The IRS has announced a second special voluntary disclosure initiative that will give taxpayers with undisclosed income from hidden offshore accounts for the 2003—2010 period the chance to get current with their taxes.
The new voluntary disclosure initiative will be available through Aug. 31, 2011. The new initiative carries higher penalties than the original disclosure initiative announced in 2009, but the penalties can be mitigated under certain circumstances.
Details of voluntary offer. IRS released details of the new voluntary offer, called the 2011 Offshore Voluntary Disclosure Initiative (OVDI), in the form of 53 frequently asked questions (FAQs).
The FAQs provide details on a number of important aspects of the voluntary offer, including the following:
Carrot and stick.
Taxpayers that fully comply with the offer will avoid criminal prosecution and will be able to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by IRS and the imposition of substantial penalties, including a fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. (FAQs 1, 4, 5, and 6)
Complying with the offer. To take advantage of the 2011 OVDI, taxpayers must:
• Provide copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for tax years covered by the voluntary disclosure. Calendar year taxpayers must include tax years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities. Fiscal year taxpayers must include fiscal years ending in calendar years 2003 through 2010.
• Provide complete and accurate amended federal income tax returns (for individuals, Form 1040X, or original Form 1040 if delinquent) for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account or entity (e.g., Schedules B, D and E).
• File complete and accurate original or amended offshore-related information returns and Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, also known as an FBAR) for calendar years 2003—2010.
• Cooperate in the voluntary disclosure process, including providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing tax and penalties.
• Pay (a) 20% accuracy-related penalties under Code Sec. 6662(a) on the full amount of underpayments of tax for all years; (b) failure to file penalties under Code Sec. 6651(a)(1) , if applicable; and (c) failure to pay penalties under Code Sec. 6651(a)
(2) , if applicable.
• Pay, instead of all other penalties that may apply, including FBAR and offshore-related information return penalties, a miscellaneous Title 26 offshore penalty, equal to 25% (or in limited cases 12.5% or 5%) of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure.
• Submit full payment of all tax, interest, accuracy-related penalty, and, if applicable, the failure to file and failure to pay penalties, or make good faith arrangements with IRS to pay in full the tax, interest, and these penalties (the suspension of interest provisions of Code Sec. 6404(g) do not apply to interest due in the new initiative).
• Execute a Closing Agreement on Final Determination Covering Specific Matters, Form 906. (FAQs 7 and 9)
FAQ 50 adds that because the 25% offshore penalty is a proxy for the FBAR penalty, other Code penalties, and potential liabilities for years before 2003, there may be cases where a taxpayer making a voluntary disclosure would owe less if the special offshore initiative did not exist. Under no circumstances will taxpayers have to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes.
The 25% penalty is reduced to 12.5% if the taxpayer's highest aggregate account balance (including the fair market value of assets in undisclosed offshore entities and the fair market value of any foreign assets that were either acquired with improperly untaxed funds or produced improperly untaxed income) in each of the years covered by the 2011 OVDI is less than $75,000. (FAQ 53)
The 25% penalty is reduced to 5% if the taxpayer: (a) did not open or cause the account to be opened (unless a new account had to be opened upon the death of the owner of the account); (b) exercised minimal, infrequent contact with the account (e.g., to request the account balance); (c) didn't, except for a withdrawal closing the account and transferring the funds to a U.S. account, withdraw more than $1,000 from the account in any year covered by the voluntary disclosure; and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. tax). For funds deposited before Jan. 1, '91, if no information is available to establish whether such funds were appropriately taxed, it will be presumed that they were. The penalty is also reduced to 5% for taxpayers who are foreign residents and who were unaware that they were U.S. citizens. (FAQ 52)
The voluntary compliance offer is not available if IRS has initiated a civil examination of the taxpayer, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities. Taxpayers under criminal investigation by IRS's Criminal Investigations division are also ineligible. (FAQ 14)
Special procedures for PFIC investments. Unlike the earlier offshore settlement initiative, the new one offers an alternative resolution regime to cases involving passive foreign investment company (PFIC) issues. It will resolve PFIC issues on a basis that is consistent with the mark-to-market methodology in Code Sec. 1296 , but won't require complete reconstruction of historical data. The highly technical terms of this alternative resolution are carried in FAQ 10.
Consequences of failing to meet the deadline. Although the terms of this initiative are available only to taxpayers who complete the voluntary disclosure process on or before Aug. 31, 2011, IRS's Criminal Investigation division's Voluntary Disclosure Practice will remain available to taxpayers who wish to voluntarily disclose their tax violations after that date. However, these taxpayers will not be eligible for the special civil terms of the new initiative and will be liable for all applicable civil penalties, including the willful FBAR penalty. In addition, the civil resolution of their cases may extend to tax years prior to 2003.
The IRS discourages “quiet disclosure.” IRS says it is aware that some taxpayers are attempting “quiet disclosure” by filing amended returns and paying any related tax and interest for previously unreported offshore income without otherwise notifying IRS. In FAQs 15 and 16, IRS strongly encourages such taxpayers to come forward under the voluntary disclosure offer. Those that don't run the risk of being examined and potentially criminally prosecuted for all applicable years. IRS says it has identified, and will continue to identify and closely review, amended tax returns reporting increases in income.