What tax professionals need to know about the IRS Offshore Voluntary Disclosure Program
More due-diligence issues practitioners should be aware of for this filing season.
November 8, 2012
Plenty of great CPAs and other tax professionals have neglected to report their clients’ foreign account holdings. If you were one of them, here are three reasons you are in good company.
First, although filing an FBAR (Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts) has been required since 1970, until recently, this requirement was rarely acknowledged or followed. It was, in essence, like driving five mph over the speed limit. Everyone drives at least five mph over the speed limit. It is the custom. It is odd when someone drives the speed limit or even below it. A similar custom was true of FBAR filings. For years FBARs were legally required to be filed. However, this law was all but unenforced. It was an after-the-fact crime to tack onto already-established charges of money laundering and similar crimes.
Second, much of the software used by tax professionals assumes that taxpayers do not have foreign accounts. At least some brands of software would, until recently, automatically check the box indicating that the client had no foreign accounts. To report clients’ accounts, practitioners would have to specifically train staff and implement a fail-safe to verify that clients were specifically asked if they had offshore holdings.
Third, clients are unaware that there is worldwide tax jurisdiction and, with no specific intent to defraud, neglect to tell their CPAs about these accounts. This is especially true for recent immigrants and workers in the United States on visas. When providing tax information, it is common for clients to assume that their holdings in their countries of origin are not relevant for their U.S. taxes. There is some good reason for this. The United States is the only member of the G-7 nations (France, Germany, Italy, Japan, the United Kingdom, and Canada) to have a worldwide tax system, which means that U.S. citizens or residents are taxed on all of their income no matter where it is earned.
This, combined with a general lack of knowledge about FBAR filing and potential consequences of improper reporting, has led many diligent tax professionals to omit foreign accounts from their clients’ tax preparation.
Where does this leave practitioners and clients? Now in its third version, the IRS’s 2012 Offshore Voluntary Disclosure Program (OVDP) and many aspects of FBAR and overseas asset disclosure are creating confusion among taxpayers and tax professionals. These issues include:
1. Uncertain obligations
It is extremely difficult for tax professionals and their clients to determine how best to comply with IRS rules for offshore asset disclosure, especially after a failure to report has already occurred. The guidance for these cases is solely on the IRS website and consists largely of 55 frequently asked questions and answers (FAQs); it is lengthy and confusing. It can be quite difficult to tell which procedures apply to a taxpayer, or what the taxpayer can ultimately expect the resolution of his or her issue to be. The only case law about FBAR penalties is Williams, 1:09 cv-437 (E.D. Va. 2010), rev’d and remanded, No. 10-2230 (4th Cir. 2012), which demonstrates the unclear nature of these cases.
Williams was a former oil company executive who engaged in tax evasion. He pleaded guilty and went to prison. During his sentencing, he was assessed penalties for willful failure to file FBARs. Williams contended that he failed to report the accounts, but that the failure could not be willful as he had already reported the accounts during plea negotiations. While the district court agreed with him, this summer, the Fourth Circuit overruled the decision and imposed FBAR penalties.
2. Uncertain penalty calculations
The primary feature of the 2012 OVDP is the payment of a penalty of 27.5% on the highest aggregate balance of offshore accounts during the period covered in the disclosure. The penalty is intended to apply to any accounts that were tax noncompliant. This becomes more complicated with the addition of the value of certain noncompliant assets, the major example being rental property. Taxpayers who have failed to report rental income earned overseas must include the total value of that property in calculating the penalty, despite the fact that (1) the OVDP penalty is intended to be in lieu of FBAR penalties, but rental property cannot be reported on the FBAR; (2) FAQ No. 37 states that transfers between accounts do not have to be included twice, although the taxpayer has the burden of proving these transfers occurred, so while the rental income has likely already been captured through account balances it need not be counted twice; and (3) the relationship between value of the rental property and the balance of offshore accounts is tenuous.
The penalties for even innocent noncompliance are harsh. In the best case, a 5% penalty is assessed on the highest account value. Additionally, there are compliance costs. The OVDP process is lengthy, and tax attorney and CPA fees are additional burdens that scare people into continuing noncompliance. These problems increase noncompliance as taxpayers must hide a little deeper to avoid getting caught by the new Foreign Account Tax Compliance Act rules.
Additionally, there is a recent 2012 Streamlined OVDP, which started in September and is full of complicated rules and uncertain qualifications.
3. Uncertain criminal prosecutions
The IRS offers no promises: Admission into either the standard or streamlined OVDP does not bar the Justice Department from bringing criminal charges. And as anyone who is engaged in tax controversy practice can attest, there is always a wide disparity of results. The IRS warns not to make a so-called quiet disclosure (which means filing amended returns disclosing foreign items without alerting the IRS), and it will be looking to prosecute and penalize those with undisclosed foreign accounts who do not disclose using the 2012 OVDP. However, the IRS also says the OVDP is voluntary.
What should you advise your clients?
For certain cases, it will be difficult for the Justice Department to bring criminal charges. But the tax practitioner is in a difficult position. The IRS has indicated that it will consider CPAs who advise quiet disclosure (or nondisclosure) to be in violation of Circular 230, and any such advice is not protected by the attorney-client privilege.
Navigating the OVDP takes a unique blend of talents. Practitioners need to apply past practices and likely IRS and Justice Department stances to the client’s situation; build the client’s case for appeal in court; and not be barred from raising claims because of a failure to exhaust administrative remedies. It takes particular skill to navigate the bureaucratic minefield of the OVDP program and honestly disclose information, while showing clients in a more favorable light.
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Anthony E. Parent, Esq., is the founder of IRS Medic, a law firm that specializes in representing taxpayers before the IRS, including offshore disclosures.