2014 STREAMLINED OVDP (OVDI) VOLUNTARY DISCLOSURE OPTION
Under the 2012 OVDP programs, and prior OVDI programs, there was a streamlined procedure that allowed for a complete waiver of all offshore penalties, but was only available to non-residents who meet certain conditions. This prior Streamlined OVDP program was replaced with the 2014 Streamlined Filing Compliance Procedures. In addition to eliminating some of the stringent conditions for qualifying under the original streamlined program, the 2014 OVDP changes also announced another variation of the streamlined OVDP program: the Streamlined Domestic Offshore Procedures.
Streamlined domestic offshore procedures: an alternative to 2014 OVDI/OVDP
Under the 2014 OVDI Streamlined procedure, U.S. residents who meet certain requirements have the option of using the Streamlined Domestic Offshore Procedures to address their unreported income and/or undisclosed foreign bank accounts. Taxpayers who qualify for, and take advantage of, these procedures simply have to pay any tax due on any unreported income they had in the past three years, plus interest on the tax, and an offshore penalty equal to 5% of their maximum aggregate balance in their unreported foreign accounts over the past six years. This 5% penalty works much differently from the penalties that are part of the offshore voluntary disclosure program. Under the standard OVDI program, the base amount for calculating the penalty is computed on the value of many classes of foreign assets that are not subject to the various international reporting requirements (i.e. directly-held real estate). Under the new streamlined OVDP program, only assets that were supposed to be reported are included in the penalty computation. Since you are not required to disclose the value of offshore real estate you own directly, these properties are excluded from the penalty computation.
Streamlined Domestic Offshore Procedure qualification requirements
In order to qualify under the new Streamlined Domestic Offshore Procedure, four eligibility requirements must be met:
- Fail to meet the non-residency requirements for the Foreign Domestic Offshore Procedure. If you otherwise qualify for the Streamlined Domestic Offshore Procedures, but were a non-resident of the U.S. for any of the three most recent years, then you will qualify for the Streamlined Foreign Offshore Procedures. Under the foreign program, there are no offshore penalties. Therefore, taxpayers who meet the non-residency requirements of the Streamlined Foreign Offshore Procedures are far better off entering that program than the Domestic Procedures because they will be able to avoid paying the 5% penalty.
- Have previously filed all required U.S. tax returns for each of the last three years. This requirement is pretty self-explanatory. The only nuance is the way the 3 year period is determined. The years in issue are the three most recent years for which the due date for filing a return has already passed. Therefore, taxpayers who have filed an extension for their prior year return, and the extended due date (generally October 15th) has not already passed, then the years in question are the three years prior to the return for which the extension applies.
- Have failed to report income from a foreign financial asset and pay tax on that income. This requirement needs a little context in order to make sense. On its face, it appears odd that the IRS requires you to have unreported income in order to qualify for this favorable 5% offshore penalty. However, the reason for this requirement is that taxpayers who properly reported all of their income and paid all the tax that was due on that income have a better option available to them. If you reported all your income, and paid all your tax, yet failed to file your FBARs or other international information returns, all you need to do is file all of the delinquent forms, amending your last three tax returns if necessary, and you will not be penalized for failing to report your accounts on time.
- Your failure to pay tax on your foreign income and report your foreign assets must have resulted from non-willful conduct. In this context, the word “willful” refers only to a “conscious disregard of a known legal duty.” Under this definition, if your failure to meet your tax obligations was due to a mistake, a misunderstanding of the law, inadvertence, or negligence, then your conduct meets this requirement.
Streamlined OVDP / OVDP submission requirements
The new streamlined OVDP / OVDI program is far simpler and less burdensome than the standard voluntary disclosure program.
The first thing you need to do is prepare amended returns for each of the most recent three years, along with all required information returns (forms 8938, 8621, 926, 5471, 5472, 3520, 3520-A), even if these information returns are not normally submitted with a tax return. It is very important that, prior to mailing the amended returns, you write in red ink the words “Streamlined Domestic Offshore” on the top of the first page of each amended tax returns. Please note that amended returns filed under these procedures are not submitted to the normal processing centers. Rather, the returns, along with all other documents other than the FBARs, need to be mailed to a designated service center in Atlanta, GA.
With the returns, you need to include a check for the entire amount of tax due, plus any interest charges that accrued in the meantime. If you compute the interest charges incorrectly, it is no big deal: you will either receive a refund or a balance due notice depending on if you underpaid or overpaid the interest. If you do receive a balance due notice for additional interest, it is crucial that you pay the balance immediately. You will not be assessed any penalties for your failure to report all of your income on your original return, or for filing any of your information returns late. This is a deviation from the OVDI/OVDP program, which requires you to pay a “substantial understatement penalty” equal to 20% of the additional tax due on your amended returns. Also, keep in mind that under the streamlined program, only three years’ worth of amended returns are required, as opposed to the 8 years required under the standard offshore voluntary disclosure program.
You also need to complete and sign a certification statement, under penalty of perjury, which says that: 1) you qualify for the 2014 OVDP Streamlined Domestic Offshore Procedures; 2) that all of your FBARS have now been filed; 3) that your failure to meet your obligations was due to non-willful conduct; and 4) that your computed offshore penalty amount is accurate (you will attach a worksheet containing your calculations).
If you failed to timely elect to defer income in certain retirement or savings plan (RSP accounts for Canadians, or other foreign retirement accounts), you can ask for the election to be applied retroactively. To do so, you must submit a statement requesting the late election, and identify the tax treaty provision that allows you to defer the income on such account, along with a statement that explains why you failed to make the election on time, signed under penalty of perjury. If the account in question is in fact a Canadian RSP account, then be sure to include form 8891 for each year and each plan.
A check for the 5% offshore bank account penalty must be included with your submission.
In addition to mailing all the documents listed above to the designated address in Atlanta, you must also file all delinquent FBARs (now known as FinCen form 114) for the past six years. These must be filed online through the FinCen website.
What if you don’t agree that you should pay the 5% offshore penalty?
The announcement of the Streamlined Domestic Offshore Procedures comes as a breath of fresh air for many non-willful violators. Most taxpayers who have relatively little money in an offshore account would be happy to pay the 5% offshore penalty to put their problems behind them, and close that chapter of their life. However, for non-willful violators with a substantial amount of money offshore, even at the 5% rate, the penalty may still seem too high given all the facts and circumstances surrounding your case. If you feel like the 5% Streamlined OVDP penalty is too steep, given the nature of your offense, you still have other options.
Keep in mind that moving forward with the Streamlined Domestic Offshore Procedure is only one of many options available to taxpayers with unreported offshore bank accounts. One of these options is to enter the voluntary disclosure program, then opt-out at the time you get the closing agreement. When you opt-out, you have an opportunity to plead your case and ask for a warning letter to be issued in lieu of any penalties. In my experience, cases where it is clear that the taxpayer did everything they thought they were supposed to do, and the FBAR violation and omission of foreign income is just an honest mistake, frequently result in the issuance of a warning letter and a complete waiver of any offshore bank penalties. It is important to note that, for taxpayers who enter the voluntary disclosure program on or after July 1, 2014, the Streamlined Domestic Offshore Procedures are not an option. It is important that you weigh all of your options, and the risks associated with each, before making a decision on what’s best for your case.
If you think opting-out might be the way to go for you, have a look at my article for a more in-depth discussion on the topic: Qualified Quiet Disclosures: Opting-out of OVDP
What about taxpayers already in the offshore voluntary disclosure program?
Although the new Streamlined OVDI doesn’t officially take effect until July 1, 2014, taxpayers who submitted a voluntary disclosure on or before June 30, 2014 may qualify for favorable “transitional treatment” under OVDP, as long as they have not yet signed a closing agreement. If you have already received a closing agreement under the OVDP program, then signed and returned the agreement, there is nothing that can be done to reduce the amount of the penalties. Under this program, non-willful violators who otherwise would qualify for Streamlined treatment qualify for the reduced 5% offshore penalty.
While this “transitional treatment” may sound like the Streamlined Domestic Offshore Procedures, it is actually quite different. Under this program, all of the OVDI rules stay in place, except the penalty amount is 5%, rather than 27.5%.
Under the OVDP transitional treatment rules, taxpayers are still required to file 8 years of amended tax returns and pay any additional tax you owe, compared with three years under the 2014 Streamlined OVDP program. Also, you will have to file 8 years of delinquent FBARS, and calculate your penalties based on your highest balance over that 8 year period, compared with six years under the domestic Streamlined OVDI program. While the offshore penalty under the transitional rules is reduced to the same 5% as the streamlined program, the transitional rules make no mention of the other penalties associated with OVDI. Therefore, under the transitional rules, taxpayers are still liable for the 20% substantial understatement penalty, as well as any applicable failure to file and/or failure to pay penalties associated with your delinquent filings. Under the Streamlined Domestic Offshore Procedures, you are only responsible for paying any additional tax due over the three year period, plus interest, and the 5% offshore penalty. No other penalties are assessed in the Streamlined OVDP program. Lastly, under the Streamlined Program, taxpayers are not required to consent to extend the period of time the IRS has to assess any additional tax and/or penalties, whereas if you enter the OVDI program, you will be required to sign such consents.
While the transitional treatment may not be quite as favorable as the Streamlined Procedures, it is still better than the alternative, which is paying the full 27.5% or other applicable amount pursuant to the 2012 OVDI rules.