Why Any Taxpayer Making an Offshore Account Disclosure Must Have Legal Advice
If you know that you have an undisclosed foreign account, you will most likely want to take advantage of the 2012 Offshore Voluntary Disclosure Program (still running through 2014 and likely beyond). While it might be possible to make an OVDP filing on your own, or with the assistance of a CPA or an uncredentialed tax-return preparer, choosing non-attorneys leaves too much to chance and opens the door to some very adverse consequences. Legal advice and assistance from an attorney is unquestionably necessary. If you even think you might have a foreign account that qualifies, you should consult with an experienced OVDP attorney first.
OVDP – The IRS’ Foreign Account Amnesty – Is Full of Traps for the Inexperienced Taxpayer or Non-Attorney Provider
OVDP, as the IRS emphasizes repeatedly, is based on full, complete and timely compliance with all program requirements. Every document and detail sent to the IRS must be perfect the first time – not later, after revisions. Many taxpayers approach the program with the hopes that their genuine good intentions will be honored, and that the IRS will respect their efforts to comply, however imperfectly. In normal IRS tax procedure, this hope might actually be realistic. Unofrtunately, the taxpayer’s usual expectations of reasonable dealing with the IRS do not apply in the case of foreign account disclosures. Here are a couple reasons why:
1) OVDP is not a program grounded in the United States tax code,
2) The IRS has issued very little written guidance about the program, and,
3) There is little relevant case law to study prior to making a filing.
In short, the OVDP is not a process for the inexperienced practitioner – the stakes are simply too high. Only tax attorneys who maintain a high workload in the OVDP area and monitor the developments in this niche, can ensure that you don’t violate any program rules while still gaining full advantage from those program rules that do work in the client’s favor.
An Incorrect OVDP Submission Can Spell Disaster
Most taxpayers that enter OVDP want to stay in the program, paying a significant fine in return for the assurance that the entire problem is cleaned up.
But what if the taxpayer is forced out of the program – or worse, waits too long and doesn’t file before the IRS learns his name?
If You Can’t Make a Voluntary Disclosure Through OVDP, You Are Exposed to All Possible Tax and FBAR Penalties
Willful Failure to File the FBAR
If the IRS determines that a taxpayer willfully failed to file a Foreign Bank Account Report, the IRS may impose a penalty equal to the greater of $100,000 or 50% of the high balance of the account in the year of non-compliance. Worse, this penalty may be imposed up to six years cumulatively, potentially creating a fine easily in excess of the actual undisclosed account balance. (The Carl R. Zwerner case, still pending in federal court, currently represents the IRS’ most aggressive application of this penalty. The asserted FBAR penalty of over $3.4 million, representing four consecutive years of the 50% penalty, is essentially 200% of the account’s high balance during those years, which was a mere $1.7 million.
What determines a willful failure to file? To hear the IRS tell it, as little as failing to check a critical box on Schedule B in which the taxpayer definitively states whether or not he/she owns or controls a foreign account. The true reality of willfulness is far less black-and-white, insofar as willfulness requires an examination of the taxpayer’s subjective state of mind regarding knowledge of the obligation to file the FBAR.
Regardless of whose interpretation ultimately prevails in a court of law, it is fair to say that even being in that situation of having to fight the IRS over just one 50% penalty, is an experience to be avoided if at all possible. OVDP, to put it simply, is one way to avoid that outcome – and usually the best way.
Negligent Failure to File the FBAR
A step below the willful failure to file the FBAR is the negligent failure to file the FBAR. It is this penalty, working in concert with the willful penalty, that drives much of the OVDP attorney’s financial analysis, which in turn often drives the decision of whether to opt-out, a right that all OVDP participants have to simply leave the program at any point during the process.
Having just explained why the willfulness penalty means that OVDP is a program to be joined with all possible haste and stayed in without further doubt, there are a large number of clients who need to work with an attorney well-versed in making factual analyses of their actions and applying them to the law. There are certain taxpayers whose actions are utterly non-culpable (simple translation: not guilty or blameworthy in nature). These individuals may have violated the FBAR requirements but – for a universe of possible reasons – can show that their actions were not willful and that, instead, they simply failed to act as a reasonable taxpayer would in attempting to comply with his/her reporting obligations. This failure to act as a reasonable taxpayer is the essence of mere negligence, and would, if proved and agreed by the examiner, lead to the imposition of a $10,000 penalty per instance of non-compliance.
Consider the taxpayer who has six years of non-compliance (all possible years within the rolling 6-year civil statute of limitations for imposing the FBAR penalty). How could facing as much as $60,000 of annual $10,000 penalties for a single undisclosed account be an outcome that would cause the taxpayer to willingly leave the voluntary disclosure program and face an audit for all civil and FBAR violations?
The answer is mathematical: there is a break-even point at which that $60,000 outcome would be equal to the 27.5% OVDP ‘special penalty’ imposed on account balance. That account balance, surprisingly, is just $281,181. While it vastly oversimplifies an OVDP specialist’s analysis of the client’s particular economics, there is a useful shorthand by accounts below a certain value will rarely – if ever – be worth an opt-out, followed by a middle-ground where an opt-out may be worth the analytical time to review. Finally, at levels above $281,000, an opt-out (assuming no ‘bad facts’) must always be seriously considered.
Civil and FBAR Criminal Prosecution
The IRS’ determination in whether it will refer a case to the Department of Justice for prosecution as a tax crime often looks to what prosecutors and tax practitioners call “badges of fraud.”
The concept of badges is applied to all sorts of tax matters, not just offshore accounts. In analyzing whether to participate in OVDP at all, or whether to opt out of the program without paying some or all of the prescribed penalties, the OVDP tax attorney must put himself in the shoes of an IRS examiner.
In an FBAR violation case, the IRS will look for indications of a willful attempt to evade taxes on the foreign account:
Was the money moved around from bank to bank, one step ahead of enforcement actions?
Was the money earned in the US and deposited directly offshore without ever being reported on a tax return?
Did the taxpayer withdraw the funds in small cash amounts and bring those amounts back to the US – or perhaps did the taxpayer establish a debit card and supported themselves financially from the balance?
Equally important are details that point to a lack of willful intent, including:
Inheritances that were deposited and never touched (this is such a non-culpable scenario that the IRS has actually established a special 5% OVDP penalty category to provide a superior outcome to those who qualify
Accounts that were established when the taxpayer was a child or young adult in his native land, before emigrating to the US and attaining citizenship or permanent residency
Small amounts in the account and very little earnings (from the account) that actually ‘evaded’ US taxes
When these kind of positive factors can be convincingly documented, the taxpayer should strongly consider whether an opt-out could yield just one or two years of a $10,000 penalty (again, this could be better than the standard 27.5% penalty) or, the true dream, warning letters (specifically, IRS Letter 3800) with no fines.
As should be obvious now, only an experienced and well-versed tax attorney can take advantage of the complete picture and tell a convincing story in the IRS’ own language.
Working With Your OVDP Attorney
A taxpayer needing to use the OVDP can expect his or her attorney to closely examine the case, and all its ramifications. In many filings there are options to pursue, that is, there is no single “right” way to handle some filings. The attorney should be able to outline all the options available, recommend the one that is most likely to yield good results, and insure that the taxpayer understands all the options. In addition the attorney must be aware of all the many traps that can enter into such a filing, and develop a strategy to avoid them, or at least minimize the potential impact.
The best advice is that if you fear that you have exposure in the area of foreign accounts, you should immediately consult with an attorney who specializes in the area. If the attorney determines that you are a non-filer, moving quickly to voluntarily disclose the account(s) to the IRS is often the best course. The attorney will work for you and for your best interests and aid you in making this difficult and time-sensitive decision.