The IRS is using both a “carrot” and a “stick” to encourage more taxpayers living overseas and those with undisclosed foreign financial accounts to comply with U.S. tax obligations. The tax agency recently announced immediate changes in its Offshore Voluntary Disclosure Program, which is designed to ease taxpayer burdens as well as expand streamlined procedures for the program.

At the same time, the IRS is hiking the penalty to almost double what it was before for certain people who owe the government taxes. (IR-2014-73, 6/18/14)

Background Information

Following two previously successful programs initiated in 2009 and 2011, the IRS established another Offshore Voluntary Disclosure Program in 2012. The 2012 program incorporates ongoing efforts to coordinate tax collections with the U.S. Department of Justice. According to the IRS, the campaign has enabled the IRS to collect about $6.5 billion in taxes, interest and penalties from more than 45,000 taxpayers who have complied voluntarily. Federal prosecutors have filed more than 100 criminal indictments since 2009. The program will remain open indefinitely, subject to modifications.

Unlike the previous programs, the 2012 program had no application deadline. The overall penalty structure for the program closely resembled the 2011 initiative. It required individuals to pay a penalty of 27.5 percent (up from 25 percent in 2011) of the highest aggregate balance in foreign bank accounts and entities or value of foreign assets during the eight full tax years prior to the disclosure.

The program requires taxpayers to file all original and amended tax returns and information returns such as the Report of Foreign Bank and Financial Accounts (FBAR). It also imposes payment for back taxes and interest for up to eight years in addition to any other applicable IRS penalties relating to accuracy and delinquency. In some cases, installment payments or an arrangement as an “offer in compromise” may be available to wayward taxpayers.

The IRS is expanding its streamlined procedures to accommodate more U.S. taxpayers with unreported foreign financial accounts. Initially, the streamlined procedures announced in 2012 were available only to non-residents who had not filed returns. Taxpayer submissions were subject to varying degrees of review based on the amount of the tax due and the taxpayer’s response to a “risk” questionnaire.

The expanded procedures are available to a wider population of U.S. taxpayers living outside the country. Furthermore, for the first time, these procedures may apply to certain taxpayers residing in the U.S. The key changes include the following:

  • Elimination of a requirement that the taxpayer have $1,500 or less of unpaid tax per year;
  • Elimination of the required risk questionnaire;
  • Requiring the taxpayer to certify that previous failures to comply were due to non-willful conduct; and
  • For eligible taxpayers residing outside the U.S., all penalties will be waived. As to eligible taxpayers residing in the U.S., the only penalty that will be assessed is a miscellaneous offshore penalty equal to 5 percent of the foreign financial assets that triggered the tax compliance issue.

Modifications to the Offshore Program

The IRS also announced several important changes in the Offshore Voluntary Disclosure Program, which are designed to ease taxpayer burdens as well as expand streamlined procedures for the program.

The modifications include the following:

  • Requiring additional information from taxpayers applying to the program;
  • Elimination of the existing reduced penalty percentage for certain non-willful taxpayers in light of the expansion of the streamlined procedures;
  • Requiring taxpayers to submit all account statements and pay the offshore penalty at the time of the Offshore Voluntary Disclosure Program application;
  • Enabling taxpayers to submit voluminous records electronically rather than on paper; and
  • Increasing the offshore penalty percentage from 27.5 percent to 50 percent in cases when it becomes public that a financial institution where the taxpayer holds an account or another party facilitating the taxpayer’s offshore arrangement is under investigation by the IRS or Department of Justice (see right-hand box). This would happen prior to the taxpayer’s Offshore Voluntary Disclosure Program pre-clearance request being submitted.

Thus, the IRS is using both liberalizations and tougher penalties to improve compliance in this area. The modifications in the streamlined procedures and Offshore Voluntary Disclosure Program are generally effective as of July 1, 2014. The higher penalty (almost doubling from 27.5 percent to 50 percent) in cases when the foreign firm is under investigation takes effect on August 4, 2014. For more details about the program and related matters, consult with your tax adviser.

In summary: The new rules should encourage voluntary compliance by a greater cross-section of taxpayers. For instance, the IRS previously allowed only taxpayers owing $1,500 or less in tax to qualify for the program, reducing its impact. This requirement is being eliminated along with greater leniency for taxpayers who claim their violations were unintentional. If the IRS accepts the claims, U.S. taxpayers living abroad won’t be penalized for failing to disclose income or assets abroad. Instead, they will only be liable for taxes for the prior three years, while taxpayers residing in the U.S. who have undeclared foreign accounts could face penalties capped at 5 percent on top of taxes owed.

The latest changes reflect a renewed emphasis on improving compliance while collecting the tax that is owed to the government. Your tax adviser can tell you how to proceed in your situation.

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