IRS's Deputy Commissioner for Services and Enforcement has issued a Memorandum carrying the penalty framework to be applied to voluntary disclosure requests containing offshore issues, i.e., the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI). The memo reveals that the penalty framework will be available to anyone that makes a voluntary disclosure after the first disclosure initiative ended in 2009 (the 2009 OVDI) through Aug. 31, 2011. It also opens up the possibility of a refund for those who paid the penalty under the original voluntary disclosure but would have paid less if the new disclosure initiative had applied to them.
Background. In the spring of 2009, IRS announced a settlement offer for those that voluntarily and timely disclose unreported offshore income for 2003—2008. Those meeting the terms of the 2009 OVDI had to pay back taxes and interest for six years, and pay either an accuracy or delinquency penalty on all six years. They also had to pay a penalty of 20% of the amount in the foreign bank accounts in the year with the highest aggregate account or asset value. However, those who came forward on a timely basis did not face criminal prosecution. The original deadline was Sept. 23, 2009, but it was extended to Oct. 15, 2009.
Last month, IRS announced a second OVDI offer for taxpayers with undisclosed income from hidden offshore accounts for the 2003—2010 period. The terms of the offer are similar to those that applied for the first settlement offer, but the penalty structure is different. The general rule is that the penalty is 25% based on amounts in foreign bank accounts, but can be as low as 12.5% or 5% for some taxpayers.
Observation: In December of last year, IRS Commissioner Shulman said that any new voluntary disclosure program would carry a higher penalty, out of fairness to those who met the original disclosure program's October 2009 deadline.
Penalty framework of second offer. The new memo from IRS's Deputy Commissioner for Services explains how IRS personnel should execute agreements to resolve tax liabilities related to offshore issues of taxpayers who make voluntary disclosure requests under the second settlement offer. It applies to all offshore voluntary disclosures received after the close of the 2009 OVDI.
Observation: When the first settlement offer was extended to Oct. 15, 2009, IRS made a point of saying that there would be no further extensions and reiterated that taxpayers who did not voluntarily disclose their hidden accounts by the new deadline faced much harsher civil penalties, where applicable, and possible criminal prosecution.
For taxpayers that make voluntary disclosure requests, and fully cooperate with IRS both civilly and criminally, the agreements are to take the following shape:
... All taxes and interest due for 2003—2010 are to be assessed. However, for accounts opened or received within this period, all taxes and interest due starting with the year the account opened or was received are to be assessed. The taxpayer also must file or amend all returns, including information returns and Form TOF 90-22.1, Report of Foreign Bank and Financial Accounts, commonly known as an FBAR.
... An accuracy-related penalty must be assessed on all years (no reasonable cause exception may be applied), and failure-to-file and failure-to-pay penalties also must be assessed, where applicable.
... Instead of all other penalties that may apply, including FBAR and information return penalties, an offshore penalty is to be assessed equal to 25% (or 12.5% or 5% if required conditions are met) of the amount in foreign financial accounts/entities and the value of foreign assets acquired with untaxed funds or producing untaxed income in the year with the highest aggregate account/asset value.
The 25% penalty is reduced to 12.5% if the taxpayer's highest aggregate account balance (including the fair market value of assets in undisclosed offshore entities and the fair market value of any foreign assets that were either acquired with improperly untaxed funds or produced improperly untaxed income) in each of the years covered by the 2011 OVDI is less than $75,000.
The 25% penalty is reduced to 5% if the taxpayer: (a) did not open or cause the account to be opened (unless a new account had to be opened upon the death of the owner of the account); (b) exercised minimal, infrequent contact with the account (e.g., to request the account balance); (c) didn't, except for a withdrawal closing the account and transferring the funds to a U.S. account, withdraw 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. tax). For funds deposited before Jan. 1,’91, if no information is available to establish whether such funds were appropriately taxed, it will be presumed that they were. The penalty is also reduced to 5% for taxpayers who are foreign residents and who were unaware that they were U.S. citizens.
The new memo says examiners and their managers have no authority to negotiate different offshore penalty percentages for 2011 OVDI cases.
Refund in the works for some? The new memo says that taxpayers who participated in the 2009 OVDI (whose cases have been resolved and closed with a Form 906 closing agreement) who believe the facts of their case qualify them for the 5% or 12.5% reduced penalty criteOf the 2011 OVDI, but who paid a higher penalty amount under the original settlement agreement, should inform IRS. Upon receipt of this information, the case must be assigned to an examiner to review and make a determination. If a 2009 OVDI case is still open and the facts meet the criteria for the reduced 5% or 12.5% penalty of the 2011 OVDI, the examiner is to assert the reduced penalty as appropriate.
The memo says more guidance will be forthcoming regarding applications of the 2011 OVDI rules to 2009 OVDI cases.
References: For voluntary disclosure as defense in criminal tax case, see FTC 2d/FIN ¶V-3829; United States Tax Reporter ¶72,014.15; TaxDesk ¶871,019; TG ¶71869.