include: (1) administrative offset, (2) tax refund offset, (3) federal salary offset, (4) referral to private collection, (5) referral to agencies operating a debt collection center, (6) reporting delinquencies to credit reporting bureaus, (7) garnishing wages of delinquent debtors, and (8) litigation or foreclosure. There are no limitation periods for offsets.
For civil actions, delinquent debts are referred to the Justice Department after aggressive collection activity has been taken and when compromise of the penalties is not appropriate. Any action to enforce FBAR penalties must be filed within two years, with the applicable period typically beginning on the date of penalty assessment. If a law suit is filed and an enforceable judgment results, collection options increase for the government.
The collection mechanisms for FBAR penalties are different than for tax penalties under Title 26. FBAR penalties are not classified as tax penalties. Therefore, a multitude of options that are available without court approval for tax penalties (such as liens and levies) are unavailable, at least until there is an enforceable judgment (court action required). These differences are important in advising taxpayers of collection options available to the government and in ensuring the government actions do not overstep their authority.
With the closing of the OVDP on September 28, 2018, it is important that anyone who needs the assurances offered through the OVDP act now, otherwise their penalty, both civil and criminal, will be less certain. For taxpayers who do not need the OVDP but have undisclosed foreign assets or income, should also move quickly to file under the proper procedure before the IRS, through third party reporting, is alerted to the undisclosed foreign accounts and foreign income. There are recent reports that the IRS will be focusing on how to more effectively use the information obtained through FATCA and other third party reporting to target taxpayers with unreported foreign accounts. The FBAR penalties are significant even for non-willful violations.
For taxpayers subject to FBAR penalties, there is an expectation that collection efforts will be aggressive given the prior opportunity to come clean through the OVDP and other procedures. When these collection efforts occur, the taxpayer will need experienced counsel to ensure all feasible options to challenge the assessments. Of course, the better option is for taxpayers to use the appropriate procedure to become compliant with their reporting obligations prior to an FBAR assessment.« Which Asset Protection Strategies Are Right for Your Clients? How You Can Keep Claims From Threatening Their Property Taking Full Advantage of the 2017 Tax Cuts and Jobs Act Key Points to Discuss With Your Clients »