There are many different tax provisions that affect international financial transactions. The Internal Revenue Service (IRS) is beginning to pay far closer attention to these matters, leading to international litigation. In order to avoid costly tax audits and avoidable disputes with the IRS, it is important to take every precaution with regard to foreign income and offshore accounts. One of the common ways of doing this for United States taxpayers, including those referred to as expatriates (expats) and legal permanent residents is through the Offshore Voluntary Disclosure Program (OVDP).
What is OVDP?
In 2010, the US Congress enacted FATCA (Foreign Account Tax Compliance Act), which was designed to prevent tax evasion and to promote cross-border tax compliance. Under FATCA, US citizens and green card holders must report certain offshore financial assets above a certain threshold on Form 8938, Statement of Specified Foreign Financial Assets along with their tax returns.
This requirement is in addition to and separate from the duty to file foreign financial accounts with an aggregate balance of $10,000 or more on FinCen Form 114, commonly known as FBAR. By failing to report offshore and foreign accounts, and therefore assets and income, a United States taxpayer may face criminal prosecution and the possibility of hefty fines and significant jail time based on charges of tax fraud or tax evasion.
As a way to encourage taxpayers to abide by FATCA and voluntarily disclose their offshore accounts and income, the US created an amnesty program offering reduced penalties (27.5% miscellaneous penalty + 20% accuracy related penalty) in exchange for compliance. The program was modified several times and reached its final format in 2014.
In order to take advantage of the OVDP, a taxpayer could not have been actively investigated by the IRS or in the midst of an audit. The underlying policy was that the foreign bank account voluntary disclosure program was supposed to be a voluntary program for those who are “coming clean” before they had been discovered by the IRS.
The requirements for the program included amending 8 (eight) years of tax returns, reporting 8 (eight) years of FBARs, submitting a Pre-Clearance Letter and several other documents in accordance with the IRS guidelines disclosed by the IRS.
What are the benefits of the OVDP?
The OVDP provides taxpayers protection from criminal liability and reduced penalties that are not available to those that are facing examination or criminal investigation.
What is foreign tax credit?
When you enter the OVDP, you will be required to provide an updated voluntary disclosure of all of your foreign income and foreign bank accounts during the disclosure period. However, you may be eligible for a foreign tax credit. This is a credit that you can receive for the taxes that you have already paid abroad. However, the tricky part is that the United States taxes you on your worldwide income. People often get confused, because they believe it’s enough if they pay the taxes in the country where the money is.
The offshore voluntary disclosure program is one of the fastest ways to get into compliance. Once you start amending your tax returns, you will have an opportunity to list the foreign taxes you paid. Foreign tax credit can help significantly reduce your liability.
The End of the OVDP
As of September 28, 2018, the “traditional” voluntary disclosure practice (also known as the “2014 OVDP program”) has been closed. Nonetheless, in November 2018, the IRS issued new guidance for those taxpayers seeking to become compliant with FATCA and avoid criminal prosecution.
The Pre-Clearance Letter is still a requirement under the new program, but taxpayers are required to amend only 6 (six) years of tax returns, instead of 8 (eight) years under the predecessor program. However, the IRS states that if an agreement is not reached, the IRS agent will have the ability to expand the period for information returns to “include the full duration of the noncompliance and may assert maximum penalties under the law.”
OVDP Tax Penalties
The penalties structure of the OVDP has also changed. Instead of an overall miscellaneous penalty of 27.5%, the IRS states that willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under Internal Revenue Manual 4.26.16 and 4.26.17.” Taxpayers will, however, be permitted to request the imposition of “non-willful FBAR penalties instead of willful penalties.”
Additionally, civil fraud penalties will be imposed in all cases under IRC section 6663 for fraud or the civil penalty under IRC section 6651(f) for the fraudulent failure to file income tax returns” for at least one tax year at issue. Moreover, the IRS examiners will have the authority to assert the civil fraud penalty for multiple tax years in particularly egregious cases. The civil fraud penalty will essentially amount to 75% of the unpaid tax.
Although the new voluntary disclosure procedures permit taxpayers to argue in any particular case that the civil fraud penalty should be replaced with a lesser accuracy penalty, the new procedures provide that the civil fraud penalty will only be waived in “exceptional” circumstances.
Although the new program might seem harsher than the original OVDP, the new program gives the taxpayers the right to appeal the liabilities imposed in connection with a voluntary disclosure to the IRS Office of Appeals, which was not possible under the traditional program.
OVDP Willful vs Non-Willful
Despite the closure of the “traditional” OVDP program, the streamlined version is still in place. In 2014, another version was created for those taxpayers whose conduct were deemed to be “non-willful.” The Streamlined Filing Compliance Procedures have a much reduced penalty (5% for taxpayers living in the US and 0% for those living overseas). It is important to leverage an OVDP attorney with deep understanding of these differences.
Besides the reduced penalty, the Streamlined Disclosure Procedure only require the amending of the last 3 (three) years of tax returns and the reporting of FBARs for the last 6 (six) taxable years. Moreover, there is no Pre-Clearance Letter that needs to be submitted and financial documents are only required in case of an audit. The only additional requirement is that the taxpayer must certify that his/her conduct was “non-willful.”
There is no straightforward definition of “willfulness.” The IRS uses the “Totality of Circumstances” test to determine if a taxpayer’s conduct is deemed willful or non-willful. For the guidance of its agents, the IRS has defined “non-willful conduct” as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law” (Internal Revenue Manual §4.26.7). This essentially creates two requirements for a finding of willfulness 1) that the taxpayer was aware of the law and 2) that the facts support the evidence that the taxpayer’s action were indeed willful.
A lot of taxpayers wonder whether they could avoid all penalties by simply amending their tax returns to include the undisclosed foreign income. The IRS has stated that these types of disclosures will be reviewed and subject to all penalties, civil and criminal, existing under the law.
Determining willfulness is a matter of law and taxpayers seeking compliance should discuss their matter with an experience international tax attorney in order to apply for the correct international tax amnesty program.
Why should you choose an experienced tax lawyer to represent you in the OVDP?
The program is incredibly complex. Whether or not it is the right option for you is something that only experienced OVDP lawyers, specializing in tax law, can determine. With a seasoned tax lawyer at your side, you will be sure that you have hired a professional who can navigate the process regardless of the course it takes.
When you are considering tax lawyers’ services, compare potential attorneys based on their experience in attorney practice, litigation, and IRS audits and whether or not they specialize in tax law. Bear in mind that hiring an attorney to help you safely get into compliance will give you the benefits of attorney-client privilege.
However, this privilege cannot go back to cover the time before you hired the lawyer and disclosed potentially incriminating information to a CPA or Enrolled Agent.
OVDP Lawyers from Brunoro Law
It is important to have the right international tax attorney when attempting to become compliant under this program because there are many different requirements and failing to fulfill them all may lead to vulnerability for IRS enforcement actions.
At Brunoro Law, we understand the complexities of this program and will work with you to get the results that you need. From the initial pre-clearance letter through the IRS evaluation, application submission, and calculation of tax payments overdue and associated penalties, we will work with you to ensure compliance and avoid prosecution.
Contact Us for Help With OVDP Tax Issues
Brunoro Law is here for you if you need help entering the OVDP. Reach out to us today and book your free one-hour consultation!
Contact us for a free consultation.