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Tax Lawyer > Blog > Domestic Tax Planning > I.R.S. program granting Amnesty from criminal tax prosecution for offshore delinquent taxpayers

I.R.S. program granting Amnesty from criminal tax prosecution for offshore delinquent taxpayers

Many American taxpayers are not completely sure about the IRS changes to Offshore Bank and Foreign Asset Disclosure Programs. Here are a few frequently asked questions we have seen lately.

Question 1: If a Taxpayer is concerned that his or her failure to report income, pay tax and submit required information returns was due to willful conduct and who wants more assurances that they will not be subject to criminal inability and/or substantial monetary penalties, should the taxpayer consider participating in the Offshore Voluntary Disclosure Program (OVDP) and not the Streamline Program?

Answer:   Yes. The Offshore Voluntary Compliance Program is a separate IRS Program that waives certain serious penalties but asserts a much higher overall penalty than the Streamlined Procedure and it assures taxpayers that they will have a perfectly clean slate.

Questions 2: What is the standard of “willfulness” that prevents a taxpayer from entering the Streamlined Program?

Answer:   The test for willfulness is whether there was a voluntary, intentional violation of a known legal duty.  A finding of willfulness must be supported by evidence of willfulness.  The burden of establishing willfulness is on the Internal Revenue Service and if is determined that the violation was due to reasonable cause, the willfulness penalty should not be asserted.


New United States tax laws require strict reporting of foreign assets and establish a new program granting Amnesty from criminal tax prosecution for offshore delinquent taxpayers.

The United States has finally caught up with the Global world when it comes to taxation. Three new laws are now in place to insure, as much as possible, that individual Americans and resident aliens will pay tax on their worldwide income.

Under the first new law known as the Foreign Accounts Compliance Act (“FATCA”), (“Foreign Asset Reporting”) beginning with the year 2011 annual income tax returns, there are new reporting requirements in place for U.S. individual taxpayers and U.S. entities. These laws require specified foreign assets that must be disclosed and reported on an information return that is filed together with the Federal income tax return.

At the same time that these more stringent disclosure of offshore assets is being demanded; the IRS has agreed to an open ended continued amnesty program for taxpayers who have not properly reported or paid tax on their worldwide income (the “Amnesty”). Unlike previous Amnesties, there is no time period to this latest program. However, I.R.S. has warned it can stop the Amnesty Program whenever it wants. The Amnesty Program charges a harsh fine but permits a taxpayer to avoid criminal penalties and a number of wealth destroying civil penalties that can be imposed on a U.S. Taxpayer who has not paid U.S. taxes on foreign bank deposits and other foreign assets.1/

This article is in two portions. The first portion considers the Amnesty program for unreported foreign income and the second portion considers the Foreign Asset Reporting Requirements. 1

the amnesty program

PART I – THE AMNESTY

A U.S. Taxpayer (the “Taxpayer”) with undisclosed foreign accounts or entities and other assets, should make a voluntary disclosure because it enables the Taxpayer to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

Penalties Avoided

The following is a list with a short explanation of each potential civil and criminal penalty that is avoided by accepting the Amnesty terms.

Civil Penalties

  1. There is a penalty for failing report a direct or indirect financial interest in, or signature authority over any financial account maintained with a financial institution located in a foreign country that exceeds $10,000.

  2. There is a penalty for failing to file an Annual Return to Report large foreign gifts and transactions with Foreign Trusts.

  3. There is a penalty for failing to report any ownership interest in foreign trusts.

  4. A penalty for certain United States persons who are officers, directors or shareholders in certain foreign corporations who do not report such information to the United States.

  5. There is a penalty for U.S. persons that fail to file and report ownership of foreign partnerships

There are Fraud Penalties that result only in Civil Penalties. These penalties can be almost as high as the tax that has been avoided.

  1. A fraud penalty for failing to file a tax return.
  2. A fraud penalty for failing to pay the amount of tax shown on the return.
  3. An accuracy-related penalty on underpayment of tax.

Criminal Penalties

The failure to report and pay taxes on foreign income and bank account by US. Taxpayer can also result in Criminal Penalties.

  1. Possible criminal charges related to tax returns include filing a false return and failure to file an income tax return.

  2. A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000.

  3. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000.

All of this can be avoided by entering into the I.R.S. Amnesty Program. However, the cost is high.

The present Amnesty program provides a tax, interest and penalty framework. Individuals must pay their taxes on any unreported income, 20% penalty on the total unpaid taxes and interest on the amounts due. In addition, individuals must pay a onetime penalty of 27.5 percent of the highest aggregate balance at any one point in time of their foreign bank accounts or entities during an eight (8) year period prior to the disclosure. Some taxpayers will be eligible for 12.5 percent penalties instead of the 27.5% penalty.

The Taxpayer must:

  1. Provide copies of previously filed original or amended federal income tax returns for all tax years covered by the voluntary disclosure. The voluntary disclosure period can be a period of eight (8) years preceding the disclosure time.

  2. File complete and accurate original or amended offshore-related information returns.

  3. Cooperate fully with the voluntary disclosure process which includes providing information on offshore financial accounts, institutions and facilitators, and signing agreements to extend the period of time for assessing tax and penalties.

  4. Pay all taxes due as a result of the disclosure. 2

  5. Pay a 20% accuracy-related penalty on the full amount of the underpayment of tax for all years.

  6. Pay a penalty for the failure to file a tax return if tax return was not filed.

  7. Pay, in lieu of all other penalties that may apply, a penalty equal to 27.5% (or in limited cases 12.5% or 5% of the highest aggregate balance in foreign bank accounts/entitites or value of foreign assets during the period covered by the voluntary disclosure.

  8. Pay all interest on the outstanding amount.

ELIGIBILITY

Taxpayers who have undisclosed offshore accounts or assets are eligible to apply for IRS Criminal Investigation’s Voluntary Disclosure Practice and penalty regime for an eight year maximum disclosure period.

Corporations, partnerships, and trusts and other entities are eligible to make voluntary disclosures.

Amnesty Not Available – Investigation Commenced

However, if the IRS has initiated a civil examination, regardless of whether it relates to undisclosed foreign accounts or undisclosed foreign entities, the taxpayer will not be eligible to come in under the Amnesty. Taxpayers under criminal investigation are also ineligible. The taxpayer or the taxpayer’s representative should discuss the offshore accounts with the agent.

The purpose for the voluntary disclosure practice is to provide a way for taxpayers who did not report taxable income in the past to come forward voluntarily and resolve their tax matters. Thus, if you, reported and paid tax on all table income but did not file FBARs, do not use the voluntary disclosure process.3

Taxpayers who reported and paid tax on all their taxable income for prior years but did not file FBARs should file the delinquent FBAR reports according to the FBAR instructions and attach a statement explaining why the reports are filed late. The IRS will not impose a penalty for the failure to file the delinquent FBARs if there are no underreported tax liabilities,

Notice of Qualification for Amnesty

Taxpayers or representatives may file to the Criminal Investigation Lead Development Center identifying information (name, date of birth, social security number and address) and an executed power of attorney (if represented) to request pre clearance before making an offshore voluntary disclosure.

Criminal investigation will then notify taxpayers or their representatives via fax whether or not they are cleared to make an offshore voluntary disclosure.

Taxpayers deemed cleared should take the steps within 30 days from receipt of the fax notification to make an offshore voluntary disclosure. Pre clearance does not guarantee a taxpayer acceptance. Taxpayers must still truthfully, timely and completely comply with all provisions of the offshore voluntary disclosure program.

PAYMENT

The terms of the Amnesty require the taxpayer to pay the tax, interest and accuracy related penalty and other penalties with their submission. However, it is possible for a taxpayer who is unable to make full payment of these amounts to request the IRS to consider other payment arrangements.

The burden will be on the taxpayer to establish inability to pay, to the satisfaction of the IRS, based on full disclosure of all assets and income sources, domestic and offshore, under the taxpayer’s control. Assuming that the IRS determines that the inability to fully pay is genuine, the taxpayer must work out other financial arrangements acceptable to the IRS to resolve all outstanding liabilities in order to be entitled to the penalty relief under this initiative.

Amnesty Documents

  1. Copies of previously filed original (and, if applicable, previously filed amended) federal income tax returns for tax years covered by the voluntary disclosure.

  2. Complete and accurate amended federal income tax return (for individuals, Form 1040X or original Form 1040 if delinquent for all tax years covered by the voluntary disclosure, with applicable schedules detailing the amount and type of previously unreported income from the account or entity (e.g. Schedule B for interest and dividends. Schedule D for capital gains and losses. Schedule E for income from partnerships, S corporations, entities or trusts.

  3. A completed Foreign Account or Asset Statement for each previously undisclosed foreign account or asset during the voluntary disclosure period. For those applicants disclosing offshore financial accounts with an aggregate highest account balance if any year of $1 million or more, a completed Foreign Financial Institution Statement for each foreign financial institution with which the taxpayer has undisclosed accounts or transactions during the voluntary disclosure period

  4. A check payable to the Department of Treasury in the total amount of tax, interest, accuracy-related penalty, and if applicable, the failure to file and failure to pay penalties, for the voluntary disclosure period. The total amount of tax, interest and penalties as described above cannot be paid, submit a proposed payment arrangement and a completed Collection Information Statement.

  5. For those applicants disclosing offshore financial accounts with an aggregate highest account balance in any year of $500,000 or more, copies of offshore financial account statements reflecting all account activity for each of the tax years covered by your voluntary disclosure. For those applicants disclosing offshore financial accounts with an aggregate highest account balance of less than $500,000, copies of offshore financial account statements reflecting all account activity for each of the tax years covered by your voluntary disclosure must be readily available upon request.

  6. Properly completed and signed agreements to extend the period of limitations.

  7. In a striking new approach to the Amnesty Program, the Program now extends the penalty beyond just offshore financial assets; if the assets are not acquired with after tax income. The offshore penalty is intended to apply to offshore assets that are related to tax on compliance. Thus, if offshore assets were acquired with funds that were subject to U.S. tax but on which no such tax was paid, the offshore penalty would apply regardless of whether the assets were producing current income. Assuming that the assets were acquired with after tax funds or from funds that were not subject to U.S. taxation, if the assets have not yet produced any income, there has been no U.S. taxable event and no reporting obligation to disclose. The taxpayer will be required to report any current income from the property or gain from its sale or other disposition at such time in the future as the income is realized.

The penalty applies to all assets directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets, tangible assets such as real estate or art and intangible assets such as patents or stock or other interests in a U.S. or foreign business, if the assets were acquired with funds that evaded the payment of U.S. taxes. Whether such assets are indirectly held or controlled by the taxpayer through an entity or alter ego, the penalty may be applied to the taxpayer’s interest in the entity or, if the Service determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying assets.

Amnesty Program – Modifications

The Amnesty cannot be taken in parts. If any part of the offshore penalty is unacceptable to the taxpayer the case will be examined and all applicable penalties will be imposed. After a full examination, any tax and penalties imposed by the Service on examination may be appealed.

Voluntary disclosure examiners do not have discretion to settle cases for amounts less than what is properly due and owing. However, because the 27.5% percent offshore penalty is a proxy for the FBAR penalty, other penalties imposed under the Internal Revenue Code, and potential liabilities for the voluntary disclosure years, there may be cases where a taxpayer making a voluntary disclosure would owe less if the especial offshore initiative did not exist. Under no circumstances will taxpayers be required to pay a penalty greater than what they would otherwise be liable for under the maximum penalties imposed under existing statutes.

The 5% Penalty

Taxpayers who meet all four of the following conditions will entitled to the reduced 5% offshore penalty (a) did not open or cause the account to be opened (unless the bank required that a new account be opened, rather than allowing a change in ownership of an existing account, upon the death of the owner of the account; (b have exercised minimal, infrequent contact with the account, for example, to request the account balance, or update accountholder information such as a change in address, contact person, or email address, (c) have, except for a withdrawal, closing the account and transferring the funds to an account in the United States, not withdrawn more than $1,000 from the account in any year for which the taxpayer was on compliant, and (d) can establish that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).

The 12.5% Penalty (Deminimus)

A taxpayer that does not qualify for a lesser payment or a 5 percent offshore penalty, but taxpayers whose highest aggregate account balances in each or the voluntary disclosure years is less than $75,000 will qualify for a 12.5 percent offshore penalty.

FOOTNOTES:

1 While the Amnesty Program has no time deadline; there is in fact a practical deadline. The third law, which does not come into effect until 2014 will require foreign institutions to report all U.S. investors to the I.R.S. Once a Taxpayer is under I.R.S. investigation, the Amnesty Program is no longer available.

2 PFIC Special Taxation. A significant number of investments involve Passive Foreign Investment Companies (“PFIC”). These investments will often add to the taxable income calculation since there may be accrued gains to account for. A lack of historical information on the cost basis and holding period of many PFIC investments makes it difficult for taxpayers to prepare statutory PFIC computations and for the Service to verify them. In order to not unduly delay matters, the I.R.S. has offered taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market methodology but will not require complete reconstruction of historical data.

3 Some Taxpayers can breathe a sigh of relief and can avoid the Bank Deposit penalty and other penalties if they reported their offshore income even though it was never disclosed in Information Returns.

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