In February 2011, the IRS announced a second voluntary disclosure program for taxpayers with unreported foreign assets. It is called the 2011 Offshore Voluntary Disclosure Initiative – OVDI. The objective is to bring taxpayers who have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with U. S. tax laws.
In announcing the 2011 OVDI, IRS Commissioner Douglas H. Shulman stated, "The situation will just get worse in the months ahead for those hiding assets and income offshore. The new disclosure program is the last, best chance for people to get back into the system. It gives people a chance to come in before we find them."
In 2009 the IRS offered a similar amnesty program for taxpayers not reporting income from foreign accounts. That program brought in 15,000 disclosures prior to its October 15, 2009 deadline.
It is not illegal to have a foreign account. What is illegal is 1) failing to disclose the accounts and 2) failing to report the income and pay income tax on income earned on the foreign assets. In addition to disclosing the existence of the accounts on your 1040 and reporting the income, Foreign Bank Account Reports ("FBARs") must be filed by any U.S. taxpayer who has signatory or other authority over a foreign account or accounts that have a combined value of more than $10,000 at any time during the calendar year.
In order to participate in the new 2011 OVDI, taxpayers must resolve any non-compliance within an eight year period, from 2003-2010. The deadline is August 31, 2011.
Taxpayers will have to pay: 1) income tax deficiencies during the eight year period; 2) interest on the deficiencies; 3) a 25% penalty on the highest aggregate balance held within foreign accounts during the eight year period; 4) accuracy-related penalties of 20% of the back taxes; and 5) if applicable, 25% of back taxes for failure to timely file a return or pay tax shown on a filed return.
For smaller holdings of not more than $75,000, the penalty will be reduced to 12.5%. The rate could be reduced to 5% if the taxpayer did not know he or she was a U.S. citizen (mostly children born in the U.S. to foreign parents and now living in the foreign jurisdiction) or if the account was inherited.
Taxpayers who participate in the OVDI will generally avoid 1) criminal prosecution; 2) civil and criminal penalties for failure to file a Report of Foreign Bank and Financial Accounts (FBARs); and 3) any taxes, interest, and penalties prior to 2003. The IRS policy on voluntary disclosures is that when a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.
If the IRS has initiated an examination, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities, the taxpayer will not be eligible to participate in the 2011 OVDI. Taxpayers under criminal investigation are also ineligible. Disclosures involving illegal source income will not be accepted.
Some taxpayers have attempted so-called ‘quiet’ disclosures by filing amended returns and paying additional taxes and interest. The IRS is currently reviewing amended returns that show an increase in income and selecting returns for audit. Individuals who are singled out for audit are not eligible to participate in the OVDI. Individuals who have filed quietly and have not yet been audited may make an application to participate in the OVDI.
Possible criminal charges related to tax returns include tax evasion, filing a false return and failure to file an income tax return. Willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties.
A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000. Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.
Warning for Tax Professionals:
It is the IRS position that it is a violation of Circular 230 to represent a taxpayer on a prospective basis if such taxpayer has noncompliance that the taxpayer elects not to resolve through a voluntary disclosure: "[a] practitioner whose client declines to make full disclosure of the existence of, or any taxable income from, a foreign financial account, may not prepare a current or future income tax return for that taxpayer without being in violation of Circular 230."