Choosing the Best Offshore Disclosure Program for Clients

Many tax practitioners will meet holders of foreign accounts who have either deliberately or unintentionally failed to accurately report their foreign accounts and will need to advise them on the best way to make the disclosure to the Internal Revenue Service.

Due to the fact that many U.S. taxpayers have not reported their income from foreign financial accounts, the IRS has implemented two programs that allow U.S. taxpayers to bring themselves into compliance with the Internal Revenue Code and the Bank Secrecy Act. Each program has its own ramifications and penalties. The two programs—the Offshore Voluntary Disclosure Program and the Streamlined Offshore Disclosure Program—are exclusive. If you participate in one, you cannot participate in the other.

Under the OVDP, the taxpayer requests permission to participate and the IRS then determines whether the taxpayer is currently under audit or investigation, and if not, the taxpayer is conditionally permitted to enter the program. As a condition, the taxpayer must disclose the source of the income that resulted in the offshore accounts and the location and identity of the accounts. To the extent the offshore account is not attributable to illegal sources of funds, the taxpayer will likely be permitted to participate in the OVDP.

Under the OVDP, taxpayers must file amended income tax returns and FBAR filings for the previous eight years identifying foreign accounts and foreign real estate, along with any other foreign income-producing assets to the extent that the foreign assets resulted in unreported income.

The taxpayer must pay all tax on the unreported income and interest on the additional tax, plus a 20 percent accuracy-related penalty as the penalty for the income tax violation. A penalty is assessed on the highest account balance plus any foreign asset that generated unreported income during the eight-year period. This penalty is normally 27.5 percent of the highest account balance. Unfortunately, there are a handful of banks that are listed as facilitator banks, and if any such institution holds any funds of the taxpayer, then the penalty becomes 50 percent for all foreign assets held.

The primary advantage to the OVDP is the fact that one is assured that the U.S. will not prosecute criminally.

On the other hand, the Streamlined Program is only available for non-willful filers. The government has not defined what constitutes “non-willful.” The government has stated that it has no intention of defining “non-willful.” Under the Streamlined Program amended tax returns for the last three years and FBAR filings for the last six years must all be filed. Under the Streamlined Program only the tax and interest are required and the penalty for the offshore account is only 5 percent of the highest balance.

The primary advantage of the Streamlined Program is the fact that the penalty structure is much smaller. The disadvantage of the program is the lack of a definition and guidance for the term “non-willful” taxpayer. Additionally, there is no assurance up front that the government does not intend to prosecute the taxpayer for criminal or civil tax fraud or evasion.

The choice of program should be guided by the facts and circumstances. It is a function of the source of your offshore funds, the nature of the failure of your disclosure and whether your behavior was willful or nonwillful. Questions to ask include:

• Did I have a purpose of avoiding or evading U.S. tax?
• Could my actions appear that I had a purpose of avoiding or evading tax? For example, bringing funds into or out of the U.S., using cash or “mules” rather than checks or wires, or moving assets between institutions, might give that appearance to the IRS.
• What is the size of the accounts?
• What is the amount of foreign assets?
• What is the source of the funds? Were they ever reported when they were first earned?
• Are the funds licit or illicit funds to begin with?
• Were the funds earned from foreign or domestic sources?
• Were the taxpayers living abroad when the accounts were set up? When the accounts were funded?
• What was the amount of earnings from the foreign accounts?
• Were FBARs filed for some accounts but not others?
• Did I provide false information to my tax return preparer?
• Am I in law enforcement, politics or a professional?
• What is the risk tolerance for the taxpayers?
• Will the spouses have different answers to these questions (perhaps separate counsel may be needed)?

The decision of when to choose the cheaper Streamlined Program over the safer OVDP is an extremely important one and should only be made after a careful examination of the facts and consultation with competent counsel. Once you elect a program, the other is no longer available as a fallback.