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When taxpayers with foreign financial accounts take advantage of the IRS voluntary disclosure practice, they know that mistakes have been made, and that penalties will follow. But they probably don’t think of themselves as “tax criminals”. They may be hoping to avoid tax fraud and FBAR penalties by coming forward on their own. Recent statements by an IRS attorney casts doubt on whether participating in the practice will be all they had hoped for.
In November, 2018, the United States Department of Treasury issued a memorandum updating the voluntary disclosure practice for those possibly facing tax fraud penalties and consequences. The practice has been an option of last resort for many years. However, it has recently become a more likely option for taxpayers looking for ways to avoid criminal consequences for their past tax mistakes. That prompted the IRS to formalize the practice and provide more guidance to what taxpayers needed to do to qualify for the practice and avoid federal tax charges.
What was not clear at the time was how the voluntary disclosure practice would affect the taxpayer’s financial obligations once the IRS investigation is over. The practice does allow taxpayers to request non-willful FBAR penalties instead of willful, but until recently it wasn’t clear what fines or penalties taxpayers could expect. And that made it difficult to say whether voluntary disclosure was a good idea for any given taxpayer.
The IRS voluntary disclosure practice isn’t the first choice for any taxpayer looking to correct errors or omissions in their tax history. The Streamlined Filing Compliance Procedures (SFCP), created in 2014, provides a better option, with lower penalties, for taxpayers who qualify. It can allow some taxpayers to avoid willful FBAR penalties and other fines by voluntarily coming forward and proving that their failure to disclose foreign financial accounts and file Foreign Bank Account Reports (FBARs) was not willful. For those who qualify, the SFCP can reduce tax penalties to as little as 5% of the highest balance of the undisclosed offshore accounts in the last 3 years.
Until last year, taxpayers who didn’t qualify for SFCP could use the Offshore Voluntary Disclosure Program (OVDP) to cap the maximum penalties for unpaid taxes and unfiled FBARs and avoid the risk of a tax audit uncovering more tax consequences later on. The savings wasn’t as favorable under this plan as the SFCP, but it was available to a broader number of taxpayers. That is, until the IRS closed the program last year.
Unlike these programs, the IRS voluntary disclosure practice doesn’t come with a promise of reduced FBAR penalties. Taxpayers signing up for the practice and their attorneys didn’t know what to expect on the financial side of things. All they knew was that the penalties would be civil, rather than criminal in nature. That took federal prison time off the table.
Then in June 2019, IRS attorney Daniel Price spoke at the Texas Federal Tax Institute in San Antonio. He said that taxpayers who use the IRS voluntary disclosure practice could expect to receive a one-year civil fraud penalty and to pay willful or non-willful FBAR penalties (if they had foreign accounts). However, in most cases, he said the IRS would not impose accuracy-related penalties or delinquency penalties. In addition, the IRS would waive the possibility of criminal tax fraud charges against the taxpayer for coming forward. Since most IRS investigations span six years, this could result in a substantially reduced financial penalty for taxpayers who qualify.
But even while Price was explaining why taxpayers could benefit from the IRS voluntary disclosure practice, he also made it seem like an onerous process. The November 2018 memorandum had listed the information taxpayers would need to provide about noncompliance to qualify, including:
But Price went further. He said that in completing the Form 14457 narrative for noncompliance, taxpayers and their attorneys should go into extensive detail about how they violated the tax code, including:
Essentially, he told taxpayers’ attorneys to make the IRS’s investigation of the noncompliance as easy as possible.
Taxpayers who are accepted into the IRS voluntary disclosure practice are expected to fully cooperate with the IRS’s investigation and provide much, if not all, of this information as part of the process. However, by encouraging tax attorneys to include these details in the initial application, Price may have been encouraging people to incriminate themselves in case they are disqualified and face criminal prosecution. Price’s statement didn’t make it easy for taxpayers to choose the program, either. He said:
“If we use this door of voluntary disclosure, you’re walking in a door that’s titled ‘tax criminal,’ ...”
By encouraging tax attorneys to temper their clients’ expectations, and provide incriminating information before they have been accepted into the program, the IRS has made it harder for taxpayers to agree that voluntary disclosure is worth the risk. Before you consider negotiating with the IRS about your unreported taxes or foreign financial accounts, you should speak to an experienced tax attorney who can explain the pros and cons of participating in any program. Otherwise you could find yourself facing an even bigger mess.
Attorney Joseph R. Viola is a tax attorney in Philadelphia, Pennsylvania with over 30 years experience. If you have questions regarding the IRS voluntary disclosure practice, contact Joe Viola to schedule a consultation.