On February 8th, the US Internal Revenue Service announced a new ‘‘special voluntary disclosure initiative designed to bring offshore money back into the US tax system and to help people with undisclosed income from hidden offshore accounts get current with their taxes‘‘. It is called the 2011 Offshore Voluntary Disclosure Initiative (‘‘OVDI‘‘). The IRS decided to open this second amnesty because of the response to the first amnesty in 2009. That program closed on October 15th, 2009 with 15,000 voluntary disclosures. Since then, more than 3,000 US taxpayers came forward to disclose foreign bank accounts. These taxpayers will also be eligible to take advantage of this new initiative.
What‘s the cost?
The 2011 OVDI involves filing documents and paying back taxes for 2003-2010 by August 31, 2011.
The reported highlight of this initiative is an offshore penalty of ‘‘only‘‘ 25%, but that‘s not the whole story.
What penalty has to be paid if accepted into the 2011 OVDI?
In most cases, in addition to the tax, the following OVDI penalties will be payable:
(1) Accuracy-related penalty of 20% on the full amount of the additional taxes for all years;
(2) Failure to file penalty (5% per month up to a maximum of 25%), if applicable.
(3) Failure to file penalty (0.5% per month up to a maximum of 25%), if applicable.
(4) Offshore penalty in lieu of all other penalties that may apply, including
FBAR and offshore-related information return penalties, equal to 25% (but see below) of the highest aggregate balance in foreign accounts/entities or value of foreign assets during the period covered by the voluntary disclosure. (Example: failure to report rental income from an Israeli apartment subjects the value of the apartment to the offshore penalty).
What assets are subject to the 25% offshore penalty?
All foreign assets, whether directly, or indirectly owned or controlled through an entity, that are related in any way to tax noncompliance. Tax noncompliance includes failure to report income generated by the asset, as well as failure to pay tax on the funds used to acquire the assets. The type of assets include: foreign accounts holding cash, securities or other custodial assets; tangible assets such as real estate or art; intangible assets such as patents or stock or other interest in business entities.
Who is entitled to the 12.5% offshore penalty?
In limited cases, an offshore penalty of 12.5% is payable. This applies to taxpayers whose highest aggregate account balance in each of the years covered by the 2011 OVDI is less than $75,000. So, for example, if in one year your account balance was $76,000, you will not qualify for this lower penalty.
Who is entitled to the lower 5% offshore penalty?
In additional limited cases, an offshore penalty of 5% is payable. This applies to:
(1) Taxpayers who meet all four of the following conditions:
(a) did not open or cause the account to be opened; (b) have exercised minimal, infrequent contact with the account;
(c) have, except for a withdrawal closing the account and transferring the funds to an account in the United States, not withdrawn more than $1,000 from the account in any year covered by the voluntary disclosure; and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).
(2) Taxpayers who are foreign residents and who were unaware they were U.S. citizens (‘‘accidental US citizens‘‘). This may be relevant to Israeli citizens living in Israel, who were born in the US, but were unaware they were also US citizens. But proving this ‘‘unawareness‘‘ may not be easy.
Why should someone make a voluntary disclosure?
US taxpayers with undisclosed foreign accounts or foreign entities should seriously consider using the OVDI. In addition to enabling one to become tax-compliant, one can avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. The initiative also offers consistency and predictability as to the total cost of resolving all offshore tax issues.
It is going to be increasing difficult to hide foreign assets. Starting with tax year 2011, US taxpayers will be required to attach a disclosure statement to their US income tax return if the aggregate value of all ‘‘specified foreign financial assets‘‘ exceed $50,000. By 2013, foreign financial institutions will be required to identify accounts held by U.S. persons and report them to the IRS or suffer 30% withholding tax at source on all U.S. source income. Additionally, the IRS has a formal ‘‘whistle blower‘‘ program and under tax treaties can receive information.
What happens if one does not utilize the 2011 OVDI?
If a US taxpayer does not take advantage of this program, which expires on August 31st, 2011, he could be subject to more onerous civil penalties and an increased risk of criminal prosecution.
For example, depending upon the taxpayer‘s facts and circumstances, the civil penalty for failure to file form TDF 90-22.1 (Report of Foreign Bank and Financial Accounts-FBAR) could be $10,000 per year for non-willful failure, not due to reasonable cause, or the greater of $100,000 or 50% of the total balance of all foreign accounts for willful failure.
The criminal penalties for failure to file an FBAR includes a prison term of up to ten years and a fine of up to $500,000. Other penalties are also prescribed.
What years are included in the 2011 OVDI?
Taxpayers must include tax years 2003-2010 in which they have either undisclosed foreign accounts and/or undisclosed foreign entities. A fiscal year taxpayer must include fiscal years ending in calendar years 2003-2010.
Who is a US taxpayer?
US taxpayers include all of the following: a US citizen; a green card holder (with certain exceptions); US corporation, including a sub-chapter S corporation; US partnership; US LLC; US trust. US taxpayers living in Israel must file US returns even if they live in Israel and also file Israeli returns. Regulations in each country and the US-Israel tax treaty allow foreign tax credits to help avoid double taxation.
What are the terms of the 2011 OVDI?
(1) Pre-clearance: US taxpayers or their representatives may request a ‘‘pre-clearance‘‘ by faxing the IRS Criminal Investigation Lead Development Center. The IRS Criminal Investigation (CI) division will notify taxpayers or their representatives via fax whether or not they have been cleared to make a voluntary disclosure. However, it is not clear under what circumstances a pre-clearance should be used, particularly since the IRS has stated that a pre-clearance does not guarantee acceptance into the 2011 OVDI.
(2) Offshore Voluntary Disclosure Letter: If one goes through the pre-clearance procedure, then after notification from the IRS, taxpayer must submit within 30 days an offshore voluntary disclosure letter. Even if the taxpayer does not go through the pre-clearance procedure, he still must submit this letter. The IRS will review the letter and notify the taxpayer or his representative by mail whether they have been preliminarily accepted or denied entry into the 2011 OVDI.
(3) Voluntary Disclosure Package: If accepted, then the taxpayer has to submit a full voluntary disclosure package no later than August 31st, 2011. Aside from providing copies of previously filed original federal income tax returns and amended returns for the years covered by the voluntary disclosure, this package includes FBARs for the years covered by the voluntary disclosure; questionnaires relating to foreign accounts and assets and other documents, depending on the value of the undisclosed items.
For those applicants disclosing foreign financial accounts with an aggregate highest account balance in any year of $500,000 or more, copies of the statements reflecting all account activity for each of the years covered by the voluntary disclosure must be included. One must also explain any differences between the amounts reported on the account statements and the tax returns submitted. For those disclosing foreign accounts with an aggregate balance of less than $500,000, these statements should be maintained and be available upon request.
Full payment of the tax, interest, and penalties must accompany the submission by August 31, 2011. However, it is possible for a taxpayer who is unable to make full payment of these amounts to request the IRS to consider other payment arrangements.
Will IRS examiners have discretion to settle cases?
No! However, ‘‘under no circumstances will taxpayers be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed by existing statutes.‘‘ In fact, examiners must compare the two types of penalties and the taxpayer will only pay the lesser amount.
Is there any appeal if taxpayer and the IRS do not agree on the terms of the final closing agreement?
No! The taxpayer can make an irrevocable election to withdraw from the 2011 OVDI by notifying the IRS in writing. The IRS can then subject all relevant years to a complete examination (tax audit). Also, the taxpayer remains within the Criminal Investigation‘s Voluntary Disclosure Practice. And finally, the taxpayer will be subject to potentially higher civil and criminal penalties.
What if all taxable income was reported but FBARs were not filed in prior years?
Do not use the voluntary disclosure process. Instead, file the delinquent FBARs according to the instructions and attach a statement explaining why the reports are filed late. The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no unreported tax liabilities and the FBARs are filed by August 31st, 2011. However, FBARs for 2010 are due on June 30th, 2011, and must be filed by that date.
What if all taxable income was reported but Forms 5471 or 3520 were not filed in prior years?
A taxpayer who has failed to file tax information returns, such as Form 5471 for controlled foreign corporations (CFCs) or Form 3520 for foreign trusts, but who has reported and paid tax on all their taxable income with respect to all transactions related to the CFCs or foreign trusts, should file delinquent information returns with the appropriate service center according to the instructions for the form and attach a statement explaining why the information returns are filed late. The Form 5471 should be submitted with an amended return showing no change to income or tax liability. The IRS will not impose a penalty for the failure to file the information returns if there are no under reported tax liabilities and the information returns are filed by August 31, 2011.
What does all this mean?
If you are a US taxpayer with unreported assets and/or income, you should obtain experienced professional advice urgently. There is much to prepare before the August 31 deadline, and the consequences of being caught later will be worse. The IRS has shown it can elicit information efficiently from Swiss and other financial institutions.
In Israel, there is a general voluntary disclosure process which should also be considered. There was talk of an Israeli amnesty last year but that has yet to materialize. Israel has tax treaties with the US, UK, France and Germany, which are all reported to hold Swiss or Lichtenstein bank data. These tax treaties can be used to exchange information between the respective tax authorities, on occasion.
If you are an Israeli resident and also have not reported taxable income from offshore accounts or assets to the Israeli Tax Authority, you should consult with an experienced Israeli tax advisor about filing original or amended Israeli income tax returns. Israeli residents have had to report worldwide income since tax year 2003.
Don Shrensky is a U.S. and Israeli CPA at Don Shrensky & Co.;
Leon Harris is a certified public accountant and international tax specialist at Harris Consulting & Tax Ltd