Upon closure of the 2011 OVDI, speculation had abounded amongst tax practitioners as to whether the IRS would institute another defined disclosure program similar to OVDI, and if so when.
I was convinced a new OVDI type program (with adjusted qualification and penalty structures) would not be announced until sometime in 2013. Somewhat surprisingly, on January 9, 2012, the IRS announced in IR-2012-5 that it has reopened the OVDI, with certain important modifications noted below. This is a very welcome development. As such, this article reviews the newly reopened OVDI and its important changes, and discusses the relative benefits and risks taxpayers should be aware of as they consider the merits of which compliance option they choose to pursue.
The IRS has been increasing its enforcement efforts against U.S. taxpayers with undeclared offshore accounts for many years now with varying levels of success. In the past year alone we have seen the following significant developments in this area:
• Over 30,000 people filed to participate in either the 2009 OVDP or the 2011 OVDI, resulting in $3.4B in taxes and penalties collected from the 95% of 2009 OVDP cases that have been closed to date, and $1B in up-front payments of tax and penalties required from the 2011 OVDI filers;
• Five South Asians were indicted by federal grand juries for not reporting assets and income held at HSBC India or other HSBC international branches;
• HSBC India received a federal subpoena against it to turn over names and information of its U.S. accountholders to the IRS;
• Credit Suisse concluded its settlement negotiations with the IRS to end its criminal investigation, and may have already disclosed names and information regarding its U.S. accountholders by the time this is published;
• Eleven other private banks, mostly in Switzerland and Israel, are being investigated by the IRS, and likely will have to disclose their respective lists of U.S. accountholders.
Noisy Disclosure and Reopened OVDI
The IRS has always had a voluntary disclosure program available to taxpayers making a timely, truthful, and complete disclosure of their non-compliance before being audited by the IRS, a so-called “noisy disclosure.” The various OVDI programs have been a subset of this larger voluntary disclosure program where taxpayers can assure themselves of certainty of outcome based on the fixed civil penalty structures, in exchange for not being able to make any type of reasonable cause argument against imposition of penalties. This is in contrast to the regular voluntary disclosure program which has no fixed penalties and where reasonable cause can be asserted by the taxpayer as a defense. Accordingly, whether a taxpayer entered the OVDI program or not depended on whether the taxpayer was in danger of being classified a willful non-filer, or had credible reasonable cause arguments, or fell in the large gray zone somewhere in between.
For those taxpayers at substantial risk of being treated as a willful non-filer by the IRS, the OVDI fixed civil penalties, generally, are substantially lower than the potential maximum willful penalties.
Therefore, filing under the OVDI generally should be a good deal for such taxpayers. For those few taxpayers, however, who have credible and strong reasonable cause arguments to avoid penalties completely, the fixed penalties of the OVDI program generally do not appear to be an attractive option.
For the vast majority of taxpayers who fall somewhere in between (i.e., clearly not a willful non-filer, but also no credible reasonable cause arguments), the decision becomes a difficult one of number-crunching and comparing all possible outcomes, followed by risk tolerance and risk aversion-based choices from amongst those possible outcomes in deciding which course to follow.
The decision making process for the many taxpayers in this gray zone is made even more difficult by the fact that the IRS has the natural leverage in this situation. Further, many commentators, and even the National Taxpayer Advocate, have noted the unfair manner in which the IRS has enhanced its bargaining asymmetry by providing empty promises in FAQ 35 and the opt-out procedures. FAQ 35 states a taxpayer would not pay more penalties under the OVDI than he or she would under existing statutes. The opt-out procedures for the OVDI states taxpayers who choose to opt-out because they are unhappy with the 25% penalty will not be treated in a negative fashion for opting-out. Many practitioners, however, have reported quite the opposite; that, IRS agents have been threatening taxpayers who indicate they may opt-out that doing so would result in a long and painful complete examination and that contrary to FAQ 35, the maximum penalties would be asserted against them rather than applying existing guidelines under the Internal Revenue Manual for applying existing statutes which, in most cases would suggest a warning letter or a penalty less than the maximum allowable.
In other words, it appears the IRS has been treating all non-willful filers as willful, or at the least, threatening to treat them as such despite the strong likelihood the IRS would not be able to prove willfulness in most cases. Given this current posture from the IRS, it is unreasonable to expect taxpayers to assume the huge risk of massive penalties that could result from rolling the dice by opting-out, and for practitioners to advise their clients to do so. Accordingly, many taxpayers in the gray zone who likely could do better under existing statutes (if fairly applied by the IRS) are pressured into staying in the OVDI and paying the 25% penalty.
While there was no fixed penalty OVDI program open, most practitioners believed many taxpayers wishing to disclose would try to utilize the open-ended nature of the general voluntary disclosure program to assert credible, perhaps even aggressive, reasonable cause arguments and try to settle their cases for less than the OVDI program fixed penalties. On the other hand, many taxpayers are wary of an open-ended voluntary disclosure and prefer the certainty offered by the OVDI program. With the reopening of the OVDI program, one thing is now certain: any noisy disclosure involving offshore accounts will be herded into the OVDI program under the fixed civil penalty structure with no ability to make reasonable cause arguments. In other words, an open-ended regular voluntary disclosure of offshore assets does not appear possible while the OVDI program is open.
Many practitioners believe the OVDI program was reopened to allow the thousands of taxpayers soon to be disclosed by Credit Suisse (and the eleven other banks currently under investigation) an opportunity to apply for the OVDI program before their names are disclosed by such banks. The reopened program is, generally, very similar to the 2011 OVDI but with two major differences. As with the 2011 OVDI, taxpayers will have to file eight years of tax returns and information returns and pay all taxes, interest and a 20% accuracy penalty on omitted income (plus late filing and late payment penalties if applicable). The first major difference is that the offshore penalty on the taxpayer’s highest aggregate balance of offshore accounts is now 27.5% instead of 25% in the 2011 OVDI and 20% in the 2009 OVDP. Under the reopened OVDI, taxpayers may still qualify for a lower offshore penalty rate of 12.5% for aggregate balances under $75,000, or 5% for certain inherited accounts, and for qualifying bona fide foreign residents or dual-citizens.
The second major difference from the 2011 OVDI program is the reopened program is open indefinitely. As such, currently, there is no deadline for a taxpayer to make their full submission; however, the IRS has stated that it may end the program at any time in the future and/or may change the terms and conditions of this reopened OVDI at any time. In other words, while there is no deadline (many complained the short timeline for submitting under the 2011 OVDI was a major problem), there is still urgency and incentive for taxpayers wishing to comply to do so as quickly as possible since the program could close at any time or the 27.5% offshore penalty could be increased at any time, perhaps even without notice or forewarning from the IRS.
The IRS continues to focus efforts on auditing silent disclosures, disclosures outside the formalities of the regular voluntary disclosure program where taxpayers simply file and mail in prior year returns and hope nothing happens; or, at least the IRS says so. The IRS has attempted to create a lot of media messages to discourage taxpayers from doing silent disclosures and force everyone into a noisy disclosure by appearing to be highly aggressive in auditing silent disclosures. Given the limited enforcement resources available to the IRS, I question whether this is a lot of sound and fury from the IRS, and whether its bark is bigger than its bite in this particular area. Taxpayers must be clearly aware, the IRS is getting more aggressive in auditing silent disclosures of offshore accounts and, therefore, this option remains highly risky and is not advisable for most taxpayers. I continue to believe, however, that a silent disclosure could be a preferred option for some taxpayers, depending on their specific circumstances, and that the IRS will never be able to succeed in forcing all taxpayers into a noisy disclosure, which is their stated goal.
The newly reopened OVDI program may offer an opportunity to those taxpayers who continue to be non-compliant with respect to reporting their offshore accounts, assets and income. Whether this noncompliance is due to recalcitrance, or simply just now learning of the filing requirements and the OVDI program, should make a major difference in how taxpayers are treated under existing statutes, but appears to be irrelevant to the IRS in its application of the OVDI program. For many, the OVDI program could be the best option available after considering all factors and potential scenarios. Taxpayers who continue their non-compliance, are slowly running out of time—the IRS is very serious about finding taxpayers with undeclared offshore assets, and has increasing tools available to find such non-compliant taxpayers.
Taxpayers who do have credible and strong reasonable cause arguments, however, may wish to question whether entering the OVDI program, at least as currently being administered by the IRS, is the right course of action. Those taxpayers at high risk of being found to be a willful non-filer who think they can escape completely by starting to disclose going forward (or closing all offshore accounts now) and hoping the standard six year statute of limitations expires before they get audited, are definitely exposing themselves to tremendous risk. With the new FATCA reporting rules now in force on taxpayers (and soon to be in force on foreign financial institutions), and given the IRS’ increased focus on this area in general, this approach likely will encounter a high failure rate. Further, the possibility of the IRS charging such taxpayers with civil fraud for actively taking steps to further conceal their non-compliance is highly likely. In that case, such taxpayers could be audited at any time in the future because no statute of limitations applies for cases of civil fraud, and the possibility of a criminal tax evasion charge would be very high as well.
Accordingly, given the high stakes involved, readers seeking to determine whether it is advisable for them to seek qualification under the OVDI program or attempt a silent disclosure, or otherwise, should immediately consult their tax advisor for an evaluation and advice on the best way forward.
The foregoing is not tax or legal advice and should not be relied upon as such. No attorney-client relationship is created or implied with any reader of this article. All taxpayers should seek independent advice from a qualified tax professional based on their individual circumstances.
Rahul P. Ranadive is admitted to the Florida and California bars and the U.S. Tax Court, and has practiced international and domestic tax planning focusing on high net-worth families with international ties for over ten years. He is based in Miami, Florida and can be reached at firstname.lastname@example.org or 305-913-7128 or by visiting www.gtecllp.com.