Offshore Voluntary Disclosure — The Next Generation

By Dennis Brager

Dennis Brager examines the next generation of partial tax amnesty for taxpayers who have failed to meet the myriad of disclosure requirements imposed on owners of foreign assets: Offshore Voluntary Disclosure Initiative (OVDI).

In February of 2011 the IRS announced a partial tax amnesty for owners of offshore financial accounts, and others who have failed to meet the myriad of disclosure requirements imposed on owners of foreign assets. This new partial tax amnesty dubbed the “Offshore Voluntary Disclosure Initiative” (OVDI) is the successor to the previous partial tax amnesty known as the “Offshore Voluntary Disclosure Program (OVDP), and is designed to be more onerous than the OVDP.

Before discussing the nuts and bolts of the OVDI it is useful to examine how we came to this point. Over the years an ever expanding reporting regime has been imposed on owners of offshore investments. This has been due to a perception that the use of foreign accounts is a prevalent means of tax evasion. In addition, law enforcement agencies believe that the use of foreign accounts disguises a host of non-tax crimes including money laundering, drug smuggling, and international terrorism.

The big kahuna is the penalty for the failure to file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). Any U.S. citizen or resident who has signatory authority over, or a financial interest in, a financial account located in another country is required to file an FBAR if the balance in the account was more than $10,000 at any time during the calendar year. The willful failure to do so is a felony punishable by a fine of $250,000 or five years in jail or both.12 The civil penalty for the willful failure to file the FBAR is the greater of $100,000 or 50 percent of the account balance; and the penalty can be imposed on an annual basis, which can easily exceed the amount in the account.13 However, if there is reasonable cause for the failure to file then no penalty is imposed.14

Even a negligent failure to file an FBAR is subject to a civil penalty of $10,000 per violation.15 Of course if any of these foreign accounts generate income that income must be reported on the relevant income tax return. A willful failure to report the income can be treated as the evasion of tax which is felony punishable by a fine of as much as $100,000 or five years in jail, or both.16 On the civil side the willful failure to report could constitute tax fraud with a penalty of 75 percent of the tax evaded.17

It is against this dark background which the OVDI must be considered. Under OVDI the vast bulk of these potential penalties, and some additional ones will disappear. OVDI is not, however a free lunch. The guidelines for the OVDI are set forth in a series of Frequently Asked Questions published on the IRS Web site in early February of 2011.18 A person who enters the OVDI program must agree, inter alia, to the following:

• The filing of amended income tax returns for the years 2003 through 201019
• Payment of all taxes due on the returns, plus interest20 An accuracy related penalty of 20 percent of the tax due pursuant to Code Sec. 6662, and if applicable, the failure to file and failure to pay penalties under Code Sec. 6651(a)(1) and (a)(2)
• A “miscellaneous Title 26 offshore penalty” equal to 25 percent of the highest aggregate balance in foreign bank accounts/entities or the value of foreign assets during the period covered by the voluntary disclosure 21

The 25-percent penalty is reduced in several narrow circumstances. If the highest aggregate offshore balance does not exceed $75,000 at any time during the OVDI disclosure period then the penalty will be 12.5 percent of the highest aggregate balance.22 All other terms of the OVDI remain unchanged.

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