New IRS Offshore Account Program
On September 28, 2018, the IRS closed the “old” Offshore Voluntary Disclosure Program, or OVDP. The OVDP offered taxpayers whose conduct was considered “willful” as to the nonreporting of foreign income with a path to compliance and more importantly an opportunity to diminish the threat of criminal charges they may face upon discovery by the IRS. If a filer failed to meet the September deadline, then he still may enter the Streamlined Filing Compliance Procedures (SFCP) program, but the filer had to satisfy a non-willful standard and similar to the OVDP may need to explain the history of the account, source of the money, and reason for nondisclosure in your Streamlined application. The OVDP and Streamlined program were offered by the IRS to serve different groups of individuals, based on whether their conduct was willful, or not. Therefore, the SFCP did not provide a suitable alternative for non-filers in many instances because their prior actions and their perceived intent make them ineligible for the Streamlined program en start writing!
Big Changes Are Coming
However, the expiration of the OVDP as a formal program did not end the need for remedial disclosures by taxpayers and a nimble IRS response, process to encourage such disclosures and reach an acceptable resolution framework. The IRS recognized this fact by issuing an Updated Voluntary Disclosure Practice Program (UVDPP) in late November 2018. In general, these changes returned control of the Foreign Bank Account Reporting (“FBAR” or Form FINCen 114) enforcement squarely in the hands of local IRS-line personnel. Formerly, it was controlled more by the Criminal Investigation unit of the IRS (note the FBAR requirements arise under the Bank Secrecy Act (BSA), not the Internal Revenue Code). The new rules are effective for all disclosures made after September 28, 2018. And the potential penalties may increase significantly in some cases over the old OVDP in return for foreclosing the assertion of criminal sanctions.
What is “Willful” and why does it matter?
Willful disregard for these reporting rules carries significant penalties. An FBAR failure deemed to satisfy the “willful” standard may be penalized as the greater of $100,000 or 50% of the unreported balance of the foreign bank account under the BSA statute. However, a non-willful failure may be penalized at no more than $10,000. (31. USC Sec. 5314). Both are penalties are substantial, but the willful penalty is clearly more severe. The UVDPP, however, offers a lower penalty regime in the case of a willful disclosure, based on certain discretionary factors.
Taxpayers that seek to participate in the UVDPP must apply and receive IRS preclearance (which formerly was an option). The criteria for preclearance are unaffected. Therefore, a taxpayer denied preclearance under the old OVDP would probably also be denied preclearance under the new disclosure program.
The IRS has the burden of demonstrating willfulness by the taxpayer and may carry its burden by either showing the taxpayer was aware of the FBAR reporting and did not investigate further how to comply (willful blindness) or tried to evade the requirements by actively concealing the accounts (conscious evasion of the rules). The examination to determine willfulness requires a review of the direct evidence that indicates the necessary state of mind and the reasonable inferences that flow from such evidence to reach a conclusion as to willfulness.
As with the old OVDP, the UVDPP submission must comply with a preclearance process and an initial submission are to be made to the IRS Criminal Investigation (CI) office. The initial submission will continue to involve the filing of a Form 14457. However, the Form 14457 will be revised, and will require applicants to provide a full and complete narrative statement about their circumstances. The narrative statement will require taxpayers to disclose the facts and circumstances of their assets, entities, related parties, and any professional advisors involved in the tax noncompliance in order for the taxpayer to be preliminarily accepted into the new program by CI.
A significant change is how the reviews will be conducted. Unlike the old OVDP, taxpayers will not submit all supporting documents to the Austin, Texas IRS office after being preliminarily accepted into the program. Under the new procedures after Criminal Investigation (CI) grants preclearance, CI will forward the disclosures to the Austin office which will route disclosures to a field examiner. A full review will be conducted in a manner similar to and IRS audit.
This is potentially troubling because it can (1) result in very broad data requests, (2) field agent(s) may want to expand the scope of the review to look at income and other taxes and (3) the field agents may not possess the skills and necessary training to conduct these FBAR audits in a dispassionate manner.
Disclosures will generally involve a six-year disclosure period, reduced from the old OVDP’s 8-
year disclosure period.
The new program loosens the rigid penalty guidelines present under the old OVDP but it greatly widens the range of possible outcomes. These old program’s rigid guidelines caused many taxpayers to “opt-out” of the OVDP and argue for the non-willful penalties available outside the old OVDP. The new program authorizes IRS field agents much more discretion in determining penalties. As a result, however, the range of possible penalty ranges has grown much wider, and can reach 75%, of the understated tax payment due before late payment charges, failure to file Forms 8938 or 5471, and interest.
Penalties will generally be asserted “under existing laws and procedures.” This suggests that field agents will need to support any penalty asserted for civil fraud or willfulness based on the specific facts of a disclosure. Therefore, in many cases, the new program will not offer a significant reduction in civil penalties compared to a disclosure outside of the new disclosured program.
Nevertheless, there are potential benefits the new disclosure program may provide. For example, the field agent may assert penalties for civil fraud under IRC § 6663 or § 66651(f), generally equal to 75% of the underpaid tax. In the new program, if the agent asserts the civil fraud penalty, the penalty will generally be applied to only the single year with the highest tax liability, and not to all six years. However, this benefit is not absolute.
Penalties could also be compounded. Under the new guidelines, the field agent can “in limited circumstances” choose to apply it to more than one tax year in the disclosure period and may even extend the penalty beyond the six-year disclosure period if the taxpayer “fails to cooperate and resolve the examination by agreement.” In the old OVDP, the IRS did not have much recourse if a taxpayer refused to sign a closing agreement and chose instead to opt out, beyond opening an audit or criminal investigation. In the new program, it appears the IRS can assert higher penalties for non-cooperative taxpayers.
The 50% willful FBAR penalties can also be applied. The IRS guidance so far does not say if this penalty will be applied to one year or to multiple years. However, the recent UVDPP announcement states that the FBAR penalties will be applied in accordance with the penalty guidelines under these Sections of the Internal Revenue Manual: 4.26.16 and 4.26.17. That probably means the penalty would be applied to the year with the highest aggregate balance.
Many taxpayers who choose to disclose their foreign assets outside of the Streamlined program do so because they have indicia of willfulness (e.g., partial or inconsistent prior reporting). Therefore, the 50% “willful” FBAR penalties may turn out to be fairly common. Nevertheless, the new program’s flexibility may offer some relief to taxpayers whose facts indicate nonwillfulness, but who cannot disclose through Streamlined because of a more technical issue.
Even if the field agent asserts the 75% civil fraud penalties and 50% willful FBAR penalties, taxpayers can request that the penalties be mitigated to the lower 20% accuracy-related penalty, and to non-willful FBAR penalties. However, the IRS expects that the reduction of penalties will be “exceptional,” at least where the taxpayers’ facts support the higher penalties. If a taxpayer disagrees with the penalties the field agent imposes, the taxpayer can appeal to the IRS’s Office of Appeals. This appeals procedure also brings the disclosure process in closer conformity to the procedures a taxpayer would find in a quiet disclosure or in an opt-out case under the OVDP.
Due to the wider range of possible outcomes (75% plus to 10%), the new OVDP offers a possibly better outcome, if it is managed well and the taxpayer is not “uncooperative”. It also offers significantly more risk if not managed well. It is troubling that field agents will be wielding such discretion. Some are good and some not so good. Managing the audit process well will be vital to getting into the low end of the possible penalty zone.