By Thomas W. Ostrander
On January 9, 2012, the Internal Revenue Service (IRS) announced that
it had reopened the Offshore Voluntary Disclosure Program (OVDP)
following the closure of the 2011 and 2009 programs and the collection
of more than $4.4 billion USD from those programs. The third offshore
program comes as the IRS continues working on a wide range of
international tax issues and follows ongoing efforts with the U.S.
Justice Department to pursue criminal prosecution of international tax
The new program will be open for an indefinite period of time, and its terms could change over time.
The program is similar to the previous programs, but with a few key
differences. The previous programs had a deadline for applying; the new
program has no application deadline.
The overall penalty structure for the new program is similar to the 2011 Offshore Voluntary Disclosure Initiative (OVDI).
The new program's penalty framework requires individuals to pay a
penalty of 27.5 percent (up from 25 percent in the 2011 OVDI and from 20
percent in the 2009 OVDP) of the highest aggregate balance in foreign
bank accounts/entities or value of foreign assets during the eight full
tax years prior to the disclosure. The 5-percent or 12.5-percent
penalties remain the same in the new program as in the 2011 OVDI. (The
5-percent penalty applied in very limited situations such as where the
taxpayer inherited an offshore account and made very small withdrawals
from the account. The 12.5-percent penalty applies to accounts whose
highest value did not exceed $75,000.)
The new program requires that taxpayers file all original and amended
tax returns and information returns, such as the Report of Foreign Bank
and Financial Accounts (FBAR). Payment for back-taxes and interest for
up to eight years as well as payment of the accuracy-related and/or
delinquency penalties are required. Under certain circumstances,
installment payouts of the liability or an offer in compromise may be
As under the prior programs, taxpayers who feel that the penalty
structure is disproportionate or unwarranted under their circumstances
may opt out and subject themselves to an audit.
More details will be available within the next month on IRS.gov. In
addition, the IRS will be updating key Frequently Asked Questions and
providing additional specifics on the new offshore program.
The factors for determining whether a taxpayer should make a
voluntary disclosure are numerous and complex. A taxpayer considering
making a voluntary disclosure may want to discuss the matter with
experienced legal counsel. That discussion would be protected from
disclosure by attorney-client privilege, which is particularly vital in
instances where the taxpayer ultimately decides not to make the
disclosure. However, a consultation regarding the voluntary disclosure
program with a taxpayer's accountant is not a privileged communication.
If the decision were made not to enter the new program, and the IRS
discovers the foreign financial account, the taxpayer's accountant could
become a witness for the IRS against the taxpayer. This would not be
the case if an attorney, rather than an accountant, had been consulted.
A taxpayer contemplating a voluntary disclosure also may want to
consider the differences in the financial consequences of participating
in the new program, opting out of the new program or making a
traditional voluntary disclosure. (It is unknown at this time, but it
appears that the IRS may initially process all voluntary disclosures
regarding offshore issues through the 2012 OVDP.) In many instances, the
2012 OVDP would involve more years, higher taxes and significantly
larger penalties than a traditional voluntary disclosure. Taxpayers
participating (willingly or not) in the 2012 OVDP may face an IRS
unwilling to negotiate, notwithstanding facts supporting the reduction
or elimination of penalties. Taxpayers who believe their situation
warrants reduced penalties may be advised by the 2012 OVDP agents that
they can opt out of the program and take their chances in a full-blown
examination. Before that decision is made, however, a taxpayer should
perform a careful analysis of the facts surrounding the case. That
analysis should be directed at determining:
Key to this analysis are issues regarding negligence, fraud,
willfulness, mitigation, burden of proof (on the taxpayer or on the IRS)
and quantum of proof (clear and convincing, or mere preponderance of
Once all this analysis is completed, the decision whether to make a
voluntary disclosure can be made and, if disclosure is made, whether it
might be under the inflexible 2012 OVDP or through potentially
less-rigid traditional means.
On January 9, 2012, Sen. Carl Levin, D-Mich., Chairman of the Senate
Armed Services Committee and Permanent Subcommittee on Investigations of
the Homeland Security and Governmental Affairs Committee, made the
following statement regarding the IRS announcement that it is reopening
its offshore voluntary disclosure program:
The fact that 33,000 taxpayers have turned themselves in
and paid $4.4 billion in back taxes, with more to follow, shows how
enormous the offshore tax evasion problem is. Taxpayers are turning
themselves in, because federal prosecutors have finally begun to go
after the individual tax haven banks, bankers, and other financial
professionals helping them cheat on their taxes. The Justice Department
needs to keep up the pressure to stop offshore tax evasion costing us an
estimated in $100 billion each year in unpaid taxes. And Congress must
finally enact stronger laws to combat offshore tax abuses, including
passing my Stop Tax Haven Abuse Act, S. 1346.
Levin's announcement comes on the heels of the U.S. Department of
Justice's indictment of three Swiss bankers, Michael Berlinka, Urs Frei
and Roger Keller for conspiring with U.S. taxpayers and others to hide
more than $1.2 billion in assets from the IRS. The indictment alleges
that these assets were hidden in undeclared accounts of U.S. taxpayers
at the Swiss bank where the defendants worked as client advisers.
According to the indictment filed in Manhattan federal court: The
defendants worked as client advisers at the Zurich branch of their bank,
which provides private banking, asset management and other services to
clients around the world.
During their time at the bank, the defendants allegedly conspired
with various U.S. taxpayers and others to hide from the IRS both the
existence of certain Swiss bank accounts, as well as the income they
generated. In particular, the defendants opened and serviced dozens of
undeclared accounts for U.S. taxpayers in 2008 and 2009, in an effort to
capture business lost by UBS AG and another large international Swiss
bank in the wake of widespread news reports that the IRS was
investigating UBS for helping U.S. taxpayers evade taxes and hide assets
in Swiss bank accounts. After the reports, both banks stopped servicing
undeclared accounts for U.S. taxpayers.
To capitalize on the business lost by the banks and to otherwise
increase the assets under their bank's management and fees earned from
those assets, the defendants and other client advisers allegedly told
various U.S. taxpayer-clients that their undeclared accounts would not
be disclosed to the U.S. authorities because the bank had a long
tradition of bank secrecy. The defendants and other client advisers at
the bank also told their U.S. taxpayer-clients that the bank was less
vulnerable to United States law enforcement pressure because the bank
did not have offices outside Switzerland. Members of the bank's senior
management participated in some of these sales pitches to U.S.
taxpayer-clients. Additionally, to further the conspiracy, the
defendants and/or other client advisers allegedly took steps that
included the following:
By 2010, the collective maximum value of the assets in undeclared
accounts beneficially owned by defendants' U.S. taxpayer-clients of and
other client advisers at this Swiss bank was more than $1.2 billion,
with many accounts holding in excess of $10,000 in any one year.
The Taxpayer Advocate's annual report to Congress disclosed that on
August 16, 2011, the Taxpayer Advocate issued Directive 2011-1, ordering
the IRS to take certain action relative to the 2009 Offshore Voluntary
Disclosure Program ("2009 OVDP"). The IRS is not bound by the directive,
but the IRS Commissioner is required to respond to the directive by the
end of January 2012.
The actions contained in the directive, if approved by the IRS Commissioner, will require that the IRS, among other things:
As stated by the Taxpayer Advocate, one basic issue with the 2009
OVDP is that it assumed all participants are tax evaders hiding money
overseas when, in fact, the IRS has steered many people into the program
who made honest mistakes. Taxpayers with bona fide arguments for not
having filed FBARs had their stories ignored and were faced with the
alternatives of paying penalties that did not apply to them or opting
out of the 2009 OVDP and face examinations that the IRS threatened could
result in even-higher penalties then the 2009 OVDP provided and even
criminal prosecution. Consequently, many taxpayers felt compelled to
accept the 2009 OVDP penalty structure even though the penalties did not
apply to their circumstances. According to the Taxpayer Advocate,
pressuring those who made honest mistakes to pay more than they owe is
more likely to prompt taxpayers to avoid all contact with the IRS and
the U.S. tax system in the future, rather than to come back into it.
Where a person is required to file an FBAR, and willfully fails to do
so, the law authorizes a penalty of up to the greater of $100,000 or 50
percent of the balance of the undisclosed account each year. Where the
IRS cannot prove that the failure was willful, the law authorizes a
penalty of up to $10,000. Finally, where a taxpayer can show that he or
she had reasonable cause for failing to file an FBAR and the balance in
the account is reported (by filing or correcting a previously filed
FBAR), the statute provides that "no penalty shall be imposed."
Under the 2009 OVDP, a person is generally subject to a 20-percent
"offshore" penalty in lieu of various penalties that otherwise would
apply, including the penalty for failure to file an FBAR. However, 2009
OVDP FAQ #35 stated that "[u]nder no circumstances will a taxpayer be
required to pay a penalty greater than what he would otherwise be liable
for under existing statutes."
This was a significant statement on which taxpayers relied. Given the
statutory provisions described above, it seemed apparent that the
phrase "existing statutes" included those statutes that reduced the
maximum FBAR penalty to $10,000 for nonwillful violations and waived the
penalty entirely in certain cases where the violation was due to
reasonable cause. Thus, FAQ #35 prompted many people whose violations
were not willful to apply to the OVDP.
On March 1, 2011, however, more than a year after the 2009 OVDP
ended, the IRS issued a memo (the "March 1 memo") suggesting it would no
longer consider whether taxpayers would pay less under existing
statutes, except in limited circumstances. The March 1 memo seemingly
contradicts the IRS's statement in FAQ #35.
Without FAQ #35, the 2009 OVDP penalty structure assumes all
participants are tax evaders hiding money overseas when, in fact, the
IRS steered many people into the program who made honest mistakes.
Without FAQ #35, the 2009 OVDP attempts to apply a single set of rules
to two very different populations-those whose violations were willful
and those whose violations were not.
Many taxpayers who entered the 2009 OVDP were relatively "benign
actors" whose primary reason for establishing and maintaining overseas
accounts was unrelated to taxes. For instance:
In these circumstances and others, the IRS may be unable to prove
willful noncompliance or may, indeed, be convinced that the
noncompliance was not willful or that the taxpayer had reasonable cause.
These taxpayers ordinarily would not be subject to an FBAR penalty, or
if they were, it would generally not exceed $10,000, particularly if the
taxpayer voluntarily corrected the problem before being contacted by
The IRS's March 1 "revocation" of FAQ #35 results in some similarly
situated taxpayers who made honest mistakes being treated differently
than others. Among similarly situated taxpayers who inadvertently failed
to file an FBAR and timely entered the OVDP, those whose cases the IRS
processed before March 1, 2011, could get a better deal (paying less
than the 20-percent offshore penalty) than those whose cases it
processed later, even where the delay in processing the application was
due to the IRS's tardiness in handling the file.
The March 1 memorandum and the "revocation" of FAQ #35, seems to
violate fundamental notions of due process and fair dealing by giving
taxpayers whose cases the IRS happened to process earlier a better deal
than those whose cases it happened to process later. As the Taxpayer
Advocate suggests, this is likely to undermine public trust.
In addition, even when making the FAQ #35 comparison, the IRS has
applied existing statutes inconsistently. Under existing statutes, the
IRS bears the burden of proving that a person willfully violated a known
legal duty before it may impose the penalty applicable to willful FBAR
violations. This is appropriate because "willfulness" is a common
element that the government has to prove in criminal cases, where the
government always bears the burden of proof. In addition, because the
existing statute specifies only a "maximum" FBAR penalty amount that the
IRS "may" impose, the statute does not contemplate that the IRS would
apply the maximum penalty for willful violations in every case.
Accordingly, IRM 4.26.16 implements existing statutes by instructing
Following the March 1 memo, the IRS selectively applied these IRM
provisions in cases where the IRS has made the FAQ #35 comparison. In
some cases, it used the maximum willful FBAR penalty for comparison
purposes, unless the taxpayer had proved the violation was not willful.
Thus, it has turned the IRS's burden of proof on its head.
The 2009 OVDP offered taxpayers dissatisfied with the penalty
structure the opportunity to "opt out" of the program. Faced with
growing concern about the "fairness" of its retroactive revocation of
FAQ #35, and concern about the opt-out alternative, on June 1, 2011, the
IRS issued a memorandum (the "Opt-Out Memo") that stated a "taxpayer
should not be treated in a negative fashion merely because he or she
chooses to opt out" of the 2009 OVDP. However, taxpayers opting out
could hardly feel that they would not be treated differently, given the
provisions of FAQ #34, which stated that for those who opt out:
All relevant years and issues will be subject to a complete examination. At the conclusion of the examination, all applicable penalties (including information return and FBAR penalties) will be imposed. Those penalties could be substantially greater than the 20-percent penalty (available to those who did not opt out).
Under these circumstances, it is unlikely that a taxpayer would
believe that opting out was a viable option when faced with the
consequence of the assertion of massive penalties. The opt-out "option"
not only suggested increased civil penalties and assessment of
additional taxes, but also included an even-larger consequence for those
who dared to seek to be treated fairly. The opt-out memo cautioned that
"to the extent that issues are found upon a full scope examination that
were not disclosed, those issues may be the subject of review by the
Criminal Investigation Division."
An issue with the IRS's 2009 OVDP penalty structure is that it will
generally not consider willfulness or reasonable cause. The penalty
structure proceeds from an assumption that all noncompliant actors
should be treated as "bad actors" under the 2009 OVDP and that anyone
who is a "benign actor" should opt out and go through the examination
process. That assumption and the IRS's approach may be viewed by some as
misguided. What taxpayer who has already come forward would take their
chances with exam, given the IRS's pronouncements regarding how that
examination will be conducted. In the examination, what standards will
the IRS will use to compute an appropriate penalty-as the IRS's shifting
position within the 2009 OVDP has demonstrated, it may not adhere to
its most recent nonbinding pronouncement-and the taxpayers would be
assuming a significant risk that the IRS could ultimately assert
penalties of 50 percent of the maximum account balance for each year
(which could bankrupt them) as well as criminal penalties.
Thus, while the IRS's assertion that anyone may request that his or
her case go to exam sounds logical, it does not appear to be a viable
option. If the IRS refuses to consider nonwillfulness and reasonable
cause within the 2009 OVDP, the practical result will be that the bad
actors and the benign actors will both pay the same 20-percent penalty.
That does not seem a fair or reasonable result.
Because of the foregoing concern, the Taxpayer Advocate issue the
directive referenced above. The IRS operating divisions responsible for
administering the 2009 OVDP have rejected the directive's most essential
provisions regarding consideration of lack of willfulness and
reasonable cause and the amendment of previously executed closing
agreements imposing unwarranted penalties. The IRS Commissioner is
required to respond to the directive by the end of January 2012.
If you would like more information about voluntary disclosure for offshore accounts, please contact Thomas W. Ostrander, the author of this Alert; Hope P. Krebs or Stanley A. Barg in Philadelphia; Jon Grouf or Megan R. Worrell in New York; Anthony D. Martin in Boston; any member of the International Practice Group; Michael A. Gillen of the Tax Accounting Group; or the attorney in the firm with whom you are regularly in contact.
As required by United States Treasury Regulations, the reader
should be aware that this communication is not intended by the sender to
be used, and it cannot be used, for the purpose of avoiding penalties
under United States federal tax laws.
Disclaimer: This Alert has been prepared
and published for informational purposes only and is not offered, or
should be construed, as legal advice. For more information, please see
the firm's full disclaimer.
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