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Enforcement at the IRS is getting tighter. Now that the Offshore Voluntary Disclosure Program is closed, taxpayers with foreign financial accounts are facing the possibility of higher penalties and tighter scrutiny of their offshore assets. One method the IRS is using is a so-called “soft letter” sent to people the IRS believes have under-reported their assets. Find out what these soft letters are, whether you are likely to get one, and what to do if you receive a soft letter from the IRS.
2018 brought some significant changes to the way the IRS addressed the failure to disclose foreign assets. In September 2018, the IRS formally closed its Offshore Voluntary Disclosure Program. This program was designed to encourage taxpayers to come forward with previously undisclosed foreign assets. By correcting tax returns and filing missing reports of financial financial accounts (FBARs) through the OVDP, taxpayers could avoid willful FBAR penalties and criminal tax consequences. That ended when the IRS cancelled the program, citing reduced numbers of taxpayers applying and completing the program.
As the OVDP wound down, the IRS also announced it would be ramping up certain large business and international compliance campaigns. These campaigns target taxpayers who the IRS believes pose a risk of under-reporting or other compliance issues. The statement dated June 28, 2018, contained 13 different campaigns, including one targeting taxpayers who failed to qualify, withdrew, or failed to comply with a voluntary reporting program like the OVDP or the Streamlined Filing Compliance Procedures (SFCP).
To encourage taxpayers to come forward and comply with IRS reporting requirements, the agency has begun issuing so-called “soft letters” (formally Form 5935). These letters warn taxpayers:
“Our records indicate that you haven’t taken necessary action to remedy your non-compliance with U.S. reporting requirements relating to foreign income, foreign entities, or foreign financial accounts.”
The letters give taxpayers three options to address the issue:
The letter warns that taxpayers who do not respond to the soft letter within 60 days may be selected for a tax audit. At the 34th Annual Tax Controversy Institute in Beverly Hills, California, Cassidy Collins of the IRS Office of Chief Counsel, said:
“It’s imperative, and we’re very much encouraging the tax practitioner community to respond to these letters. . . . If you ignore the letters, there is a high likelihood we’ll pick you for an examination.”
Deciding which option is best for you, and whether to respond when you receive a soft letter from the IRS is not always easy or straightforward. The SFCP may be a good option for taxpayers to avoid heightened willful FBAR penalties, but only if they can certify that their behavior was non-willful. In other words, taxpayers using SFCP must swear that their failure to disclose assets and file necessary tax forms and FBARs was due to negligence, inadvertance, or a good-faith mistake or misunderstanding of what the law requires.
However, recent court decisions show that willful FBAR determinations can often apply even when a taxpayer “recklessly” ignored an obligation to file. That means increasingly, taxpayers may find that they are not eligible for the SFCP and its reduced penalties.
If you truly believe you are compliant with all the IRS reporting requirements and have no tax deficiencies for offshore activities, filing the narrative statement requested in the soft letter may be prudent. However, before you do so you should carefully review your situation with a tax attorney experienced with foreign asset reporting requirements. If it is later discovered that you failed to report assets or missed a necessary filing it could result in substantial financial penalties.
If you aren’t sure if you have met all the filing requirements, or discover that something is missing, filing the requested disclosures can create even bigger problems. Because there is no audit or grand jury subpoena issued, taxpayers using this option are essentially volunteering information about their non-compliance without any promise of leniency or relief from penalties. In these cases, it is wise to simultaneously work with your CPA and tax attorney to amend past returns and file missing FBARs, to minimize your risk of tax penalties.
The worst thing you can do if you receive a soft letter from the IRS is nothing. Ignoring this request for “voluntary” information could expose you to a time consuming and expensive audit, as well as substantial financial penalties. If you have received a soft letter, contact an experienced tax attorney right away so you can choose the right way to respond to protect yourself and your foreign assets.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding how to respond to a soft letter from the IRS, contact Joe Viola to schedule a free consultation.