Should Everyone with Undeclared Foreign Assets Make a Voluntary Disclosure to the IRS?06/25/2017 | Asher Rubinstein, Esq.
Are there Less Costly Alternatives to a Voluntary Disclosure?
We have written extensively about the erosion of foreign banking secrecy, IRS discovery of undeclared foreign accounts, and the IRS Offshore Voluntary Disclosure Program (OVDP) to come into tax compliance before the IRS discovers the foreign assets. However, entering the OVDP means that you will pay a 27.5% penalty on the highest aggregate value of the foreign assets. We recognize that this penalty, although much less than civil and criminal tax fraud penalties, is still quite onerous. The question thus becomes: are alternatives available to come into IRS compliance, and, at the same time, to also avoid the 27.5% penalty of the OVDP?
Many tax attorneys advise their clients with undeclared foreign assets that the OVDP is their sole option. Such attorneys scare their clients by citing the many Department of Justice (DOJ) criminal prosecutions of Americans with undeclared offshore accounts, and the attorneys promote a voluntary disclosure as the only way to become compliant and avoid civil or criminal tax fraud consequences.
We do not believe that everybody with foreign assets should automatically rush to enter the OVDP and pay the high penalties. The OVDP, with its “one size fits all” 27.5% penalty, is not always the best, or only, course of action in all offshore cases.
The OVDP is usually a good idea if you have significant undeclared foreign income. It is also a very good idea if your facts might give rise to a criminal tax fraud prosecution (for example, you established a foreign trust or foundation to hide the true ownership of the foreign account, or you diverted taxable income to a foreign account).
The OVDP is also a wise choice if your facts are such that the IRS can prove that you willfully failed to report the foreign asset. If the IRS can show that you are financially sophisticated, that you controlled the investment of your foreign assets, that you made frequent deposits to or withdrawals from your foreign account, or that you knew or should have known of your disclosure obligations and you disregarded those obligations, then the OVDP will probably protect you in such circumstances. You would be well advised to pay the OVDP penalty in return for no criminal prosecution and the higher willful penalties that would apply outside the OVDP.
It is also a good idea to consider a voluntary disclosure if DOJ is actively going after your foreign bank (e.g., Credit Suisse, Bank Leumi, HSBC and many other foreign banks in Switzerland, Israel and elsewhere around the world), or you have reason to believe that the IRS or DOJ will learn of your foreign assets (e.g., if your bank is a target of a John Doe Summons or treaty request). If your facts are in line with these scenarios, you should be discussing voluntary disclosure with a tax attorney. The penalty of the OVDP will almost certainly be lower than if you do not disclose and the IRS learns of your account.
However, the OVDP may not be an appropriate avenue for everyone with foreign assets. For instance, the OVDP may not be the best course of action if:
- You had signature authority or power of attorney over a foreign account, but not beneficial ownership of the funds in the account (i.e., those funds were not yours). This is often the case when a parent adds a child to the account for convenience or inheritance purposes. In such a case, the child associated with the account can often come into IRS compliance by filing retroactive FBAR forms disclosing the power of attorney or account signature authority, without a formal voluntary disclosure and without the 27.5% OVDP penalty.
- The unreported foreign income was so low, or offset by losses, that there was no tax loss to the IRS. If there was no tax loss to the IRS, then amended tax returns may not be required. In such a case, it may be possible to file retroactive FBAR forms, and avoid a formal voluntary disclosure and the 27.5% penalty.
- The foreign assets were not non-compliant; for example, you owned foreign real estate but did not derive rental income or did not realize capital gains on the sale of the foreign assets. Again, if there was no unreported foreign income, then you may be able to avoid the OVDP and its penalty.
In cases such as these, we would examine whether a client might benefit from the Mitigation Guidelines of the Internal Revenue Manual. Assuming no offshore tax evasion, no prior FBAR or civil tax fraud penalties, and no criminal taint associated with the offshore funds, we may be able to argue for lower FBAR penalties under the Mitigation Guidelines.
While we normally advise against “quiet disclosures” (i.e., submission of amended tax returns now reporting previously unreported foreign income, along with FBAR forms, outside the OVDP), it may be possible to achieve compliance by filing retroactive FBAR and other disclosure forms, without a formal OVDP submission, and without paying the 27.5% OVDP penalty.
It must be cautioned that this course of action is very fact specific. We must address the particular facts of the client’s foreign assets, the past non-compliance, the client’s reported income, the amount of unreported foreign income and the tax loss to the IRS. Not everyone with foreign assets should avoid the OVDP, but not everyone with foreign assets should enter the OVDP. Experienced tax counsel can examine your facts, assess your risks, and discuss alternative strategies.
There are cases where people made a formal disclosure under the OVDP, and later realized that their penalty may be lower outside the OVDP. For example, a taxpayer may be able to show “reasonable cause” for not filing their FBARs. But the concept of reasonable cause - - however honest and factual - - has no relevance within the OVDP, where the 27.5% penalty is set and non-negotiable. Outside the OVDP, however, reasonable cause might lower or perhaps in some cases even negate penalties for not filing the FBARs. In such a case, we advise clients on the possible positive and negative consequences of “opting out” of the OVDP. Again, the point is that the OVDP may not be the best course of action. There may be better alternatives outside of the OVDP, depending on the particular facts of the case. In addition, outside the OVDP, the Mitigation Guidelines of the Internal Revenue Manual may apply, lowering the penalties.
We do not promote the OVDP as a “one size fits all” means to achieve tax compliance for anyone and everyone with offshore assets. We believe that consideration should be given to all possible alternatives, OVDP or otherwise.