The IRS recently announced the reopening of its successful Offshore Voluntary Disclosure Program (OVDP) effective January 9, 2012. The IRS also announced that its two prior foreign bank account disclosure initiatives, in 2009 and 2011, have brought in more than $4.4 billion in additional tax collections to-date and that over 33,000 people participated in these programs.
Under the initial 2009 OVDP, taxpayers were required to come forward and file tax returns or amended returns identifying all foreign bank accounts and income going back six years. Back taxes and interest were due for this six-year period, together with a 20% accuracy-related or delinquency penalty. An additional report, the Foreign Bank Account Report of Foreign Bank and Financial Accounts (FBAR), was required to be filed for the six-year period and a related penalty of 20% of the highest foreign account value during the six-year period was also due. The 20% FBAR penalty could be reduced to 5% but in very limited circumstances, such as where the taxpayer himself did not open the foreign account, there was no banking activity in the account and all applicable U.S. taxes had been paid on the funds in the account.
The 2009 ODVP ran from March 23, 2009 through October 15, 2009. Due to the success of the 2009 OVDP, the IRS announced a second OVDP program, applicable from February 8, 2011 to September 9, 2011 (the 2011 OVDP), but with less favorable terms to taxpayers. Under the 2011 OVDP, returns or amended returns for an eight-year period, 2003 – 2010, must be filed reporting all offshore bank account income and the related taxes and interest must be paid; however, if the income relates to a period less than eight years than only returns for such periods must be filed. The taxpayer also must file or amend all FBARs for the same period. A 20% accuracy-related or delinquency penalty is to be assessed on all years. Finally, instead of all other penalties that may apply, including FBAR and information return penalties, a 25% “offshore penalty” was due based on the highest aggregate account/asset value. The 25% “offshore penalty” could be reduced to 12.5% if the taxpayer’s highest aggregate account balance in each of the years covered by the 2011 OVDP was less than $75,000. The 25% offshore penalty may also be reduced to 5% for inherited accounts where the taxpayer: (a) did not open or cause the account to be opened (unless a new account had to be opened upon the death of the owner of the account); (b) exercised minimal, infrequent contact with the account (e.g., to request the account balance); (c) except for a withdrawal closing the account and transferring the funds to a U.S. account, did not withdraw more than $1,000 from the account in any year covered by the voluntary disclosure (2003-2010); and (d) the taxpayer can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. tax). For funds deposited before Jan. 1, 1991, if no information is available to establish whether such funds were appropriately taxed, the IRS gave the taxpayer the benefit and presume that they were. The penalty is also reduced to 5% for taxpayers who are foreign residents and who were unaware that they were U.S. citizens, such as a child of foreign parents born in the U.S. but raised abroad.
The terms of the new 2012 OVDP are similar to the 2011 OVDP. Unlike the 2009 and 2011 programs, the 2012 OVDP has no set expiration date. The IRS does caution, however, that it could change or end the new program at any time.
Under the 2012 ODVP, taxpayers must file returns and pay back taxes for up to eight years, and pay a 20% accuracy-related or delinquency penalty. The FBAR or “offshore penalty” has been increased to 27.5% of the highest foreign account balance, but, as with the 2011 ODVP, may be reduced to 12.5% and 5% in certain instances.
Under the 2012 ODVP, the IRS does now make clear that a taxpayer does not have to participate in the program but may opt out and be subject to the regular examination process. If a taxpayer believes that the proposed penalties under the 2012 ODVP are disproportionate to the taxpayer’s conduct, opting out and being subject to the regular civil audit process may be more beneficial. On the other hand, the taxpayer must be prepared to face a full civil audit, with all areas of inquiry potentially open.
After the conclusion of the 2011 OVDP in September 2011, there was uncertainty among taxpayers whether there would be another OVDP program or whether a taxpayer’s only remaining option to get back into the system was to disclose and risk a full audit and potential criminal prosecution. The announcement of the 2012 OVDP is welcome news for these taxpayers. While the upper-level penalty for participating is now higher (2.5% higher on account balances as compared to the 2011 program), successful participation in the program provides freedom from criminal prosecution and the knowledge of a certain tax result. While the 2012 OVDP does not have a set expiration date, the IRS could announce changes to the program, such as a further increase in the penalty rate, or the termination of the program at any time. Individuals with foreign income or accounts who sat on the fence in 2009-2011 should strongly consider participating in what could now be their best offer from the government. The IRS has increased its criminal investigations and civil audits of foreign banking activity, and being identified before electing to participate in the 2012 OVDP risks more taxes for a greater period of years going back, much more extensive FBAR and civil fraud penalties and, of course, criminal prosecution and prison.