A Current Assessment of the IRS Streamlined Offshore Procedures04/21/2016 | By: Asher Rubinstein, Esq. | Journal of Taxation and Regulation of Financial Institutions
This article will appear in the May/June 2016 issue of the Journal of Taxation and Regulation of Financial Institutions.For many years, US taxpayers with undeclared offshore assets have been able to pre-emptively disclose these assets to the IRS, pay back taxes and penalties, and avoid criminal prosecution. As long as the IRS wasn’t already aware of the foreign assets and as long as the taxpayer wasn’t already under audit or investigation, and provided that there was no criminal taint to the assets, the taxpayer’s voluntary disclosure would result in far lower penalties than if the IRS otherwise learned of the assets (such as via an audit, treaty request to a foreign country, court summons upon a foreign bank, whistleblower, report from foreign country or foreign bank, or one of the many ways the IRS could otherwise discover the foreign assets).
While such an opportunity for confession in return for lower penalties is good for both the IRS and the taxpayer, the penalty itself is no slap on the wrist: The current IRS Offshore Voluntary Disclosure Program (OVDP) assesses a penalty of 27.5% of the highest aggregate value of the offshore assets (inclusive, for example, of foreign rental properties, bank accounts and life insurance), and 50% if the accounts are at certain banks, mostly in Switzerland.
However, the IRS received criticism that the OVDP treated all taxpayers with foreign assets equally. Take, for instance, the person who immigrated to the US years ago but left behind, “back in the old country”, legitimate bank accounts dating from childhood. This person faced the same penalty as the American businessman who availed himself of a foreign tax haven jurisdiction, established “secret” numbered accounts, affirmatively diverted taxable income to these accounts and did not report the accounts and foreign income to the IRS. The same penalty would also apply to the American citizen living abroad for decades, with legitimate accounts and assets in his country of residence, who apart from US citizenship has no tax nexus to the US, and who didn’t realize that the retirement plan in his country of residence was reportable on an FBAR. In the OVDP, all three taxpayers would pay the same penalty.
The Streamlined Offshore procedures were introduced by the IRS in 2012 for those taxpayers who did not willfully hide offshore assets. Such non-willful taxpayers with more benign facts could make a Streamlined disclosure that corrected the last three tax years (rather than eight years under the OVDP) and pay a reduced penalty; if the taxpayer resides in the US, 5% of the asset value (rather than 27.5% or 50%, depending on the bank, under the OVDP), and for taxpayers who reside abroad, zero penalty.
The Streamlined procedures perhaps exhibit a sort of “gentle side” of the IRS, an IRS that took into account the criticism of tax professionals and the Taxpayer Advocate who pointed out the inequity of the OVDP not distinguishing willful from non-willful taxpayers and imposing the same high penalties on both. In response to such comments, the IRS introduced the Streamlined procedures to allow taxpayers with undeclared foreign assets to come clean and, so long as there was no willful tax fraud, come into compliance with the lowest of penalties. More egregious taxpayers, those with background facts that are more willful, can still come clean in the more formal and more expansive OVDP and avoid criminal prosecution, but would pay much more in civil penalties. The Streamlined procedures thus give a break to non-willful taxpayers. It is less onerous and less expensive than the OVDP. In practice, our experience has been that the Streamlined procedures are a “good deal” for such non-willful taxpayers because they come into compliance at a significantly reduced cost.
But, the Streamlined procedures come with a risk: if the IRS does not agree that the taxpayer is non-willful, then the Streamlined application will be rejected, the amended returns will be audited, and it will be too late to apply for the OVDP. In such a case, all potential penalties, civil and, if applicable, criminal, could apply. Examples and an analysis of indicia of willful and non-willful conduct are discussed below. Taxpayers making a Streamlined submission must include a Certification of non-willful conduct, signed under penalty of perjury. If a taxpayer’s Streamlined application is not accepted, there is no OVDP safety net, all penalties are potentially on the table, including an examination by the IRS Criminal Investigations Division and possible referral to the U.S. Department of Justice for criminal prosecution, as well as possible perjury consequences in addition to tax fraud charges. To say that the Certification is a crucial document is an understatement. A false Certification, or one that does not adequately support a claim of non-willfulness, could have tremendous negative consequences.
The Genesis of the Streamlined Offshore ProceduresAs noted, the Streamlined procedures emerged from the OVDP, and a recognition by the IRS that not all taxpayers disclosing foreign assets were culpably “willful”. The OVDP itself emerged from the IRS and DOJ’s campaign against Swiss banking secrecy. It was the success of that campaign that led to the OVDP.
In 2008, the US Department of Justice (DOJ) sued the Swiss bank UBS both criminally and civilly for encouraging and facilitating US tax fraud by US taxpayers through “secret” bank accounts in Switzerland. In 2009, UBS settled these charges by paying a large penalty ($780 million) and revealing to DOJ the identities of approximately 5,000 US taxpayers with accounts at UBS in Switzerland. This event is considered to be the beginning of the end of Swiss banking secrecy. Subsequent DOJ/IRS enforcement actions spread to Credit Suisse, Wegelin, Julius Baer, Pictet and virtually every other Swiss bank. In addition to targeting the banks themselves, DOJ has also prosecuted individual bankers, attorneys and other professionals who were deemed to be facilitators of the tax fraud. DOJ/IRS also investigated and criminally prosecuted many US taxpayers with undisclosed bank accounts in Switzerland. In the last few years, DOJ/IRS enforcement has expanded from Switzerland to non-compliant accounts in other countries, including Israel, India, Liechtenstein, Luxembourg, the Cayman Islands and other former “tax havens”.
Contemporaneous with the DOJ initiative against UBS and other Swiss banks, in 2009, the IRS offered its OVDP program through which US taxpayers with undeclared and untaxed foreign assets may make a full declaration, pay back taxes and interest, and pay lower penalties than would apply if the IRS had otherwise discovered the foreign assets. Many consider the OVDP a “win-win” for both parties: the taxpayer comes into U.S. tax compliance, makes amends for prior non-reporting, avoids criminal prosecution, caps the penalties, and now has access to the previously non-compliant funds and, if desired, may bring those funds to the US or continue offshore, henceforth compliant. The government benefits from the additional new revenue and brings new, previously hidden assets into the U.S. tax system, without having to expend resources for audits, investigations, requests to foreign governments under tax treaties, court summonses and prosecutions of taxpayers.
The 2009 OVDP became the OVDI (an “Initiative” rather than “Program”) in 2011, then the OVDP again in 2012. In 2012, the Streamlined procedures were first offered and were modified in 2014. The modifications included more permissive entry requirements that allowed greater numbers of taxpayers to pursue the Streamlined procedures. For instance, the 2012 Streamlined procedures only applied to non-resident, non-filing U.S. taxpayers with a low compliance risk and less than $1,500 of tax due. The 2014 modifications expanded eligibility to domestic taxpayers and did away with the $1,500 cap on tax due. This would be another indication of a kinder, gentler IRS offering the Streamlined procedures to more taxpayers to bring more people into compliance with lower penalties. Others might argue that further relaxing the Streamlined eligibility requirements allowed the IRS to “mop up” those taxpayers who still had unreported foreign assets despite five years of opportunity to join the OVDI or OVDP.
The Title – Streamlined “Procedures” and not a “Program” – Semantics?The IRS Offshore Voluntary Disclosure Programs (OVDP) and Offshore Voluntary Disclosure Initiative (OVDI) were formal IRS programs, formally titled as such, and governed by lengthy FAQs with many rules and examples. As the programs developed, they were centralized at an IRS office in Austin, Texas and became more systematized, routine and predictable. From Austin, the case files would be routed to an IRS revenue agent “in the field” (i.e., at some IRS office somewhere in America) who would scrutinize the OVDP documents, often request additional information, and possibly make adjustments to the income reported, tax and penalties. Taxpayers successfully concluding the OVDP or OVDI signed IRS Forms 906, a closing agreement, and the case was then closed. A closing agreement gives the taxpayer the comfort that the previously non-compliant offshore assets are now compliant. This allows many taxpayers to breathe a sigh of relief that they will not go to jail for tax fraud or lose their foreign assets to severe penalties.
In contrast, we have Streamlined “procedures”, rather than a “program” or “initiative”. This gives a suggestion, perhaps, of being less formal. And yet, the Streamlined procedures are also governed by lengthy FAQs with rules and examples. There are significant eligibility requirements to participate in the Streamlined procedures. One noteworthy qualification is that domestic taxpayers must have previously filed income tax returns for the prior three years and only amended returns are accepted in the Streamlined procedures. In other words, untimely original returns are not accepted in the Streamlined procedures for domestic residents. On the other hand, foreign residents may file late original returns in the SFOP. There are exact foreign residency requirements for participation in the SFOP.
There is less paperwork in a Streamlined submission than in an OVDP submission. Apart from three years of amended tax returns (rather than eight years in the OVDP), the Streamlined submission does not include Foreign Account or Asset Statements, nor IRS Form 872 extending the statute of limitations to assess tax, nor the Waiver of the statute of limitations to collect penalties for failing to file the FBAR, all of which are documents that are required under the OVDP. Streamlined submissions also go through the IRS office in Austin and are also reviewed by IRS revenue agents. Tax returns in a Streamlined submission may be selected for audit, while amended returns in an OVDP submission are “verified” by IRS revenue agents. There is no real distinction between audit or verification.
So is there really a distinction between Streamlined “procedures” that are themselves complex, rule-based and contain potential traps (among them, the perjury trap discussed above, and an inability to apply to the OVDP after a Streamline rejection), and the Offshore Voluntary Disclosure “Program”, or is the difference in titles merely semantics?
One very important difference between the Streamlined procedures and the OVDP is that the OVDP offers a “preclearance” while the Streamlined procedures do not. Preclearance is usually the first step in an OVDP application, and consists of the taxpayer (or his counsel) sending a fax to a specific fax number at the IRS Criminal Investigations office in Philadelphia setting forth the taxpayer’s name and identifying information and (since 2014) the name of the foreign bank(s) holding the non-compliant foreign accounts to be disclosed. Putting aside the issue of providing potentially incriminating information to the IRS, the purpose of the pre-clearance fax was for the IRS to run the information through its databases to determine whether or not the IRS was already aware of the taxpayer’s foreign assets. If the taxpayer’s preclearance fax reached the IRS prior to the IRS learning of the taxpayer’s offshore assets, the IRS would respond that the taxpayer is pre-cleared; in other words, eligible to continue in the OVDP.
There is no preclearance step in the Streamlined procedures. The Streamlined procedures require the three years of amended returns, payment, six years of FBARs and the Certification of non-willful conduct, all together, as the only submission (unless more information is later requested by the IRS). The risk in the lack of preclearance is that a taxpayer provides incriminating information to the IRS without knowing whether the IRS already has the taxpayer on its radar. However, the same risk applies in the OVDP when the taxpayer faxes his request for pre-clearance identifying the foreign bank(s), without knowing whether the IRS already has this information.
Another significant procedural difference is that in Streamlined, there is no Form 906 closing agreement. Streamlined applicants therefore do not get the official “closure” that OVDP participants get. In fact, with the Streamlined procedures, there may not even be an acknowledgment by the IRS at all. In some, but not all cases, the IRS sends a notice that a penalty was charged and the penalty corresponds to the Streamlined penalty amount, but there is no indication of acceptance, completeness or closure. The Streamlined “procedures”, at a minimum, seem to have less paperwork than the OVDP, and a greater potential for no contact from an IRS agent. For Streamlined applicants, “no news is good news”, but again, there is no closure. Such is the tradeoff for a far lower penalty.
A further tradeoff is also that the lower penalty of the Streamlined procedures carries a risk that the IRS does not accept the Certification of non-willfulness. To be risk-free, the IRS offers the OVDP with its higher penalty. This distinction in risks is unrelated to titles. The titles, whether “Program”, “Initiative” or “Procedures” are essentially meaningless.
The Big Question: Was the Taxpayer Willful?Willful non-compliance is the voluntary, intentional violation of a known legal duty. In simple terms, it means “I know I have to report my foreign account, but I am not going to.” However, since it is unlikely that the IRS would obtain such a confession from a U.S. taxpayer, the IRS will look at the taxpayer’s actions in assessing willfulness.
On the other hand, the IRS defines non-willful conduct as: “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” Apart from providing this definition, which is rather amorphous, the IRS has provided little published guidance on what constitutes willfulness. Again, the IRS will look to the taxpayer’s actions in considering whether the taxpayer was non-willful.
The following examples would all suggest a willful failure to disclose foreign accounts: An American taxpayer opening an account in a tax haven jurisdiction (Switzerland, Cayman, Panama, etc.), although that taxpayer has no personal connection to that jurisdiction, e.g., never lived there and doesn’t do business there.
- Opening the account in the name of a foreign entity, such as a foreign corporation, trust or foundation.
- An American taxpayer answering “no” when his CPA asks if he has a foreign account.
- Diverting foreign earned income to a foreign account, rather than sending the earned income to a US account and reporting it to the IRS.
- Opening a foreign account under a “code name” and/or requesting that statements not be sent to the US.
- Opening a foreign account using a foreign passport and/or a foreign address.
The following facts might support a Streamlined application based on non-willfulness:
- The foreign account was created by a foreign relative and was inherited by the US person who only recently learned about the account and US tax reporting requirements.
- The US taxpayer created the account while living in the foreign country, and then moved to the US, did not know the account was reportable and did not access the account after moving to the US.
- The US taxpayer disclosed her foreign accounts to her CPA, who reported them and tax was paid on the foreign income; however, one small account was accidentally omitted.
- The taxpayer lived abroad for many years, filed US tax returns properly, but did not realize that some assets, such as foreign retirement plans, are also reportable to the IRS and taxable.
- The taxpayer reported the foreign account and paid tax on the foreign income to the foreign government and believed that since the account was already subject to foreign tax and reporting, it wasn’t also subject to U.S. reporting.
The taxpayer’s sworn statement of non-willfulness is thus a critical document and will be the basis of the IRS agreeing or disagreeing that the taxpayer’s failure to disclose was non-willful. If the IRS rejects the non-willful certification, the taxpayer’s statements could form the basis of an IRS audit with potentially severe consequences including large penalties.
Another danger is that if the IRS concludes that the statement is false, the taxpayer could be subject to prosecution for filing a false statement or even for perjury. Obviously, consultation with legal counsel is advisable to analyze whether the taxpayer’s particular facts would support non-willfulness. If the facts suggest that the claim of non-willfulness is questionable, taxpayer and counsel should instead consider the OVDP.
In analyzing the taxpayer’s background facts under the context of “willfulness”, taxpayer and legal counsel should examine the following questions:
- What was the reason for opening the foreign account?
- What is the taxpayer’s background?
- What is the source of funds in the foreign account?
- Does the taxpayer have ties to the country where the account was/is located?
- Did the taxpayer pay foreign taxes on the foreign assets?
- How was the account opened?
- What were the taxpayer’s instructions to the bank?
- Did the taxpayer access the accounts?
- Did the taxpayer manage the accounts?
- Did the taxpayer choose investments?
- Were there transfers or withdrawals?
- Was the account titled in the name of an entity like a trust, corporation or foundation?
- How large was the account?
- What was the tax loss to the IRS?
- Was the account moved?
- What was the taxpayer’s conduct vis-a-vis the foreign assets and preparing his annual income tax return?
Again, if the IRS rejects a certification of non-willfulness in an application for the Streamlined disclosure procedures, it will be too late for the taxpayer to then apply for the OVDP. The Streamlined procedure is therefore an all-or-nothing avenue. In this context, there are no degrees of willfulness. If the conclusion points towards non-willfulness more than willfulness, the client should give serious consideration to the Streamlined procedures and its significantly reduced penalty. On the other hand, if the taxpayer does not want to bear the risk of the IRS rejecting a claim of non-willfulness, the OVDP becomes the better alternative.
AssessmentSince 2012, when the Streamlined procedures were introduced, more than 30,000 taxpayers have used the Streamlined procedures, with 20,000 taxpayers alone since 2014 when the Streamlined procedures were modified and relaxed to include more taxpayers. In comparison, more than 54,000 taxpayers have participated in the OVDP and its incarnations since 2009. These numbers would support the suggestion that the Streamlined procedures are the IRS’ “mop up” strategy of bringing into compliance those remaining taxpayers who had not come forward under the OVDP since 2009. If so, the Streamline procedures can be considered successful in achieving that goal. It is unlikely that the 30,000 Streamlined taxpayers would have instead pursued the OVDP, handing over to the IRS severely more excessive penalties for non-willful conduct. By giving such taxpayers another, less painful way to achieve compliance, the IRS brought these taxpayers and their foreign assets back into the US tax system at the lowest cost to the IRS. Again, a win-win for both taxpayer and government. Perhaps the Streamlined procedures are indeed more about encouraging compliance than extracting penalties. Could this be, in fact, a kinder, gentler IRS?
Speaking from the experience of our own law practice, we are encouraged by what we have seen from the IRS in connection with the Streamlined procedures. Initially, we were concerned that the IRS could, for example, point to one solitary fact that could be construed as willful - - that one ATM withdrawal while in Europe on vacation - - to reject the Streamlined submission and, once rejected and precluded from OVDP, assess severe penalties. But we have not seen this on the part of the IRS. Indeed, we have even received inquiries from IRS agents on several occasions as to whether our OVDP clients would like to transition to Streamlined.
We have not seen much opposition by IRS to our Streamlined submissions. An informal poll among tax lawyer colleagues across the country whose law practices consist of many OVDP and Streamlined submissions confirms that the IRS has been accepting the Streamlined submissions with few rejections. This is not necessarily indicative of a kinder, gentler IRS, because it is almost certain that these tax practitioners have submitted Streamlined applications for those clients whom counsel has concluded are indeed non-willful. As noted above, often clients believe themselves to be non-willful, yet a closer examination of the facts suggests otherwise, or at a minimum could be viewed differently by the IRS.
Vetting the taxpayer and his background facts to arrive at an assessment of willfulness is, once again, crucial. If a client had a Swiss account titled in the name of an offshore corporation, we would not allow that client to proceed with a Streamlined application no matter how much the client protested his non-willfulness, and we suspect that our colleagues would not allow it either. Hence what appears to be a fantastic “success rate” for Streamlined submissions is entirely contingent upon proper evaluation of clients’ facts.
On a basic level, the Streamlined procedures simply make sense. If a taxpayer had willful facts, that taxpayer should go the route of the OVDP. That is why the OVDP was created. Such a taxpayer is offered protections from prosecution. That is a good deal, even if the taxpayer had an account at a “naughty bank” and now has to give the IRS 50% of the account. If the taxpayer is non-willful, then go the Streamlined route. Once the taxpayer and counsel determine the willfulness question, the next course of action is clear. Willful, step right to OVDP. Non-willful, step left to Streamlined. On the fence, request pre-clearance and then if precleared, submit the Streamlined documentation. The real issue, of course, is analyzing the taxpayer’s facts against the legal question of what constitutes willfulness? But once determined, the path forward should be clear.
The Streamlined procedures are also particularly successful with respect to US expats. In many cases, Americans have lived abroad for much if not all of their lives, have professional and personal lives and roots in foreign countries, yet are still tethered to the IRS. Such taxpayers can come into compliance at no penalty. This is a source of strength for the United States: its citizens live abroad, project American expertise and remit taxes back to the US. Of course, to the extent that an expat American views the burdens of IRS compliance to outweigh the benefits of US citizenship, renunciation of citizenship is an option. But even that route requires tax compliance before proper renunciation.
While the Streamlined procedures (and the OVDP as well) can be considered successes, it is important to understand that they are not open-ended or permanent. In January 2016, an IRS official speaking at an international tax conference in Miami noted that both the OVDP and the Streamlined procedures “are not permanent programs. These are opportunities.”
 The OVDP penalty is 27.5% of the highest aggregate foreign asset values over the eight year look back period. However, there is a list published by the IRS of foreign banks, most (but not all) of them in Switzerland, which are or were already under investigation by the DOJ, and for disclosures of accounts at a bank on this list, the OVDP penalty is 50% and applies to all foreign accounts disclosed in the OVDP, whether or not on this list of banks. Offshore tax practitioners colloquially refer to this list as the “naughty list”. The IRS updates this list as prosecutions and/or settlements with foreign banks are announced by DOJ. The list can be found on the IRS 2014 OVDP FAQs, at FAQ 7.2.
 Report of Foreign Bank and Financial Accounts, FinCEN 114 (previously, T.D. F 90-22.1).
3] There are two distinct Streamlined procedures for non-willful taxpayers, the Streamlined Domestic Offshore Procedures (SDOP) and the Streamlined Foreign Offshore Procedures (SFOP). Such naming may invite confusion, as “domestic offshore” seems contradictory and “foreign offshore” seems redundant. Naming aside, non-willful taxpayers who are US residents may utilize the SDOP, while non-willful taxpayers who meet foreign residency thresholds (see infa at footnote 7) may utilize the SFOP. As noted, the penalty for the SDOP is 5% of the highest aggregate balance of the foreign assets, and there is no penalty in the SFOP. Procedurally, the two Streamlined procedures are substantially identical. Taxpayers must certify their non-willfulness in both procedures. As such, henceforth in this article, references to the “Streamlined procedures” apply to both SDOP and SFOP.
4] However, a taxpayer who is already in the OVDP may request to “transition” to Streamlined and if the IRS rejects the taxpayer’s statement of non-willfulness, the taxpayer is still within the OVDP.
5] IRS Form 14654 for domestic filers and IRS Form 14653 for foreign resident filers.
6] IRS Form 906, Closing Agreement on Final Determination Covering Specific Matters.
7] Generally, a taxpayer must not have had a U.S. “abode” and must have lived abroad for 330 days in any of the last three tax years to qualify for the SFOP. “Abode” is defined in IRC Section 911(d)(3) and Treasury Reg. §1.911-2(b). There is a different non-residency requirement for taxpayers who are not U.S. citizens or green card holders, which is based on the “substantial presence” test.
8] IRS Form 14452, Foreign Account or Asset Statement.
9] IRS Form 872, Consent to Extend the Time to Assess Tax.
10] Consent to Extend the Time to Assess Civil Penalties Provided by 31 U.S.C. § 5321 for FBAR Violations (no form number).
11] Creative tax counsel have employed a hybrid strategy which involves a pre-clearance fax to the IRS, and then after securing pre-clearance, submitting a Streamlined application. Such a strategy may apply, for example, to a taxpayer with a foreign account at a bank known to be under DOJ/IRS investigation, who therefore desires pre-clearance and whose facts are non-willful. Such a taxpayer would face a 5% Streamlined penalty (or zero penalty if he/she is a non-resident) rather than a 50% OVDP penalty.
12] This assumes that there is no criminal activity associated with the foreign assets and the source of funds. If there is a criminal taint in any way, the taxpayer is not eligible for the OVDP. Assuming no criminal taint, the taxpayer would be accepted into the OVDP and the rest of the process should be risk-free, further assuming that the taxpayer follows all of the OVDP rules and makes a truthful and complete disclosure.
13] There is an additional quirky difference between the OVDP and Streamlined procedures. The OVDP penalty is assessed on the highest FBAR balances, which are the peak balances during the calendar year. The SDOP penalty is assessed on end-of-year balances.
14] Internal Revenue Manual (IRM) 184.108.40.206.5.3.
15] Of the many prosecutions by DOJ of Americans with non-disclosed foreign assets, a significant number of the prosecutions involve taxpayers who utilized foreign entities, e.g., Panama corporations or Liechtenstein Stiftungs (foundations). Prosecutors are keen on targeting such arrangements as they evidence an additional layer of tax fraud, the establishment of a sham entity to further obfuscate the true beneficial owner of the foreign assets.
16] Even if the expat taxpayer lived abroad and failed to file US tax returns, the taxpayer could file the late tax returns and declare foreign income under the Streamlined Foreign Offshore Procedures (SFOP). As noted earlier, such an opportunity is not available to a US resident taxpayer under the Streamlined Domestic Offshore Procedures (SDOP), because SDOP does not allow for filing late tax returns, only amended tax returns.
17] With most Swiss banks settling with DOJ in return for non-prosecution agreements, the banks have provided DOJ and IRS with information about account closures and movements of funds to other banks, the so-called “leaver” accounts. DOJ and IRS are especially driven to investigate and prosecute these account owners, as they show an added level of intent to stay ahead of the IRS rather than come into tax compliance. Many of the leaver accounts went to jurisdiction like Dubai, Israel, Singapore, Hong Kong and Panama. These jurisdictions are now targets of DOJ investigation.
18] IR-2015-116 (Oct. 16, 2015).
20] One astute colleague, after confirming that none of his Streamlined submissions had been rejected by the IRS, added that he would not want to alert the IRS to that fact.
21] See footnote 1.