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Offshore Voluntary Disclosure Program Round Four: 
IRS Announces Further Changes to Encourage Broader Compliance

On June 18, 2014, the Internal Revenue Service (IRS) announced extensive changes to the Offshore Voluntary Disclosure Program (OVDP) last revised in 2012. [1] Coinciding with changes to the OVDP are changes and expansion of the Streamlined Filing Compliance Procedure (SFCP) previously only available to U.S. citizens and lawful permanent residents residing outside of the United States. In general, the changes to both regimes reflect a concession by the IRS that a ‘‘one size fits all’’ program may not be the best approach to encourage compliance.

BRIEF HISTORY OF OFFSHORE VOLUNTARY DISCLOSURE INITIATIVES

       ‘‘Our goal is to build on the success the IRS has already had in reducing offshore tax evasion through the OVDP, which allows individuals to avoid criminal prosecution if they disclose their foreign accounts and pay a substantial penalty.’’ IRS Commissioner John Koskinen

Although the IRS has had measures in place to encourage disclosure of foreign accounts for over a decade, the genesis of the current OVDP goes back to May 2009 when the IRS announced an ‘‘amnesty’’ for individuals with foreign accounts who failed to file FinCEN Form 114 Foreign and Financial Bank Account Reports (formerly Form TD F 90-22.1) (‘‘FBARs’’) and other required information returns regarding foreign accounts and assets or report and pay tax on the income of those accounts and assets (‘‘2009 OVDP’’). The 2009 OVDP closed on September 23, 2009. It was followed approximately a year and one half later by the offshore voluntary disclosure initiative announced on February 8, 2011 (‘‘2011 OVDI’’). The 2011 OVDI also closed within months of its announcement on September 9, 2011. In contrast to the limited duration of the initiatives in 2009 and 2011, the OVDP in place since June 26, 2012 (‘‘2012 OVDP’’) was an open-ended program without a specific sunset date, with the qualification it could be closed or changed at any time.

In each of the three prior incarnations, the amnesty from criminal prosecution was not free. Previously unreported income from foreign accounts and assets often created additional tax subject to statutory interest and a 20% understatement penalty. Taxpayers were also subject to significant penalties for the failure to file FBARs and other information returns (‘‘Offshore Penalty’’). The Offshore Penalty increased from 20% under the 2009 OVDP, to 25% under the 2011 OVDI, to 27.5% under the 2012 OVDP. In addition, participation in each of the previous compliance initiatives required disclosure of the banking institutions at which the offshore accounts were held and the personnel at those institutions who assisted the taxpayer in opening and maintaining the foreign accounts. In response, the IRS received more than 45,000 disclosures and collected approximately $6.5 billion in taxes, interest, and penalties. [2]

Starting September 1, 2012, the IRS offered nonfiling taxpayers residing outside the United States since at least January 1, 2009, an alternative to the OVDP. [3] The SFCP allowed nonresident U.S. persons(that is, U.S. citizens and lawful permanent residents residing outside the United States) to come into compliance by filing significantly fewer years’ back returns (three years instead of eight). Those taxpayers who represented a low compliance risk could avoid all penalties for past noncompliance. [4] ‘‘Low risk will be predicted on simple returns with little or no U.S. tax due.’’ [5] However, for those taxpayers representing a high compliance risk the enticement of fewer years’ returns with no penalties could prove to be a trap. Unlike the OVDP which capped penalties and generally assured no criminal prosecution, a taxpayer representing a high compliance risk could be subject to the same examination and penalties as taxpayers who opted out of the OVDP. [6] Compliance risk was determined on the basis of nine factors including the presence of material economic activity in the United States, complete reporting of income in the taxpayer’s country of residence, previous assertions of FBAR penalties, financial interest in or authority over accounts or entities outside the country of residence, and indications of ‘‘sophisticated tax planning or avoidance.’’ [7] Most importantly, eligibility for the SFCP was considerably more narrow than the OVDP. The SFCP was only available to taxpayers residing outside the United States since January 1, 2009, who had failed to file U.S. income tax returns for those years.

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[1] See Robert E. Ward, 2012 Offshore Voluntary Disclosure Program: Issues and Opportunities, 41 Tax Mgmt. Int’l J. 548 (Oct. 12, 2012).
[2] Statement of IRS Commissioner John Koskinen, posted to IRS.GOV June 18, 2014.
[3] See generally Information Release 2012-65 (June 26, 2012), Instructions for New Streamlined Filing Compliance Procedures for Non-Resident, Non-Filer U.S. Taxpayers.
[4] Id. ‘‘For those taxpayers presenting low compliance risks, the review will be expedited and the IRS will not assert penalties or pursue follow up actions.’’
[5] Id. In the author’s experience with nonresident taxpayers who opted out of the OVDP, the complexity of the return or the amount of tax due was often not a bar to successful use of the SFCP.
[6]Id.
[7] Id. Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers Effective for OVDP Submissions Made On or After July 1, 2014, posted to IRS.GOV June 18, 2014 (‘‘2014 FAQs’’).