With so many programs and so little time... What is a noncompliant US taxpayer to do?

The Internal Revenue Service (“IRS”) has a number of special compliance programs designed for United States taxpayers who have not reported all of their non‐U.S. income or who have not complied with all of the various reporting requirements applicable to non‐U.S. income and assets. These programs are sometimes referred to as “amnesty” programs, but they do not provide much, if any, relief from tax, interest, and/or penalties. Certain programs may, however, provide protection against criminal prosecution.

Several of these compliance programs are currently available. Before they provide us with any information regarding their case, potential clients often ask, “Which program is best for me?” The answer is always that each case must be considered separately and there are no “one‐size‐fits‐all” solutions. An appropriate strategy cannot be determined until all of the relevant facts and circumstances are considered. Because of the potential criminal consequences of noncompliance, the decision as to which program to pursue should be made only after consultation with an attorney.

The options currently available include:

1. Streamlined Filing Compliance Procedures: The IRS recently expanded the availability of the streamlined filing compliance procedures significantly. Previously this procedure was available only to certain non‐resident U.S. taxpayers who met very specific requirements. The new procedure is available to both non‐resident and resident taxpayers whose failure to report foreign financial assets and pay all tax due was the result of non‐willful conduct. 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. The “non‐willful conduct” standard is only slightly less vague than the “low risk” standard in the prior streamlined procedure and taxpayers should proceed cautiously when considering these programs.

The main advantages of these procedures are that they require preparation of fewer returns and taxpayers may not be subject to any penalties. Taxpayers are required to submit only three years of income tax returns (with all applicable information returns), six years of foreign bank account reports (FinCEN Form 114 or FBAR), and a certification statement indicating that they meet the eligibility requirements. Taxpayers will be subject to income tax and interest. The IRS will not impose penalties for late filing and/or late payment, accuracy‐related penalties or penalties for failure to file information returns. Taxpayers who qualify for the non‐resident program will not be subject to any penalties while taxpayers who qualify for the resident program will pay a 5% penalty based on the highest aggregate balance/value of the taxpayer’s foreign financial assets that are subject to the penalty during the years included in the submission.

The disadvantages are that there is no protection from criminal prosecution, returns submitted through this procedure may be selected for audit under the existing audit selection process applicable to any U.S. tax return, and once application to this procedure is made the taxpayer no longer has the option of 

 2. Filing Under New Delinquent FBAR and Delinquent International Information Return Submission Procedures: Taxpayers who (a) have unfiled FBARs, (b) included all income from the unreported accounts on their income tax returns, (c) are not already under IRS investigation, and (d) have not been previously contacted by the IRS regarding delinquent FBARs may file the delinquent FBARs directly with the Treasury Department with an explanation of why the returns are being filed late. If all of these requirements are satisfied, the IRS will not impose an FBAR penalty.

Taxpayers who (a) have unfiled international information returns (IRS Forms 5471, 3520, 3520‐A, etc.), (b) reported and paid tax on all their taxable income associated with any entity or transaction reportable on such information returns, (c) have reasonable cause for not timely filing the information returns, (d) are not already under IRS investigation, and (e) have not been previously contacted by the IRS regarding delinquent information returns may file the delinquent information returns (with amended income tax returns, if required) directly with the appropriate service center. Such returns should be submitted with a reasonable cause statement setting forth all the facts related to the failure to file. Imposition of penalties will be determined based on whether the IRS agrees with the reasonable cause position.

Returns submitted through these procedures will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.

There is no guidance provided on how many years of delinquent FBARs and/or information returns should be filed. We normally recommend that taxpayers file for the last six years.

3. The Offshore Voluntary Disclosure Program: Anyone may apply to participate in the OVDP, but taxpayers must first be cleared through the Criminal Investigation division. Taxpayers who participate in the OVDP are required to file eight years of amended or original income tax returns (including all required information returns) and eight years of FBARs. They will be subject to income tax, interest, and penalties (accuracy, late filing and/or late payment), and a one‐time OVDP penalty currently equal to 27.5% of the value of the taxpayers foreign accounts and certain other foreign assets for the year during the eight‐year period where the aggregate value of such assets was the highest. For taxpayers with accounts at certain listed financial institutions, the penalty is increased from 27.5% to 50%. Like the prior offshore voluntary disclosure program, there is no filing deadline for the current program. The IRS reserves the right, however, to increase the voluntary disclosure penalty or to cancel the program at any time.

The advantages of this program are that taxpayers are very unlikely to face from criminal prosecution (as long as they cooperate completely), taxpayers are provided with peace of mind in the form of a closing agreement that concludes the matter once and for all, and taxpayers have more certainty with respect to penalties, which may be less than what would be imposed under the Code. The disadvantages of this program are that it requires eight years of income tax returns and FBARs, the program is very rigid and IRS agents have little flexibility in regard to penalties, taxpayers are required to provide account statements for all foreign accounts for all eight years (which may be difficult to obtain), and the process is very time consuming.

Taxpayers who have entered OVDP who disagree with the application of the OVDP penalty given the facts and circumstances of their case may elect to opt out of the program. In such situations, the IRS may conduct a full examination of the submitted returns and may determine whether a reduction in penalties is warranted (for example, if the taxpayer had reasonable cause for their failure to timely comply).

4. Service Center Filings: Some taxpayers will not meet the eligibility requirements of the streamlined filing compliance procedures, but may feel that they do not have offshore income and/or assets substantial enough to justify a voluntary disclosure or they may feel that there were extenuating circumstances that justified their failure to properly file. These taxpayers may wish to simply file original and/or amended income tax returns with the information returns and a reasonable cause statement and hope for the best. This is a very risky strategy but it may be appropriate in certain cases. Taxpayers deciding to pursue this route should do so very carefully and only after consultation with an attorney who is knowledgeable about offshore reporting matters and all of the available programs.

Cantor & Webb