DON’T QUALIFY FOR THE STREAMLINED PROCEDURE? YOU CAN STILL SEEK RELIEF WITH OVDP
Before jumping into the nuts and bolts of the OVDP, I think it would be beneficial if we recapped our discussion from our previous blog (Part 1 in our Delinquent Taxpayer series). Therefore, I’ve put together the following bullet points summarizing the key points:
As a U.S. citizen, you are required to annually file a U.S. tax return and report your worldwide income regardless of (a) the amount of income you earned; and (b) the amount of tax you paid in your country of residence.
If you have not filed a tax return or Foreign Bank Account Reporting (FBAR) for any of the years during which you resided outside the U.S. (or filed a return and failed to report all of your income), you may face civil and even criminal penalties.
One way to resolve your delinquent taxpayer status is to file your returns and FBARs via the Streamlined procedures. Utilizing this procedure requires you to file only 3 years of tax returns and 6 years of FBARs and should result in a fresh start with the IRS while avoiding significant penalties.
The Streamlined procedure is NOT available for everyone and only those who meet certain criteria will be accepted. See our last blog for details on the criteria.
So what happens if you do not meet the criteria for the Streamlined procedure? Has your fate been sealed and you have no alternative but to wait for that dreadful IRS letter assessing you with exorbitant penalties and threating even criminal prosecution? The answer is no.
If you do not meet the criteria for the Streamlined procedures, you can still rectify your situation by utilizing the traditional Offshore Voluntary Disclosure Program. However, it is important to be clear – the OVDP is by no means as simple and generous as the Streamlined procedure. As I will explain below, it will require a lot more disclosure on your part and the results will be a bit more costly. Nevertheless, it is by far (in our professional opinion) a much better option than doing nothing or even submitting delinquent returns under the radar (also known as “Quiet Disclosure”).
As stated on the IRS website, the program’s objective is: “…to bring taxpayers that have used undisclosed foreign accounts and undisclosed foreign entities to avoid or evade tax into compliance with United States tax laws.”
In general, the program is open for any U.S. citizen (or green card holder) who has undisclosed foreign accounts or assets. Typically, this includes individuals who have either failed to file a U.S. tax return while living overseas or have filed timely returns but failed to include and report all of their income and foreign bank accounts on these returns. More importantly, the IRS has said that it will not accept individuals for whom the IRS has already initiated a civil or criminal investigation or examination as well as individuals for whom the IRS has already received information whether from the media, an informant or a government agency.
In a nutshell, the first step is to obtain a “pre-clearance” from the IRS regarding your intention to make a submission under the OVDP. This is done by faxing the IRS your identifying information together with a power of attorney if using a representative. Next, you will be required to submit the OVDP letter and attachment which essentially is a letter explaining your situation and a lengthy questionnaire about your foreign activities. Following this, you should receive a “preliminary acceptance letter” from the IRS with a detailed list of the tax returns and information you will be required to provide at which point, you will begin preparing your OVDP submission package. You will be expected to pay any tax you may owe for these years as well as interest and certain penalties. However, with respect to some of the penalties, such as the FBAR penalties, a reduced rate will apply.
Now that we’ve discussed the program’s eligibility and requirements, it’s time to get to the main point – the outcome, namely, what benefit can you expect from participating in this program.
Avoid criminal penalties – it is important to emphasize that a careful reading of the literature published by the IRS reveals that even if you successfully participate in the program, the IRS does not guarantee immunity from criminal prosecution. As stated on the IRS website “Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution.” Nevertheless, it is our professional opinion (based on experience) that taxpayers who were not willful or intentional in failing to file their tax returns and/or FBARs are most likely not going to be criminally prosecuted as long as they carefully adhere to the requirements of the OVDP. This idea is further supported by the IRS’ own announcement on their website which states: “When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.”
Substantially reduce civil penalties – as for the civil penalties, the larger penalties will be substantially reduced. However, certain smaller penalties will not be waived. These penalties include; (i) a 20% accuracy related penalty applied to the tax owed (if any); (ii) failure to file penalties and (iii) failure to pay penalties. These penalties may sound scary, however, most expats are entitled to certain benefits under the tax code that can significantly reduce their tax liability in the U.S. thereby resulting in these remaining penalties being relatively small amounts. As for the more substantial penalties, such as the penalties that can be imposed for failing to file FBARs as well as other information returns that should have been included in your tax return, the IRS will substantially reduce all other penalties to either 27.5%, 12.5% or even as low as 5%. The determination of which reduced rate will apply in your case will ultimately depend on the particular facts of your case. The IRS has released a list of factors it will consider when deciding which level of penalties to apply.
TIMING AND DEADLINES
Unlike the previous two Offshore Voluntary Disclosure Programs, the current program does not have a set deadline. As stated on the IRS website;
“Unlike the 2009 OVDP and the 2011 OVDI, there is no set deadline for taxpayers to apply. However, the terms of this program could change at any time going forward. For example, the IRS may increase penalties or limit eligibility in the program for all or some taxpayers or defined classes of taxpayers – or decide to end the program entirely at any point.”
It is clear from this message that the IRS is reserving its right to modify the program and potentially be less generous with respect to penalties. To assume the IRS won’t go ahead and exercise this right is a grave mistake as evident from the differences between the current program and its previous two versions which applied significantly lower rates.
Assuming you’re currently delinquent on your U.S. taxes and do not qualify for the Streamlined procedure, you are strongly encouraged to consider the OVDP. I realize that to some individuals the concept of paying any penalties may sound scary and unattractive, but one should be mindful of the full extent of consequences they would face should the IRS choose to exercise all of the powers afforded to it under the law. Furthermore, one should keep in mind, that if the IRS chooses to examine or investigate you before you come forward, the program will no longer be available to you.
Lastly, it is important to address another phenomenon known as “Quiet Disclosure.” Under this approach, an individual would simply submit three years of returns and six years of FBARs (just as required under Streamlined) without formally utilizing either of the programs (i.e., Streamlined or OVDP). Instead, the strategy advocates an “under the radar” approach whereby the taxpayer sends in their delinquent returns and FBARs and hopes they get processed without anybody noticing. In our professional opinion, taxpayers opting for this approach are committing a grave mistake as the IRS has explicitly announced on their website that they frown upon taxpayers looking to bypass the options encouraged by the IRS. Their website states: “Those taxpayers making “quiet” disclosures should be aware of the risk of being examined and potentially criminally prosecuted for all applicable years.”
At Expat Tax Professionals, we assist U.S. expats from all around the world with their tax delinquencies allowing them to start fresh with the IRS. We try hard to understand each individual’s predicament and accordingly advise on the program most suitable for them.
Feel free to reach out to us with questions about your particular case.