The objective of the recently expired Offshore Voluntary Disclosure Program (OVDP) enabled willful U.S. taxpayers with undisclosed foreign assets to become compliant with U.S. tax laws, while concurrently avoiding serious statutory civil penalties and practically removing any risk of criminal prosecution. On November 29, 2018, the Internal Revenue Service (IRS) posted Internal Revenue Manual (I.R.M.) §9.5 interim guidance in a memorandum (the “memo”) addressing the process for all domestic and offshore voluntary disclosures since the closing of the OVDP on September 28, 2018. Generally, the voluntary disclosure process maintains some similarity to the OVDP, but taxpayers and practitioners should note the revisions highlighted here, including the higher penalties for unreported taxes due and delinquent informational reporting.
The memo clarifies that the IRS Criminal Investigation (CI) will be responsible for screening all domestic and offshore voluntary disclosure requests to determine taxpayer’s eligibility to make such disclosure. As such, the IRS stated that “CI will require all taxpayers wishing to make a voluntary disclosure to submit a preclearance request on a forthcoming revision of Form 14457.” The Form 14457 will require taxpayer-specific information, including “a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance.”
Also, for all voluntary disclosures received after September 28, 2018, the memo provides that, unlike the OVDP’s eight-year disclosure period, in disclosures resolved by an agreement, only the most recent six tax years are required to be disclosed under the new procedures. Upon the IRS’s review and consent, a “cooperative” taxpayer may be allowed to submit for prior years. Expansion of the disclosure period may be desirable when rectifying tax issues involving unreported taxable gifts, correcting tax problems before entity sale or acquisition, and other circumstances.
Significantly, under the interim guidance, taxpayers making a voluntary disclosure are subject to a much larger penalty for evasion. While the OVDP imposed a 20% annual accuracy-related penalty on unreported taxes due, the interim guidance provides for a 75% fraud penalty on the year with the highest tax liability. Specifically, the IRS states in the memo that:
Except as set forth below, the civil penalty under I.R.C. §6663 for fraud or the civil penalty under I.R.C. §6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. For purposes of this memorandum, both penalties are referred to as the civil fraud penalty.
Note that, based on an analysis of the facts and circumstances of each case, the IRS may in “limited circumstances” apply the civil fraud penalty to other years. Obviously, many practitioners see the increased penalty as potentially having a chilling effect on voluntary disclosures; however, all things considered, the primary objective of a voluntary disclosure should be to receive the protection from criminal prosecution.
The memo addresses other penalties, as well. As for the penalties for willfully failing to file FinCEN Form 114, Report of Foreign Bank Accounts (FBAR), the memo explains that the IRS will assert such penalties per the existing IRS penalty guidelines under I.R.M. 4.26.16 and 4.26.17. Generally, willful FBAR violations result in a penalty of up to the greater of $100,000 or 50% of the maximum account value. The memo goes on to state that although a taxpayer is not precluded from requesting the lesser non-willful FBAR penalty, “granting requests for the imposition of lesser penalties is expected to be exceptional.”
Interestingly, the IRS states in the memo that “[p]enalties for the failure to file information returns will not be automatically imposed.” Rather, IRS agents have the discretion to assess such penalties. In making their determination, the memo clarifies that an agent’s discretion will take into consideration other penalties already proposed, like the willful FBAR penalty and civil fraud penalty. Presumably, one may expect that if steep FBAR penalties were imposed, the agent may withhold informational return penalties in his or her discretion.
The memo indicates that all impacted I.R.M. sections will be updated within 2 years of the date of the memo. Furthermore, the memo’s procedures will be effective for all voluntary disclosures received after September 28, 2018.
While the updated process continues to allow taxpayers to escape criminal prosecution by voluntary disclosure, taxpayers face a higher penalty for unpaid taxes and delinquent informational reports and an array of new rules for the disclosure itself. An experienced tax professional’s guidance should be sought to navigate the new process.
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