The IRS has had an Offshore Voluntary Disclosure Initiative (OVDI) now for approximately seven years. What began as a temporary OVDI program is now indefinite until further notice. However, seven years later, taxpayers have more options to choose when deciding the best method to disclose their foreign activities.
Traditional OVDI Program – 27.5% penalty or greater
Under this program, the taxpayer is eligible to make an OVDI if he/she is not currently under audit, the money in the foreign account or asset was earned legally, and the IRS does not already know about the taxpayer’s foreign account or assets. The wild card is whether the IRS already knows about the taxpayer. This can be confirmed in advance by doing a pre-clearance request with the IRS OVDI centralized office.
[This article is course content for the Tax Season 2016 CPE quiz, worth 3 CPE credits! Reach the quiz and additional content HERE.]
Once accepted to this program, the IRS will provide the taxpayer a letter stating that it is their policy to not recommend criminal proceedings as long as the taxpayer remains truthful and transparent during the OVDI process. The IRS does not (and cannot) grant immunity, but it is their policy not to seek criminal charges in an OVDI.
Once the taxpayer is accepted to the OVDI, the taxpayer must prepare and file eight years of amended (or original) income tax returns and the same amount of Forms 114a (FBARs) to report the income and the bank account, respectively. The taxpayer will be required to pay the tax, a 20% penalty on the tax, and interest.
The taxpayer will also be required to pay a minimum 27.5% penalty on the highest value of the account over the eight-year period, but it could be 50% if the bank is a “listed bank.” The IRS has a list of banks that have cooperated to such an extent that the value of the taxpayer’s OVDI is not as great and, in turn, it penalizes the taxpayer and requires her to pay a 50% penalty.
IRS OVDI Streamlined Program
Beginning in the summer of 2014, the IRS introduced the Streamlined Program. This program is designed for non-willful taxpayers. That is, taxpayers who did not intentionally fail to report the existence of the foreign asset or its income. Under this program, a taxpayer must submit three years of amended income tax returns (or original income tax returns for non-residents) and six years of Form 114a (FBARs).
A taxpayer that resides in the United States must pay the tax, a 20% penalty on the tax, and interest. This taxpayer must also sign a statement under penalties of perjury and pay a 5% penalty on the highest year-end value of the foreign bank account.
A taxpayer that does not reside in the United States must pay the tax and interest only. This taxpayer is also required to sign a statement under penalties of perjury that she did not intentionally fail to report the income and the assets.
This program is a relief for those non-compliant taxpayers that are able to sign the required statement under penalties of perjury.
Quiet Disclosure
A taxpayer that does not want to participate in the above programs, but desires to come into compliance, may do what practitioners call a “quiet disclosure.” This type of disclosure is where the taxpayer prepares a certain number of amended income tax returns or original returns, and a certain number of FBARs and simply files the materials in the ordinary course.
This type of disclosure may still qualify as a voluntary disclosure under the IRS’s Internal Revenue Manual and provide the same level of criminal protection as any other choice listed above, but the unknown is the penalties. If a taxpayer is selected for examination or civil audit, there are many penalties that may apply.
The IRS Agent has great discretion in the assertion of penalties. There is a penalty ceiling but no minimum amount. The examiner may determine that the facts and circumstances of a particular case do not justify a penalty. If there was an FBAR violation but no penalty is appropriate, the examiner will issue the FBAR warning letter, Letter 3800.
However, when a penalty is appropriate, the IRS has established penalty mitigation guidelines so that the penalties determined through the examiner’s discretion are uniform. The examiner may determine that a penalty under these guidelines is not appropriate, or a lesser amount than the guidelines would otherwise provide is appropriate.
To qualify for mitigation, the person must meet four criteria including:
1. The person has no history of criminal tax or Bank Security Act (BSA) convictions for the preceding ten years and has no history of prior FBAR penalty assessments.
2. No money passing through any of the foreign accounts associated with the person was from an illegal source or used to further a criminal purpose;
3. The person cooperated during the examination; and,
4. IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in a foreign account.
The following is a chart from the IRS’s Internal Revenue Manual:
Normal FBAR Penalty Mitigation Guidelines for Violations Occurring After October 22, 2004 - Per Person Per Year
| Non-Willful (NW) Penalties | |
| To Qualify for Level I-NW - Determine Aggregate Balances | If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000 at any time during the year, Level I – NW applies to all violations. Determine the maximum balance at any time during the calendar year for each account. Add the individual maximum balances to find the maximum aggregate balance. |
| Level I-NW Penalty is | $500 for each violation, not to exceed an aggregate penalty of $5,000 for all violations. |
| To Qualify for Level II-NW - Determine Account Balance | If Level I-NW does not apply and if the maximum balance of the account to which the violations relate at any time during the calendar year did not exceed $250,000, Level II-NW applies to that account. |
| Level II-NW Penalty is | $5,000 for each Level II-NW account violation, not to exceed 10% of the maximum balance in the account during the year |
| To Qualify for Level III-NW | If Level I-NW does not apply and if the maximum balance of the account to which the violations relate at any time during the calendar year was more than $250,000, Level III-NW applies to that account. |
| Level III-NW is | $10,000 for each Level III-NW account violation, the statutory maximum for non-willful violations. |
| Willfulness Penalties | |
| To Qualify for Level I - Determine Aggregate Balances | If the maximum aggregate balance for all accounts to which the violations relate did not exceed $50,000, Level I applies to all accounts . Determine the maximum balance at any time during the calendar year for each account. Add the individual maximum balances to find the maximum aggregate balance. |
| Level I Penalty is | The greater of $1,000 per violation or 5% of the maximum balance during the year of the account to which the violations relate for each violation. |
| To Qualify for Level II – Determine Account Balance | If Level I does not apply and if the maximum balance of the account to which the violations relate at any time during the calendar year did not exceed $250,000, Level II applies to that account . |
| Level II Penalty is per account | The greater of $5,000 per violation or 10% of the maximum balance during the calendar year for each Level II account. |
| To Qualify for Level III | If the maximum balance of the account to which the violations relate at any time during the calendar year exceeded $250,000 but did not exceed $1,000,000, Level III applies to that account . |
| Level III Penalty is per account. | The greater of (a) or (b): (a) 10% of the maximum balance during the calendar year for each Level III account, or (b) 50% of the closing balance in the account as of the last day for filing the FBAR . |
| To Qualify for Level IV | If the maximum balance of the account to which the violations relate at any time during the calendar year exceeded $1 million, Level IV, the statutory maximum, applies to that account. |
| Level IV Penalty is per account the statutory maximum | The greater of (a) or (b): (a) $100,000, or (b) 50% of the closing balance in the account as of the last day for filing the FBAR. |
Adam Fayne is a partner with the law firm of Arnstein & Lehr LLP. Fayne was an attorney with the IRS Office of Chief Counsel. He may be reached at 312-876-7883 or
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