IRS/OVDP (7/1/14) Risks & Perils – Part 1

The IRS Offshore Voluntary Disclosure Program (OVDP)/2014 is a continuation of the 2012 IRS/OVDP with modified terms (which are the successors to the short-lived e.g. 6 months+ 2009 IRS/OVDP; 2011 IRS/Offshore Voluntary Disclosure Initiative (IRS/OVDI).

Unlike its prior programs, the IRS /OVDP (2014) has no set deadline for taxpayers to apply. The terms of the program can be changed at any time. The IRS may increase penalties or limit eligibility in the OVDP for all or some taxpayers, or decide to end the program entirely at any time (See: IRS/Offshore Voluntary Disclosure Program/ Frequently Asked Questions and Answers: FAQ #1).

Under IRS/OVDP FAQ 1.1 significant changes have been made to the 2012 OVDP:

1) 50 % Offshore Penalty on the highest balance in the account for the years the offshore account was undeclared and unreported. The 50% offshore penalty applies to 95 Swiss banks (see FAQ 7.2) in which the taxpayer had an account who have settled with the US Dept. of Justice and are now disclosing the names of US taxpayers (most recent i.e. #95 was Bank of Julius Baer who settled 2/4/16).

The 50 % penalty applies to all offshore undisclosed bank accounts if:

Either a foreign Financial Institution at which the taxpayer had an account or, a Facilitator who helped the taxpayer establish or maintain the offshore arrangement has been publicly identified as being under investigation or as co-operating with a government investigation. In addition, if either the Financial Institution or Facilitator has been identified in a “John Doe Summons” i.e. a court-approved issuance of a summons seeking information about US taxpayers who may hold financial accounts at the foreign financial institution or have accounts established or maintained by the Facilitator.

Examples of a public disclosure are cited in FAQ #7.2 which include without limitation:

A Public Filing in a judicial proceeding by any party or judicial officer, or

Public Disclosure by the US Dept. of Justice regarding either a non-prosecution agreement or a deferred prosecution agreement. The List of Foreign Financial Institutions or Facilitators meeting this criteria is available to date at FAQ #7.2

The 50% penalty (FAQ #7) is in lieu of penalties that may apply to undisclosed foreign accounts, assets and entities, including FBAR and offshore related information return penalties(FAQ #5).

The 50% penalty is only for Listed Financial Institutions which currently total 95 but the IRS public pronouncements confirm that they “are expanding the net” and moving from Switzerland to the Caribbean.

If the 50% penalty does not apply, the Offshore Penalty (i.e. Title 26 Misc. Offshore Penalty) remains at 27.5%. Under FAQ # 8, the offshore penalty applies to OVDP assets as defined FAQ #35: “The offshore penalty applies to Taxpayer’s off-shore holdings that are related in any way to taxpayer’s tax non-compliance which includes failure to report gross income from the assets, report the assets, as well as failure to pay US tax that was due with respect to the funds used to acquire the assets.

OVDP assets include: all assets owned directly or indirectly by the taxpayer(regardless of the form of ownership or character of assets).

OVDP assets include: financial accounts holding cash, securities or other custodial assets, tangible assets such as real estate or art, and intangible assets such as patents or stock or other interests in a US or foreign business.

The offshore penalty may be applied to the taxpayer’s interest in the entity or, if the IRS determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying asset.

For purposes of the calculation of the offshore penalty (either 27.5% or 50%), the values of the OVDP assets are aggregated for each year and the offshore penalty is calculated at the applicable rate of the highest years aggregate value during the period covered by the voluntary disclosure.

If the taxpayer has multiple OVDP assets where the highest value of some OVDP assets is in different years, the value of OVDP assets are aggregated for each year and a single offshore penalty is calculated at the applicable rate of the highest year’s aggregate value.

The bottom line is, the 50% penalty along with tax, interest, and additional penalties: accuracy-related 20% penalty on tax underpayments for all tax years, and if applicable up to 25% annual failure to file/pay penalties, may entirely wipe out taxpayer’s off-shore accounts and still leave a balance due.

In addition, another trap for the unwary: e.g.. the highest annual balance was $5m, the taxpayer only has $1m left on account, but the penalty at the 50% rate is $2.5m which not only exhausts the $1m but leaves a balance due of $1.5m (plus tax, interest, other penalties.

#2) Payment Up Front/Risk of Criminal Prosecution

Under IRS/OVDP (FAQ#20) the taxpayer must pay with his OVDP submission the tax, interest, offshore penalty (either 27.5% or 50%) and accuracy-related penalty and if applicable annual failure to pay/file up to 25% penalty. So the Taxpayer who enters the OVDP pays in full with no assurance of either acceptance in the OVDP or no criminal prosecution (as the IRS states in FAQ #4: the OVDP ” generally eliminates the risk of criminal prosecution for all issues relating to tax non-compliance and failing to file FBARS” but the IRS does not guarantee no criminal prosecution.

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