In March of this year, we devoted this column to the Internal Revenue Service's newly announced 2011 Offshore Voluntary Disclosure Initiative for disclosing income from foreign accounts and assets. Key features of the program are an Aug. 31, 2011, deadline, an eight-year disclosure period, a maximum 25 percent penalty for failure to disclose, reduced 12.5 or 5 percent penalties in specified situations, and various documentation and disclosures required with the submission.
In June, the service released additional information on the disclosure initiative in the form of additions to its list of frequently asked questions. Those additions provide for a possible extension of the deadline beyond Aug. 31, 2011, an additional category of taxpayers eligible for a reduced maximum penalty under the program, clearer procedures for opting out of or being removed from the program, and revised - and generally more favorable - penalty calculations.
EXTENSION BEYOND AUG. 31, 2011
The IRS has announced that taxpayers seeking to come in under the disclosure initiative may request an extension of the deadline for up to 90 days where they are having difficulty assembling all of the necessary information by the August 31 deadline.
Complete disclosures under the Offshore Voluntary Disclosure Initiative are required to include the disclosure initiative letter, a foreign account or asset statement, copies of filed original and amended tax returns, an accounts summary and penalty calculation, payment or proposal for a payment arrangement, a statute of limitations extension, and, for certain taxpayers, foreign financial institution statements.
Taxpayers making an extension request to submit their application beyond the Aug. 31, 2011, deadline must include a list of the items that are missing, the reasons that they are missing, and the steps taken to secure them. The request must also include the statute of limitations waiver extension.
Taxpayers will want to consider how likely they are to obtain the missing information by the deadline before submitting an extension request. Taxpayers could be put into the situation of having identified themselves to the IRS without being able to meet the requirements of the OVDI by the deadline. This could expose the taxpayer to a regular examination, regular penalties, and even criminal prosecution.
In any event, the IRS in its additional guidance that allows the extension is offering no promise of an automatic approval of a taxpayer's extension request, nor did it give any guidelines on what is needed to be approved for a full 90-day extension within its announcement that "up to 90 days" may be approved.
EXPANDED REDUCED PENALTIES
The 5 percent penalty under the OVDI may apply to taxpayers who can demonstrate that the foreign account was not used to hide income and any withdrawals of more than $1,000 in any year were transferred to an account in the U.S. It could also apply to a taxpayer who is a foreign resident and was unaware of also being a U.S. citizen.
In the recently expanded frequently asked questions, the IRS also states that the 5 percent penalty can apply to taxpayers who are foreign residents, who met all of their tax requirements of the country of residence, had $10,000 or less of U.S.-source income each year, and included on the foreign tax returns all offshore-related income that was not reported on the U.S. return.
Clearly the reduced penalties continue to be aimed at taxpayers who failed to fulfill their U.S. tax obligations out of ignorance, rather than out of an intent to hide income or assets.
During the 2009 Voluntary Disclosure Initiative, the IRS ended up getting into discussions about the degree of willfulness of the taxpayer and the scope of the penalty that will apply. For the 2011 initiative, the IRS is clearly stating that it does not intend to get into such negotiations. The taxpayer must decide whether the scope of the voluntary disclosure program with its stated penalties will be advantageous to the taxpayer, or whether the taxpayer might be better off being subjected to a regular examination.
A regular examination could expose the taxpayer to a larger number of tax years at issue and also to potentially larger penalties and even criminal prosecution. On the flip side, however, it could also permit a waiver of some of those penalties where there was a lack of willfulness or other factors. The frequently asked questions give a number of examples of situations in which a taxpayer might want to consider opting out of the voluntary disclosure initiative.
The IRS emphasized that the act of opting out of the Offshore Voluntary Disclosure Intiative will not be a factor held against the taxpayer. Still, the taxpayer will be entering into a regular examination with none of the protections afforded by the disclosure initiative. The Department of Justice recently announced charges against a taxpayer who made a "quiet disclosure" during the 2009 voluntary disclosure program by filing foreign bank account reports and amended returns but not formally participating in the voluntary disclosure program.
One of the requirements of the disclosure initiative is full cooperation and disclosure with the IRS. The service has provided guidance clarifying the standards that will be used to determine when a taxpayer will be removed from the OVDI. The guidelines state that removal will occur where there is a documented history of lack of cooperation such that the case will not be resolved in an appropriate time frame under the OVDI. As with opting out, removal subjects the taxpayer to a regular examination with none of the protections of the OVDI.
VALUE OF FOREIGN BUSINESS
One of the requirements of the OVDI is to calculate the appropriate tax, interest and penalty, and to submit payment or propose a payment schedule. In determining the 25 percent offshore penalty, the IRS had required that the taxpayer include the value of the taxpayer's interest in an entire business, even if the business was a foreign business. The revised set of frequently asked questions removes this requirement to include the value of the foreign business.
The changes made to the 2011 Offshore Voluntary Disclosure Initiative by the IRS in the most recent revisions to its set of frequently asked questions respond to a number of concerns raised by taxpayers and their representatives.
On the whole, the changes are taxpayer-friendly, providing either further flexibility or further clarity in determining whether to participate in the current disclosure initiative. Tax practitioners will want to bring these changes to the attention of their clients so that an informed decision can be made by the August 31 deadline as to the merits of entering into the program. AT
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
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