Jonathan W. Benowitz, CPA
Associate Editor
Loyola University Chicago School of Law, JD 2019

The IRS has decided to shutdown its Offshore Voluntary Disclosure Program (OVDP) on September 28, 2018.  The program offers amnesty from criminal prosecution and a set penalty structure for those who have previously failed to disclose foreign bank accounts and other foreign assets, including those held through undisclosed foreign entities. Failure to disclose could include failure to file the annual FinCEN Form 114, most commonly referred to as the foreign bank account report or “FBAR”, as well as the failure to report income from such accounts and assets on tax returns and the failure to provide various other foreign information forms and returns.

According to the IRS, the OVDP and its related programs have generated a total of $11.1 billion in back taxes, penalties and interest since it started in 2009.

Foreign Asset Reporting Affects More Than Millionaires

All U.S. taxpayers (including green card holders and U.S. citizens abroad) are required to report their foreign bank and financial accounts to the Financial Crimes Enforcement Network or FinCEN if the value of the accounts exceeds $10,000 in the aggregate at any time of the year, and check the appropriate box on IRS Form Schedule B due with an annual tax return.  Such accounts and other specified foreign financial assets are also required to be reported to the IRS on Form 8938 if the value exceeds certain thresholds. Other foreign information returns and reports include Form 5471 to report certain foreign corporations, Form 3520 to report foreign gifts and foreign trust transactions, and Form 3520A to report foreign grantor trusts.

In addition to possible criminal prosecution, the penalties for a failure to disclose foreign accounts and assets for income tax purposes can be significant. Moreover, the penalties for failure to report foreign bank accounts have been frequently described as draconian, even by the IRS’s own Taxpayer Advocate Service.

FATCA and Inter-Governmental Agreements: A Tightening Net

The United States has been targeting unreported foreign accounts for many years.  In 2010, Congress passed the Foreign Account Tax Compliance Act (“FATCA”), part of the HIRE Act, which encouraged foreign financial institutions and government all over the world to disclose information about American account holders. Financial institutions that refuse to comply would be subject to a 30% withholding tax on US source interest and dividends as well as on the payment of principal of US stocks and bonds. The result of such a tax, given the U.S.’s status as the world’s top investment destination, would be extremely costly, if not ruinous, to many foreign banks.

FATCA has resulted in intergovernmental agreements with most of the globe, even those jurisdictions known for their banks’ secrecy, such as Switzerland and the Cayman Islands. From India to Israel to every noteworthy tax haven, financial institutions are now required to decline to do business with Americans or reveal their U.S. accountholders to the U.S. government. The U.S. Treasury’s FATCA resource page lists 113 countries that have agreed to disclose information about American account holders.

While this push has revealed major criminal tax evaders, it also encompasses millions American taxpayers holding foreign accounts living around the globe.  Despite an enormous increase in foreign bank account reporting to over a million FBARs filed this year,  this number is only a fraction of the estimated 9 million Americans living abroad— and an even smaller sliver of the 40-million foreign-born population (assuming some fraction maintain foreign financial ties). Most unreported foreign accounts in a globalized America are held for ordinary purposes, such as inheritance, business, retirement, and everyday banking.

What Does The OVDP Program Do?

The OVDP is an IRS program that provides a single mechanism for individuals to become compliant with both income tax and FBAR requirements.  FinCEN, whose mission is to prevent the illicit use of the financial system and combat money laundering, does not enforce the FBAR requirement; rather, enforcement is delegated to the IRS.  This allows the IRS to offer an integrated reduced penalty for a voluntary disclosure in lieu of the myriad of civil and criminal penalties that could otherwise apply.

Criminal penalties for failure to file FBARs can be a fine of up to $250,000 and/or up to five years in prison. Civil penalties for failure to file FBARs or for material omissions of information, which may be imposed even when criminal penalties are imposed, include the greater of $100,000 or up to 50% of the account balance or $100,000 for a willful failure to file and up to $10,000 for a non-willful failure to file, although the non-willful penalty may be waived for reasonable cause.

In regard to civil penalties for failing to file certain international related income tax forms and returns or material omissions from a filing, there is a $10,000 penalty for Forms 5471 and 8938. The penalty for the Form 3520 is the greater of $10,000 or 35% of the transfer to or distribution from a foreign trust; the penalty for the Form 3520A is the greater of $10,000 or 5% of the trust assets treated as owned by the U.S. grantor of the foreign trust. The IRS FAQs for the OVDP lists other penalties that could apply.

Under the OVDP, in lieu of all other penalties that may apply to the undisclosed foreign accounts, assets and entities, there is a penalty of 27.5% (or 50% for accounts with certain listed foreign financial institutions) of the highest aggregate value during the period covered by the voluntary disclosure (normally 8 years of tax returns and 6 years of FBARs) of the taxpayer’s offshore holdings that are related to tax non-compliance, which is quite high.  However, without the relief the program provides, the penalties over multiple years of non-reporting can exceed the total value of the unreported accounts several times over.  The amount of the penalty has increased over the years of the program, with the percentage having been originally set at 20%.

For sophisticated individuals who used foreign financial accounts to willfully evade taxes, the hefty penalties and thorough reporting requirements seem both appropriate and necessary to ensure that the taxpayer has been brought back into full compliance and paid a substantial price for willful noncompliance.  However, for the many taxpayers whose failure to disclose foreign assets was non-willful, or taxpayers abroad who didn’t file anything at all through lack of knowledge, OVDP penalties seem excessive, and the OVDP initially provided reduced penalties.

The IRS has alternative routes to compliance for non-willful taxpayers.

Are there Alternatives now that the OVDP Program Ending?

For those individuals whose failure to report foreign assets and income was non-willful, the IRS developed streamlined procedures, which it called simply Streamlined Filing Compliance Procedures.  The IRS is continuing the Streamlined program.

There are two parts of the program: one for U.S. taxpayers residing in the U.S. and one for U.S. taxpayers meeting certain foreign residency or presence requirements. Both of the Streamlined programs require the filing of 3 years of tax returns or amended tax returns, including all required foreign related forms and returns, and 6 years of FBARs, along with a narrative explaining the circumstances of the taxpayer’s noncompliance and the non-willful nature of the failure to report, as well as certification of the non-willfulness.  For taxpayers residing in the U.S., there is a penalty of 5% of the highest aggregate value of the taxpayer’s foreign financial assets required to be reported on an FBAR or Form 8938. There is no asset-based penalty for taxpayer’s meeting the foreign residency or presence requirements.

For taxpayers who do not need to file amended returns to report and pay additional tax and have reasonable cause for failing to file foreign information returns or FBARs, the IRS describes the procedures that should be done to file delinquent information returns or delinquent FBARs.

For those taxpayers who need to file amended returns and do not want to pay the 5% penalty because they believe they have reasonable cause, they may want to file amended returns with delinquent foreign information returns and a reasonable cause statement, but they can be subject to a “quiet disclosure” examination by the IRS. If the IRS finds that the taxpayer lacks reasonable cause, the IRS will assert penalties and possible provide a referral to criminal investigation if the IRS believes the taxpayer’s failure to timely file the information returns was willful.  The IRS warns against quiet disclosures in its OVDP FAQs.

Conclusion: Alternatives Provide No Certainty In Criminal Amnesty

The OVDP is the only program of its kind to offer protection for criminal prosecution for failing both to file FBARs and to report foreign income and assets on tax returns and forms, with a known penalty no matter the reason for the failure.  As such, taxpayers with criminal exposure who wish to come into compliance have little reason to delay applying to the OVDP.  With the United States receiving foreign financial information through intergovernmental agreements, there are many reasons not to delay.  As time is running out on the OVDP, taxpayers who delay in reporting may find themselves with little recourse when their bank or trusted financial advisors gives their name to the IRS.