U.S. citizens and green-card holders (U.S. Person) are subject to taxes on their worldwide income. Along with this, they also need to comply with certain additional filing requirements to report their foreign accounts, foreign assets and foreign incomes. This reporting is required regardless of whether the U.S. person is living in the United States or in any other foreign country.
Often, a U.S. person residing in a foreign country is unaware of his/her U.S. tax filing responsibility. Once informed, they could be subject to penalties and interest on the unpaid taxes as well as onerous penalties for failure to file certain reports upon filing late tax returns. Taxpayers could also face a number of criminal charges, including tax evasion, filing a false return, and failure to file an income tax return.
Re-gaining Compliance with IRS Streamlined vs OVDP
To encourage compliance, the U.S. Internal Revenue Service (IRS) introduced procedures that offer reduced penalties to taxpayers who voluntarily disclose their failure to file. First, the IRS provides the option of ‘Streamlined Filing’ for U.S. citizens residing in foreign countries whose failure to fail was not a result of willful conduct. This filing option was further extended to domestic U.S. citizens and green-card holders, who missed complying with their reporting requirement in respect of foreign accounts and assets, due to unawareness or other acceptable reasons. These two programs for resident and non-resident U.S. persons are also known as ‘Streamlined Foreign Offshore Filing Compliance Procedure’ and ‘Streamlined Domestic Offshore Filing Compliance Procedure’.
Having said that, there are many U.S. persons who deliberately avoid filing FinCEN FBAR Form 114, Form 8938 and/or other US tax forms required for U.S. tax compliance to save on taxes. In order to help these taxpayers fully comply with their U.S. tax responsibility, the government introduced the Offshore Voluntary Disclosure Program (OVDP).
What is Offshore Voluntary Disclosure Program (OVDP)?
The OVDP is an opportunity to get current with the IRS voluntarily. Since, as the IRS continues to sign agreements with various foreign countries to share the financial data of their respective citizens, they are aggressively seeking out non-filers and are likely to catch-up soon with these U.S. taxpayers. A U.S. person should keep in mind that the voluntary disclosure offers lower penalties as compared to the penalties imposed and risk of criminal prosecution when the IRS catches the taxpayer.
The following is an overview of the IRS’ Offshore Voluntary Disclosure Program (OVDP) for U.S. persons, who are still contemplating a voluntary disclosure to the IRS.
Situations Considered As Willful Non-Disclosure
The first point that a US person needs to determine is: whether the IRS will consider the non-disclosure as willful or non-willful. Non-willful conduct has been defined by the Department of Treasury as 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.” Willful conduct requires some activities that are meant to hide the existence of offshore bank accounts such as:
- Reporting one account maintained at the foreign financial institution and excluding the other.
- Layering, i.e. setting up various trusts and corporations
- Dual citizenship holders using the second passport as identity proof
- Requesting minimal correspondence from the foreign financial institution
- Significant cash-based transactions usually made in person at the bank
- Low dollar inter-bank transfers, carried out multiple times
- Being unable to provide proper explanation as to how the account was missed even when the return preparer asked about foreign accounts and assets.
- Having a high degree of financial and business sophistication and education.
Overview: Offshore Voluntary Disclosure Program (OVDP) for Willful Non-Disclosure
Step 1: Preclearance
Obtaining preclearance is not a required step and does not guarantee acceptance into the OVDP, however, it helps to determine if the taxpayer is eligible for the program before making substantial incriminating admissions. U.S. citizens and residents or their representative would send a request by fax to the IRS Criminal Investigation Lead Development Center (CILDC) to be tax compliant using OVDP. In this request, the taxpayer needs to provide his/her personal and foreign financial information, such as: name, dates of birth (if individual), tax identification number (TIN), contact address and number, along with full information of the foreign financial institution where the undisclosed asset(s) is maintained, entities (example: corporation, trusts, LLCs) used to own these assets, and associated information.
Step 2: Preliminary OVDP
Upon preclearance acceptance, the taxpayer needs to submit an offshore voluntary disclosure letter and an accurately completed Form 14454, Attachment to Offshore Voluntary Disclosure Letter to the IRS Voluntary Disclosure Coordinator. This submission requires detailed disclosure of the taxpayer’s offshore financial accounts and assets. The CILDC will review the letter and attachment, and inform the representative or taxpayer if the preliminary voluntary disclosure has been accepted or declined.
Step 3: OVDP Filing
Upon approval, within 90 days the taxpayer needs to provide copies of the following documents (listed below) for the period (tax years) covered by the OVDP. The taxpayer must also submit payment of the calculated tax due and penalties to a separate IRS address.
- Original federal income tax returns filed, including any attached schedules
- Amended federal income tax returns, including any attached schedules
- FBARs, Form 8938, Form 3520 & 3520-A, and any other tax and information forms required to be filed
- Signed OVDP Letter (including enclosures and attachments) submitted to Criminal Investigation
- Foreign Account or Asset Statement for each undisclosed OVDP asset
- Signed Taxpayer Account Summary With Penalty Calculation
- Signed agreements to extend the period of time to assess tax (including tax penalties) and to assess FBAR penalties
Once the taxpayer has submitted the voluntary disclosure package, he or she must cooperate with the assigned IRS examiner on any requests for more information. The examiner determines whether the voluntary disclosure is correct, accurate, and complete and verifies the tax, interest, and civil penalties owed.
Step 4: Closing Agreement
Once the examiner completes the review, he will present the taxpayer with a Form 906, Closing Agreement on Final Determination Covering Specific Matters, outlining the terms of the disclosure. The taxpayer’s execution of the closing agreement completes the voluntary disclosure as long as the taxpayer has satisfied his or her other obligations under the program.
Note: A couple who file as ‘Married Filing Joint’ and intend to make a voluntary disclosure may file a joint disclosure, however, they will individually need to request preclearance.
OVDP Penalties
Instead of paying all other penalties that may apply to the undisclosed foreign accounts, assets and entities, including FBAR and offshore-related information return penalties and tax liabilities for years prior to the voluntary disclosure period, participating taxpayers generally agree to pay an “offshore penalty” equal to 27.5% of the highest year’s aggregate value of “OVDP assets” during the period covered by the OVDP, along with any applicable failure-to-file, failure-to-pay, and accuracy-related penalties.
This penalty is increased to 50% for certain taxpayers. A 50% offshore penalty applies if an already identified and under investigation foreign financial institution or facilitator assisted the U.S. person with setting up the offshore accounts/assets, along with the penalties applicable on failure to file the particular US tax form.
Choosing Between OVDP for Willful Non-Disclosure & Streamlined Program
The main benefit of the Offshore Voluntary Disclosure Program is that it protects a taxpayer from criminal prosecution, while the Streamlined program does not. If a taxpayer believes that he may be at risk of being considered willful or prosecuted as a criminal, then, it may be worth paying the higher OVDP penalties for the peace of mind.
If a taxpayer intended to hide their accounts from the IRS, they should use the OVDP program. If the taxpayer simply was unaware of the filing requirements, the Streamlined program would be the best choice. A taxpayer must sign, under penalties of perjury, that their conduct was non-wilful to be eligible for the Streamlined program. The IRS can investigate this statement and if they prove willful conduct can initiate criminal proceedings.
OVDP is a complex filing procedure that should not be taken lightly. Additionally, not all information is required to be disclosed. Often taxpayers are so frightened that they provide excessive information which could further ruin their tax situation. Therefore, it is advisable to always consult a tax professional regarding voluntary disclosures and being tax compliant. A tax professional can also compare the various programs to determine the best choice for the taxpayer.
AG TAX LLP CAN HELP
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of US and Canadian tax laws as well as cross-border compliance.
Furthermore, as a full service accounting firm, AG Tax assures complete assistance with even your most complex tax needs.
We can assist with:
- Canadian Personal and corporate tax returns
- Cross Border Taxation and Business Planning
- US Personal and Corporate Taxation
- Disclosure of Foreign Assets and other information filings
- Retirement planning
- Estate Planning, Inheritance tax advice
To obtain a quote or to arrange for a consultation to discuss your tax related queries, please contact us at:
416-238-5920 (Greater Toronto Area, ON)
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Disclaimer: The information in this publication is accurate as of the time of its publication. AG Tax assumes no responsibility for changes to tax legislation subsequent to the publication of this document. The information provided is for general information purposes only and should not be acted upon without seeking professional advice. If you would like to engage our services, please contact our staff and obtain authorization to send our firm confidential information. A client relationship is not created by the transmission of information. A client relationship is only formed with our firm when a scope and engagement letter signed by the firm and the potential client detailing the terms of engagement is present.
