The world of international tax compliance has undergone a sea change since 2009. Although the IRS is stretched to the limit with budget cuts, forcing it to reduce audit activity in other areas, it has made international tax compliance a priority.
Much of the credit (or, depending on your perspective, the blame!) goes to Bradley Birkenfeld, a private banker who worked in UBS wealth management in the early 2000s. In 2007, Birkenfeld provided extensive disclosure and information about U.S. taxpayers who were hiding assets and income in offshore accounts held by UBS. The IRS estimated that UBS clients held as much as $20 billion in undeclared accounts.
In February 2009, UBS agreed to pay a fine of $780 million to the U.S. government and entered into a deferred prosecution agreement with the Department of Justice. UBS also handed over the names of U.S. account holders who held undisclosed accounts. The next month, the IRS announced the creation of a new voluntary disclosure program, the Offshore Voluntary Disclosure Initiative (OVDI).
Background on OVDI and OVDP
The Birkenfeld episode revealed to the IRS that the scale of international tax avoidance and non-disclosure was bigger than previously assumed. It prompted the IRS to start the OVDI as a way to ferret out unreported foreign income and for taxpayers to come forward voluntarily to report foreign assets. To encourage compliance, taxpayers could enter the OVDI and pay stiff penalties, but at the same time take comfort that they would never face criminal prosecution or the prospect of even higher penalties. In particular, the draconian rules for filing “foreign bank account reports” or FBARs provide for extremely high penalties and unpredictable risk. The OVDI offered certainty and a clean slate, albeit at a high price.
The OVDI offered a uniform penalty structure that allowed taxpayers to calculate, with reasonable accuracy, the penalty and taxes they would have to pay if they entered the program. In 2011, the IRS modified the OVDI into the Offshore Voluntary Disclosure Program (OVDP), which has been modified several times since then. In 2015, the IRS announced that it received more than 54,000 disclosures resulting in more than $8 billion of revenue. Clearly, the program was working well.
IRS Rejections from OVDP and Voluntary Withdrawals from OVDP
Not all taxpayers qualify for the OVDP. To enter the OVDP, the first step is to receive pre-clearance from the IRS criminal division. If the IRS already has information on your identity because, for example, a Swiss bank provided information on accountholders, or a service provider such as a lawyer or trustee identified you, the IRS denied entry to the OVDP. While the vast majority of taxpayers who applied received pre-clearance, the OVDP was not a “get out of jail free” card for everyone.
Not all taxpayers who applied to the OVDP completed the program. Instead, after applying for entry, some taxpayers got cold feet and decided to leave. Like the five stages of grief, taxpayers with foreign accounts sometimes have very different attitudes over time.
At first, they jump at the chance for certainty. Later, the reality of the monetary penalty, which in some cases can mean a massive decrease in wealth and even a decrease in living standards for retired individuals or those who spent part of their lives working abroad, can lead to second thoughts.
2017 OVDP Audit Campaign
On May 10, 2017, the IRS announced a campaign to audit taxpayers with unreported offshore income and accounts. The campaign will focus on individuals who applied to the OVDP, but who were never formally accepted. This group of taxpayers, which currently consists of approximately 6,000 taxpayers, were either denied acceptance by the IRS Criminal Investigation division, or withdrew on their own before they were formally accepted.
The main target will be taxpayers who omitted offshore income and therefore have income tax deficiencies. Individuals who merely filed delinquent information returns will probably not be included.
The IRS will choose among three possible courses of action for the taxpayers in this group:
- No further action if the taxpayers have become compliant,
- “Soft letters” to taxpayers outlining different options to deal with relatively minor non-compliance, and
- Examination under normal exam procedures for noncompliant taxpayers.
The “soft letters” will require some response from the taxpayer to demonstrate how they have come into compliance, such as filing an amended tax return or making a payment. Criminal investigations may also be possible.
All tax years with open statutes will potentially be subject to audit. It is unclear if the IRS will aggressively apply the special statute of limitations rules that apply to offshore assets and income. These rules extend the statute of limitations for such unreported income and assets, but because many of these rules are relatively new, they are also untested in court.
Evaluate Your Options
If you have noncompliance issues, you should evaluate their different options before deciding on a course of action. Your best course of action will depend on many different factors, including whether you live in the United States or abroad, the amount of income that was not reported, and others. In addition, if you enter the streamlined program, the penalties will generally be far lower than the OVDP, but you will disclose your income outside of the protection of the OVDP, thereby becoming exposed to the risk of even higher penalties if you are audited.
Jon has extensive experience representing taxpayers with foreign account compliance issues, including:
- entering and completing the OVDP program;
- filing delinquent international information returns and FBARs with reasonable cause statements; and
- entering and completing the streamlined filing procedure.