The IRS has answered 51 “frequently asked questions” (FAQs) about its voluntary disclosure and settlement option for previously unreported offshore financial accounts and entities and income from them. The six-month window for making disclosures under the program ends Sept. 23. Although IRS Commissioner Doug Shulman said the program can allow taxpayers to avoid criminal prosecution if they voluntarily report their offshore income, such disclosures, like other taxpayer voluntary disclosures, are screened for eligibility by the IRS’ Criminal Investigations Division, noted Vernon Jacobs, a CPA who is a member of the AICPA International Tax Technical Resource Panel. Generally, avoiding criminal prosecution under voluntary disclosure rules entails several conditions, including that the Service must not have already begun a civil examination or criminal investigation into the specific tax liability or received information about it from a third party (see “Voluntary Disclosure to the IRS: A Viable Option,” JofA, March 08, page 40).
The penalty framework for unreported offshore assets is outlined in March 23 memos by deputy commissioners and a public statement by Shulman. They are available, along with the FAQs and Internal Revenue Manual guidelines on voluntary disclosure, on the IRS Web site.
For qualifying voluntary disclosures, the Service will look back six years and require taxpayers to file or amend returns as necessary. These include information returns and Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, commonly known as FBAR. The IRS will assess all taxes and interest due for those years, plus either an accuracy or delinquency penalty on all years. It will waive other penalties in lieu of a penalty equal to 20% of the amount in a foreign bank account or entity in the year with the highest aggregate account balance or asset value. The latter penalty may be reduced to 5% if (1) the taxpayer did not open or cause any account to be opened or entity to be formed, (2) there has been no activity in any account or entity during the period it was controlled by the taxpayer, and (3) all applicable U.S. taxes have been paid on funds within the account or entity and only their earnings have escaped U.S. taxation.
Other penalties that may be waived under the 20% offer include the penalty for failing to file an FBAR, which can include criminal sanctions and civil sanctions as high as $100,000 or half the balance of the account. Other information returns that may be required for foreign accounts and transactions carry separate failure-to-file penalties.
Issues clarified by the FAQs, which were released May 6 and updated June 24, include:
- Taxpayers who have properly reported and paid taxes on all taxable income but failed to file FBARs will not be penalized if they properly file them and attach a statement explaining why the report or reports are late. They should do so without using the voluntary disclosure process. Rather, they should send copies of the delinquent reports, along with copies of tax returns for all relevant years, to the Philadelphia Offshore Identification Unit, a dedicated administrative office established by the IRS under the program.
- Taxpayers filing amended returns making a “quiet disclosure,” that is, outside the voluntary disclosure process, may still take advantage of the settlement option’s reduced penalties. However, because voluntary disclosure can result in forbearance of criminal prosecution, the Service encourages eligible taxpayers to use the voluntary disclosure program and warns that a quiet disclosure will not go unnoticed. “The IRS has identified, and will continue to identify, amended tax returns reporting increases in income. The IRS will be closely reviewing these returns to determine whether enforcement action is appropriate,” it said.
- Taxpayers under civil examination are not eligible to make a voluntary disclosure under the program, regardless of whether the examination relates to undisclosed foreign accounts or entities.
- Taxpayers who have not reported all income from an offshore merchant account may use the program.
- Taxpayers who voluntarily disclosed offshore accounts and entities and income from them before the start of the program are eligible for the terms of its penalty framework.
- Although the penalty framework generally requires payment of all taxes and interest for all years covered, taxpayers who demonstrate to the satisfaction of the IRS they are unable to pay may be eligible for alternative payment arrangements.
The FAQs also provide an example of the reduction in penalties taxpayers could realize: A taxpayer who started with a $1 million balance in a foreign account and earned $50,000 a year in interest over the six-year lookback period would pay $386,000 in tax and penalties, plus interest. Without the program, the same taxpayer could be liable for more than $2.3 million in tax and penalties for the period, not including interest. Furthermore, the taxpayer could incur additional penalties, besides the risk of criminal prosecution.
Given the complexity and potential hazards of voluntary disclosure, Jacobs encourages taxpayers to consult an attorney specializing in international tax issues. He lists several, along with other related information, here. The AICPA Tax Section also has resources available here.