IRS Opens Second Offshore Voluntary Disclosure Initiative

On February 8, 2011, the Internal Revenue Service announced its 2011 Offshore Voluntary Disclosure Initiative (OVDI) designed to allow U.S. taxpayers with undisclosed income from offshore accounts or entities one more opportunity to become current with their tax obligations. The deadline to come into full compliance with the OVDI is August 31, 2011.

When the 2011 OVDI was announced, the IRS commissioner Doug Shulman stated that “this new effort gives those hiding money in foreign accounts a tough, fair way to resolve their tax problems – once and for all. It gives people a chance to come in before we find them.”

The new initiative, announced in part through a news release (IR-2011-14), is different in several ways from the 2009 offshore voluntary disclosure program which ended as of October 15, 2009. Under the 2011 OVDI, applicants must pay a penalty of 25% of the highest aggregate account balance in the foreign bank accounts or entities from 2003 through 2010. Of course, participants must also pay back taxes and interest for those eight years, as well as failure to pay penalties, and either a 20% accuracy-related penalty or a 25% delinquency penalty, depending on the situation.

Instead of a penalty of 25% of the highest aggregate account balance, some taxpayers will be eligible for either a 12.5% or a 5% penalty. Applicants whose offshore accounts or assets did not surpass $75,000 in any of the calendar years covered by the 2011 OVDI will qualify for the 12.5% penalty. Applicants may qualify for the lower 5% penalty if they: (a) did not open or cause the account to be opened; (b) have exercised minimal, infrequent contact with the account; (c) have not withdrawn more than $1,000 from the account in any year covered by the OVDI, except for a closing of an account with a transfer of funds to the U.S.; and (d) can establish that all applicable U.S. taxes have been paid on the funds deposited to the account. For funds deposited before January 1, 1991, if no information is available to establish whether such deposits were appropriately taxed, it will be presumed that they were. In addition, the 5% penalty will apply when taxpayers living abroad did not realize that they were U.S. citizens.

Critically, taxpayers who wish to participate in the new initiative must file all original and amended tax returns and include payment for taxes, interest, accuracy-related or delinquency penalties, and failure to pay penalties, by the deadline of August 31, 2011. This August 31st deadline means that taxpayers who wish to participate need to gather information from the foreign bank or banks, arrange for their accountants to prepare amended returns for eight years, complete an application and comply with all of the other applicable requirements listed as submission requirements on the IRS website, and write out a check to cover the taxes, interest, accuracy-related or delinquency penalties, and failure to pay penalties, by the August 31st deadline.

Those taxpayers that applied under the general IRS voluntary disclosure program after the 2009 offshore account program closed will be treated as eligible for the benefits of the 2011 OVDI. Like the 2009 voluntary disclosure program, taxpayers who are already under audit or are already known to have foreign accounts by the IRS, will not be eligible for the 2011 OVDI.

Taxpayers who can not pay the full amount due by August 31 can request the IRS to consider other payment arrangements, but the burden will be on the taxpayer to show an inability to pay, based on a detailed written disclosure of all domestic and offshore assets and income sources.

As a result of the 2009 program, the IRS gathered nearly 15,000 disclosures from around the world. Since that program officially ended, another 3,000 taxpayers have applied through the general IRS voluntary disclosure program. Through those filings, the IRS has gathered a significant amount of information regarding foreign banks that marketed their services to U.S. taxpayers, and the IRS is now pursuing those banks. Without providing details, Commissioner Shulman implied that banks in dozen of countries are being looked at and the IRS has been tracking a migration of undisclosed foreign bank account assets out of Europe and into Asia.

In announcing the 2011 OVDI, the IRS issued details in a frequently asked questions and answers format, the FAQs. The FAQs are over fifteen pages long and provide details on the OVDI procedures and the need to file Reports of Foreign Bank and Financial Accounts (FBARs) with the U.S. Treasury Department. The FAQs also outline a methodology for taxpayers who have investments that constitute passive foreign investment companies (PFICs) to comply with what otherwise is generally considered to be a fairly complex PFIC compliance scheme.

Taxpayers who are on the fence with respect to whether they should come forward, should consider Commissioner Shulman’s parting comments on February 8. “For those hiding cash or assets offshore, there is an obvious reason to come in now. If we find you, you face harsher penalties and the possibility of jail time. If you come in voluntarily, you pay a steep price but avoid going to jail.”

Given the potential complexity and stress of addressing all of the requirements of the 2011 OVDI by the fixed deadline of August 31, 2011, in part because the program requires taxpayers to address eight years of returns, we strongly recommend that interested taxpayers work with professional tax advisers to make sure that they take advantage of what is being characterized as a last opportunity.

This alert was written by Peter J. Ulrich, a Director in the Gibbons Corporate Department in its Newark office.