Offshore Voluntary Disclosure Program (OVDP) explained
By law, every U.S. citizen and U.S. resident is required to file certain financial disclosures and U.S. income tax returns (provided certain requirements are met), regardless of their place of residence. On a more fundamental principle, all U.S. citizens residing outside of the United States are expected to comply with U.S. law, including tax law, no matter how complex that law is or how frequently the law or regulations change. And they do change a lot and often.
With the new technological capabilities, enhanced transparency, and ever-increasing collaboration of foreign financial institutions with the U.S. Internal Revenue Service (“IRS”), locating and tracking of delinquent U.S. taxpayers outside of the United States is no longer a serious challenge. Moreover, since the enactment of Foreign Account Tax Compliance Act (“FATCA”) in 2010, most U.S. counterparts signed Model I or Model II Intergovernmental Agreements (“IGAs”) with the United States and enacted domestic legislation consistent with the IGAs.
In case of Canada, for example, under currently effective Model I IGA, Canadian financial institutions (a term broadly defined) are required to report beneficial ownership of certain accounts to the Canada Revenue Agency (“CRA”) that in turn transmits that information to the IRS. That in turn, makes it almost impossible to stay off of the IRS’s far-reaching radar. In short, ignorance is not bliss when it comes to tax laws and the consequences of being non-compliant may be severe. In some cases, civil penalties, quite substantial at that, are just the beginning of what may end up for delinquent taxpayers in potential criminal prosecution in a worst-case scenario. And, the clock is ticking… and, time is running out for taking a proactive approach and protecting one’s interests.
Delinquent taxpayers often ask why should they come into compliance now, after all, the IRS has not been able to “find” them all those years. The answer is simple: coming into compliance voluntarily and pro-actively, under one of the IRS amnesty programs, allows delinquent taxpayers avoid substantial civil penalties and generally eliminate the risk of criminal prosecution with respect to the matters covered under the applicable amnesty program. Importantly, once in compliance, the taxpayers can stop worrying that one day, the IRS may get to them. If that happens, the delinquent taxpayer loses all protection that in many cases may be otherwise available under one of the amnesty programs.
In the days preceding the 2014 amendments to the IRS amnesty programs and the introduction of new submission procedures, making a “quiet disclosure” was not necessarily being encouraged by the IRS, but in many cases likely “tolerated.” After the June 18, 2014, program amendments, the IRS explicitly stated that the “[t]axpayers are encouraged to avail themselves of the protection from criminal prosecution and the favorable penalty structure offered under the OVDP. Unlike a voluntary disclosure through the OVDP, quiet disclosures provide no protection from criminal prosecution and may lead to civil examination and the imposition of all applicable penalties.” One should hesitate making a quiet disclosure under the currently applicable compliance framework, as doing so may potentially be considered as a “willful conduct” and, for example, disqualify a delinquent taxpayer from SFCP, thus resulting in significant civil penalties, and, potentially, depending on the taxpayer’s facts and circumstances, criminal prosecution.
Doing nothing is becoming less of an option and may actually work against the delinquent taxpayer. First, although the amnesty programs currently in effect are open-ended and the IRS and Treasury officials have informally stated on numerous occasions that the IRS and the U.S. Department of Treasury do not have plans to close the program, the reality is that the programs may be closed anytime. With significant media exposure to this topic, making an argument that one was unaware of her/his U.S. tax filing and FBAR disclosure obligations in 2016 is much more difficult to make than making that same argument a few years ago or pre-FATCA days. Second, delinquent taxpayers who knew about their U.S. tax filing and FBAR disclosure obligations or who would fail making an ignorance of the law argument are worse off because they may lose the “non-willful conduct” argument, thus resulting in substantially higher civil penalties and potential criminal prosecution. This argument would be even more difficult to maintain for delinquent taxpayers who studied in the United States, are highly educated, have U.S. source income, or otherwise have close ties with the United States.
Who should consider OVDP & SFCP?
Are you a U.S. citizen, green-card holder, or a dual citizen of the United States and some other country (or countries), living or working outside of the United States? How do you know you are up to date on your taxes and fully tax compliant? More importantly, how do you know if you are not missing out on filing additional disclosures with the U.S. government?
- Have you been filing your U.S. tax returns (which, by the way, are not necessarily limited to income taxes) or stopped filing them at some time?
- Do you still have some unfiled or back taxes?
- Do you have any offshore income (that you earned outside of your country or residence and outside of the United States) or accounts?
- Have you opened a bank account or have been asked by your financial institution to provide updated information, including the details about your U.S. citizenship?
- Have you been asked to provide Form W-9 or Form W-8BEN (W-8BEN-E) to a U.S. payor/withholding agent?
- Have you been asked by a border officer when crossing Canada-U.S. border whether you are compliant with U.S. taxes and other reporting obligations?
- Have you started the process in the earlier years (2009, 2010, 2011) and never filed a complete OVDP submission?
- Have you been receiving IRS notices, but kept ignoring them?
Did you know that some of your bank accounts, life insurance policies, registered and non-registered investment accounts located in countries other than the United States must be reported on Form 114 FinCen (Foreign Bank Account Reporting (FBAR)) annually?
If you are not 100 per cent sure what the answers to the above questions are, you should talk to us. There are a number of “tax amnesty” programs that the IRS currently offers to help individuals and entities with undisclosed offshore (non-U.S.) accounts and assets, unreported offshore income, as well as delinquent tax returns and international information returns to ensure their U.S. tax compliance and other reporting obligations are fully met. The IRS has programs that are suitable to both U.S. taxpayers residing outside the United States and U.S. taxpayers residing in the United States. The availability of such programs to any delinquent taxpayer depends on a number of factors, but all of the programs are premised on the critical factor - the lack of the IRS initial contact or an IRS examination. In addition, the availability of programs that provide some or complete penalty relief depends on what is known as “willful conduct” of a delinquent taxpayer.
IRS currently available options for delinquent taxpayers to become compliant
Offshore Voluntary Disclosure Program (OVDP)
The OVDP provides an opportunity for delinquent taxpayers with undisclosed income from offshore accounts to become compliant and to avoid criminal prosecution. But the relief comes at a price: the delinquent taxpayers applying to the OVDP must agree to pay a miscellaneous offshore penalty and other applicable penalties (such as accuracy-related penalties, failure-to-file and failure-to-pay penalties).
The miscellaneous offshore penalty may equal 27.5 per cent or 50 per cent of the highest aggregate value of undisclosed assets during the years covered by the OVDP. The 50 per cent penalty generally applies if at the time of submitting the pre-clearance letter to the IRS Criminal Investigation Unit “an event has already occurred that constitutes a public disclosure that either (a) the foreign financial institution where the account is held, or another facilitator who assisted in establishing or maintaining the taxpayer’s offshore arrangement, is or has been under investigation by the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person; (b) the foreign financial institution or other facilitator is cooperating with the IRS or the Department of Justice in connection with accounts that are beneficially owned by a U.S. person or (c) the foreign financial institution or other facilitator has been identified in a court-approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a “John Doe summons”) at the foreign financial institution or have accounts established or maintained by the facilitator.” The IRS posted a list of foreign financial institutions or facilitators and continually updates it. That list can be found here.
OVDP is generally suitable for those delinquent taxpayers who may face a detection risk by the IRS or may be subject to criminal prosecution. Both individuals and entities are eligible to participate in OVDP.
Streamlined Filing Compliance Procedures (SFCP)
The SFCP is generally designed to provide an opportunity to become compliant for those delinquent taxpayers who did not have “willful conduct” in failing to disclose their foreign financial assets and pay all tax due with respect to those assets. In contrast to the OVDP, the SFCP is only available to individual taxpayers or estates of individual taxpayers.
The eligibility to the SFCP is premised on meeting several eligibility criteria. Structurally, the SFCP is split into two sub-programs: (i) streamlined procedures for non-U.S. residents - Streamlined Foreign Offshore Procedures (“SFOP”); and (ii) streamlined procedures for U.S. residents – Streamlined Domestic Offshore Procedures (“SDOP”).
THE FOLLOWING REQUIREMENTS MUST BE MET TO BE ELIGIBLE TO PARTICIPATION IN EITHER SFOP OR SDOP:
- Non-willful conduct certification requirement. Delinquent taxpayers must certify, under penalties of perjury, that their failure to report all income, pay all tax and file all required information returns, including FBARs was due to non-willful conduct.
- IRS initial contact. Delinquent taxpayers with respect to whom the IRS has initiated a civil or criminal examination are not eligible to participate in SFCP.
- Valid Taxpayer Identification Number. Delinquent taxpayers must have either a valid Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN). For those taxpayers who don’t have ITIN, they can attach ITIN application (Form W-7) to their streamlined submission.
- Mutually exclusive procedures. SFCP and OVDP are mutually exclusive in that once a delinquent taxpayer filed her/his submission under SFCP, she/he is ineligible for OVDP. The same is true if the delinquent taxpayer applied for OVDP (she/he is then ineligible for SFCP).
THE FOLLOWING ADDITIONAL REQUIREMENTS APPLY FOR DELINQUENT TAXPAYERS WHO WOULD LIKE TO BECOME COMPLIANT USING SFOP:
- Non-residency requirement. Generally, with respect to U.S. citizens or Green card holders (different test applies to non-U.S. citizens or Green card holders), a taxpayer meets the non-residency requirement if she/he, in any one or more of the most recent three years for which the U.S. tax return due date (including all applicable extensions) has passed, the taxpayer did not have a U.S. abode and was physically outside the United States for at least 330 full days. This is an especially harsh test for those delinquent taxpayers who may have traveled to the United States during the covered period for business, without the ability to control their travel.
- Failure to report the income from undisclosed foreign financial assets. The delinquent taxpayers filing SFOP submission must have failed to report the income from a foreign financial asset and pay tax, and may have failed to file FBAR with respect to a foreign financial account.
- Non-willful conduct. The delinquent taxpayers filing SFOP submission must have failed to file applicable U.S. tax returns and FBARs, or other relevant information returns, due to a non-willful conduct. Such conduct is defined as a conduct due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.
THE FOLLOWING ADDITIONAL REQUIREMENTS APPLY FOR DELINQUENT TAXPAYERS WHO WOULD LIKE TO BECOME COMPLIANT USING SDOP:
- Failure to meet the non-residency requirement under SFOP. Delinquent taxpayers who failed to meet the non-residency requirement under SFOP may qualify for SDOP.
- Previously filed tax returns. Delinquent taxpayers applying for SDOP must have filed a U.S. tax return (when required) for each of the most recent three (3) years for which the U.S. tax return due date (including applicable extensions) has passed.
- Failure to report the income from undisclosed foreign financial assets. The delinquent taxpayers filing SDOP submission must have failed to report the income from a foreign financial asset and pay tax, and may have failed to file FBAR with respect to a foreign financial account.
- Non-willful conduct. The delinquent taxpayers filing SDOP submission must have failed to file applicable U.S. tax returns and FBARs, or other relevant information returns, due to a non-willful conduct. Such conduct is defined as a conduct due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.
Delinquent FBAR Submission Procedures
Under IRS Delinquent FBAR Submission Procedures, delinquent taxpayers who failed to disclose their foreign financial assets or accounts can become compliant, provided they meet certain requirements of the procedures.
For example, delinquent taxpayers must not be under a civil examination or a criminal investigation by the IRS and should not have already been contacted by the IRS about the delinquent FBARs.
Delinquent International Information Return Submission Procedures
Under IRS Delinquent International Information Return Submission Procedures, delinquent taxpayers who failed to file certain international information returns, such as Forms 5471, 5472, 3520, 3520-A, and other similar forms can become compliant, provided they meet certain requirements of the procedures.
For example, delinquent taxpayers must have reasonable cause for not timely filing the information returns. In addition, delinquent taxpayers must not be under a civil examination or a criminal investigation by the IRS and should not have already been contacted by the IRS about the delinquent information returns.
How do you know which program is right for you?
The procedural alternative to become compliant depends on a number of factors, and should be determined based on all applicable facts and circumstances. Some factors that should be considered include a possibility of criminal prosecution, the source of funds, ability of delinquent taxpayers to meet the requirements of a particular IRS program, and other factors.
A willful conduct determination is another critical aspect that should assist delinquent taxpayers in figuring out what option would allow them to resolve their non-compliance issues in the most tax- and cost-efficient manner.
Finally, qualification for any of the programs should consider additional effects of prior transactions or future tax planning for individuals and businesses applying to one of the IRS programs.