FBAR Penalty Under Offshore Voluntary Disclosure Program Reduced from 27.5% to 5% for Certain U.S. Residents Under Recent Modifications to Offshore Amnesty Program

Perhaps the most common complaint regarding the 2012 Offshore Voluntary Disclosure Program is the "one size fits all" nature of this amnesty program. Because "non-willful", small-time foreign account holders are lumped in with sophisticated, offshore tax-dodgers and subject to the same draconian 27.5% FBAR penalty under this program, many of those holding undisclosed foreign bank accounts have elected to forego the amnesty program and make a "quite disclosure" instead. For, although approximately 45,000 individuals have entered the offshore amnesty program since its inception in 2009, it is believed that as many as ten times that amount have disclosed their foreign bank accounts via a "quite disclosure" so as to avoid paying the 27.5% penalty.

Unfortunately, the IRS does not have the resources to identify and examine all of these "quite disclosures" and, therefore, is "leaving much money on the table" in its fight against offshore tax evasion. In an effort to deal with this issue and encourage more taxpayers to join the amnesty program as opposed to filing "quite disclosures", the IRS recently made significant modifications to the 2012 Offshore Voluntary Disclosure Program, most notably the introduction of new streamlined procedures that closely mirror the "quite disclosure" process and will reduce the one-time FBAR penalty by 80% for many applicants.

The 2012 version of the OVDP initially introduced streamlined filing procedures which provided for a reduced 5% FBAR penalty for participants who met certain requirements. However, the "hoops" that one had to jump through to qualify for this lower penalty were not attainable for most U.S. residents. The most problematic requirement for U.S. residents was that the applicant must not have opened the foreign account at issue, thus effectively limiting this reduced 5% penalty for U.S. residents to those residents who inherited the offshore account. There were also restrictions on how much money could be withdrawn from the account by the U.S. resident and the frequency of contact/instructions regarding the management of funds in the offshore account. As such, the streamlined filing procedures and reduced 5% penalty introduced in 2012 were, for all practical purposes, only available to nonresidents of the U.S.

In an effort to allow a broader group of U.S. taxpayers (primarily U.S. residents) to qualify for the lower 5% FBAR penalty under the OVDP, the IRS expanded and modified the streamlined filing procedures under the OVDP, effective July 1, 2014. The Offshore Voluntary Disclosure Program, as modified effective July 1, 2014, is now referred to as the 2014 OVDP. Under the new, modified rules it is much easier for U.S. residents to qualify for the reduced 5% one-time FBAR penalty and, thus, avoid the normal OVDP FBAR penalty of 27.5 % of the highest account balance over the 8-year look-back period. Most importantly, there is no longer a requirement for U.S. residents that the foreign account be opened by someone other than the U.S. resident taxpayer applying for entry into the 2014 OVDP. Provided the resident taxpayer has filed U.S. income tax returns for the most recent 3 years, the applicant need only sign a certification that his or her noncompliance resulted from non-willful conduct.

Another recent modification in favor of the U.S. resident taxpayer is that the applicant need only file, and pay back income taxes on, 3 years of amended U.S. income tax returns (as well as accuracy-related, failure to pay, and failure to file penalties), as opposed to the 8 years of amended returns required under the normal, non-streamlined procedures. In addition to paying the one-time 5% FBAR penalty (the base for which is the highest aggregate foreign account balance over the last 6 years), the U.S. resident accepted under the new streamlined procedures must file 6 years of amended FBARs. The new streamlined procedures are even more favorable for nonresidents of the U.S., as they are not required to pay the one-time 5% FBAR penalty or the other penalties applicable to U.S. residents.

Another interesting caveat of the modified streamlined procedures is that even those who have already applied and been accepted into the 2012 OVDP can qualify for the new, more-favorable streamlined procedures by requesting such treatment in writing. The only requirement for qualifying for this retroactive relief is that you must not have executed a Closing Agreement with the government regarding your entry into the 2012 OVDP.

As they say in life, there are no free lunches. Such is the case with the new streamlined procedures, as there is some downside/risk associated with a 2014 OVDP filing under the new streamlined procedures. First of all, the 3 years of amended returns, certification, and other materials submitted under the new streamlined procedures are subject to 3 levels of review within the IRS (field examiner, supervisor and territory manager). The real risk is that your "non-willful" certification will not withstand the scrutiny of this three-level IRS review, resulting in a determination that your noncompliance was "willful", a follow-up conventional audit, and the assessment of standard FBAR penalties. It is also important to note that once you file your 2014 OVDP application under the new streamlined procedures, you cannot go back into the regular (non-streamlined) OVDP program (to get immunity from criminal prosecution)if the IRS later determines that your conduct was willful.

There is also no documented closure with the new streamlined procedures as the receipt of the three amended returns and other materials will not be acknowledged by the IRS and no closing agreement is executed at the conclusion of the streamlined process. By contrast, when you forego the streamlined procedures and pay the standard 27.5% penalty under the 2014 OVDP, you will execute a closing agreement with the IRS at the conclusion of the process, which provides you with confirmation that all of your offshore account disclosure issues have been resolved.

Obviously, an assessment of one's "willfulness" in not reporting his or her offshore bank account and related income is required in order to make an intelligent decision as to whether to utilize the new streamlined procedures under the 2014 OVDP. Unfortunately, this is a subjective test that does not lend itself to bright-line rules and regulations. However, the IRS did provide some guidance in the recent announcement regarding the modifications to the streamlined procedures. In outlining the new eligibility requirements for streamlined treatment, the IRS provides that non-willful conduct is conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

If you have been "on the fence" for some time regarding a possible voluntary disclosure of your offshore account under the OVDP, now might be the time to come forward and do just that now that the penalty has been drastically reduced for non-willful violators. Obviously, an assessment of your level of "willfulness" and a risk/reward analysis will need to be performed taking into consideration all facts and circumstances of your case. Give us a call and we will be happy to go through this exercise with you and discuss the specific details and requirements of the new streamlined procedures under the 2014 OVDP.