U.S. taxpayers are required to report income that is earned outside the U.S., even if that income has already been taxed. This requirement often trips up taxpayers who have recently moved to the United States. If you have recently moved to the United States and maintain bank accounts in your home country or foreign income-generating assets (such as rental property and/or inherited real estate), you must report the income from these assets and pay tax in the U.S., even if tax has been paid in your home country.
The IRS has developed voluntary disclosure programs that allow taxpayers to come forward, correct their past mistakes, pay past-due taxes, and pay a set penalty or, in some cases, pay no penalty. The first disclosure program, the Offshore Voluntary Disclosure Program (“OVDP”), was initiated in 2009. The second, the Streamlined Compliance Filing Procedures, was later developed by the IRS for taxpayers whose actions were innocent (non-willful) and are thus afforded lower penalties and assessments.
I: The OVDP
The OVDP requires the taxpayer to correct eight years of tax returns by either filing amended tax returns or original tax returns if no tax returns were filed, filing eight years of correct FBARs, and paying a penalty of twenty-seven and a half percent (27.5%) on the foreign assets associated with tax noncompliance. This penalty increases to fifty percent (50%) if the taxpayer has an account at a bank identified by the IRS as a financial institution that has aided and abetted in tax evasion.
The OVDP is not a short term process by any means. However, at the conclusion of the OVDP process, the IRS and the taxpayer will enter a Closing Agreement (Form 906) where the IRS will recommend to the Department of Justice that criminal charges should not be filed based on the taxpayers voluntary disclosure and compliance in the program. A benefit that the OVDP offers is that the IRS cannot later audit matters that are subject of the OVDP process.
II: Streamlined Compliance Filing Procedures
The Streamlined Compliance Filing Procedures are only available to taxpayers whose failure to report foreign income or foreign assets was non-willful. Non-willful conduct is defined by the Internal Revenue Service 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.” See Internal Revenue Service Eligibility for the Streamlined Domestic Offshore Procedures (Sept. 25, 2015) https://www.irs.gov/Individuals/International-Taxpayers/U-S-Taxpayers-Residing-in-the-United-States. The Streamlined Procedures require the taxpayer(s) sign a statement under penalty of perjury that their conduct was non-willful.
Taxpayers that reside in the United States can enter the Streamlined Domestic Offshore Procedures (“SDOP”). Under the SDOP, applicants must file three years of amended returns and six years of corrected FBARs. At the time of application, they also must pay all taxes and interest that are due with the amended returns, along with a five percent (5%) penalty (as opposed to 27.5% or 50% under the OVDP). The penalty only applies to financial assets (which excludes rental real estate) and is based on the assets year-end value (whereas the OVDP bases the penalty on the highest aggregate value during the disclosure period).
Taxpayers that meet certain non-residency requirements may enter the Streamlined Foreign Offshore Procedures, which largely mimics the SDOP except that there is no associated penalty.
There are some negative aspects associated with the Streamlined Procedures that are not present with the OVDP. For example, under the Streamlined Procedures, (1) there is no determination letter or closing agreement, so taxpayers are not informed whether their applications were accepted; (2) the IRS still may pursue criminal action against the taxpayer; (3) the IRS still may audit the taxpayer; and (4) if the IRS ends up rejecting a Streamlined application, both the Streamlined Procedures and OVDP are no longer available, and the draconian penalty explained above regime applies. Accordingly, selecting the Streamlined Procedures carries significant risks for the taxpayer, specifically in the event that the IRS rejects an application, in which case the IRS has all the information it needs to assess high civil penalties or even criminal prosecution.
III. Why Hire a Tax Attorney Before Selecting a Voluntary Disclosure Program?
Based on the aforementioned risks and considerations, it is imperative that you seek the advice of a tax attorney experienced with foreign income reporting rules and disclosure requirements. The ability to have your attorney assess your situation under the protection of the attorney-client privilege should provide you with greater peace of mind in the selection of the appropriate disclosure program.