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The IRS recently encouraged U.S. taxpayers to come clean about unreported foreign financial assets and income. The agency offered up two voluntary disclosure procedures to save non-compliant taxpayers from steep penalties and criminal prosecutions. But which one should you use?
In a statement issued October 21, 2016, the IRS urged U.S. taxpayers to take advantage of its voluntary disclosure procedures to minimize the risk of penalties and criminal prosecutions. The statement referenced two programs: the Offshore Voluntary Disclosure Program (OVDP) and the Streamlined Filing Compliance Procedures (SFCP). Both allow for amended tax returns and reduce penalties. So which voluntary disclosure procedure should you use: OVDP or Streamlined?
One key difference between the OVDP and the SFCP is willfulness. Taxpayers using the OVDP are admitting their failure to disclose foreign assets and income was willful. In the streamlined procedure, the taxpayer certifies that his or her behavior was non-willful. At the University of San Diego School of Law-Procopio International Tax Institute annual conference, John McDougal, special trial attorney for the IRS Small Business/Self-Employment Division explained the difference:
Non-willful conduct is 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.
That opens the door for many U.S. taxpayers to qualify for the streamlined procedure. McDougal says:
Anything that does't rise to the level of tax fraud or the willfulness standard for [the foreign bank account report] is fair game for streamlining. ... As long as you weren't fraudulent or willful in the FBAR sense ... even gross negligence is an appropriate baseline for filing streamlined.
The broad definition of non-willful conduct is good news for many taxpayers. Under the streamlined filing compliance procedures, a U.S. resident who voluntarily discloses their non-willful non-compliance could face a penalty as low as 5% of the highest balance of the undisclosed offshore accounts in the last 3 years. Non-residents won't pay any SFC penalty at all. Unpaid taxes and interest are still due, however.
That's a big savings compared to the OVDP, which has a fixed penalty of 27.5% of the highest balance in the undisclosed accounts over the last 8 years. For example, a U.S. resident with an undisclosed $10 million account paying 1 percent interest at current rates might expect maximum taxes due around $200,000 over five years. Under the SFCP, the penalty on this account could be as low as $500,000. Under the OVDP, that same taxpayer would end up paying $2.75 million in penalties.
With such a vast difference in penalties, you may wonder why anyone qualified for SFCP would choose to file using the Offshore Voluntary Disclosure Program. However, the OVDP provides a degree of certainty and finality that the SFCP does not. Its fixed 27.5% penalty makes calculating your total tax liability easy. Under the SFCP, penalties depend on a determination of willfulness and on the limited discretion of the tax examiner. While the SFCP penalties are usually lower, in some larger cases they could end up being far more expensive.
The OVDP also removes any worry of an audit. It is possible for the penalties assessed under the SFCP to change when the returns filed are later selected for an audit using existing procedures. If an audit determines that the original return was fraudulent or the FBAR violation was willful, the taxpayer could end up paying more, even after it appeared the issue had been resolved. In contrast, during the OVDP, the taxpayer admits that his or her conduct was willful and agrees to pay the fixed penalty in lieu of any other penalties that might be due, including FBAR penalties. That means nothing a subsequent audit could uncover will result in additional payments to the IRS for the disclosed period.
The facts and circumstances of your particular case may cause you to place more value the lower penalties of the SFCP or the certainty of the OVDP. But it isn't a choice to be made lightly. The decision of which voluntary disclosure procedure is right for you should only be made after careful consideration with the advice of your tax attorney.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding SFCP qualification or requirements, contact Joe Viola to schedule a consultation.