The tax attorneys at Nardone Law Group routinely advise Ohio taxpayers about the Internal Revenue Service’s Offshore Voluntary Disclosure Program. Whether or not the Offshore Voluntary Disclosure Program is beneficial to a particular taxpayer depends upon that particular taxpayer’s facts and circumstances. For example, there are instances in which Nardone Law Group may advise a taxpayer not to pursue the Offshore Voluntary Disclosure Program. See our prior article on one scenario where opting out of the Offshore Voluntary Disclosure Program may make sense. But, there are also circumstances where Nardone Law Group may recommend that a taxpayer take advantage of the Offshore Voluntary Disclosure Program, rather than opting out. This article discusses one situation in which opting out of the Offshore Voluntary Disclosure Program may not be appropriate.
When Opting Out of the Offshore Voluntary Disclosure Program May Not Make Sense
As noted in our prior article, the 27.5% Offshore Voluntary Disclosure Penalty takes the place of various penalties otherwise imposed outside the Offshore Voluntary Disclosure Program. There are exceptions to some of the penalties otherwise imposed outside the Offshore Voluntary Disclosure Program, which could prevent those penalties from applying to certain taxpayers. Thus, there may be cases where a taxpayer in the process of making a voluntary disclosure would owe less by opting out of the Offshore Voluntary Disclosure Program. But, in certain instances, opting out of the Offshore Voluntary Disclosure Program may result in greater liability and/or the possibility of criminal prosecution.
The Internal Revenue Service has published Frequently Asked Questions and Answers related to the Offshore Voluntary Disclosure Program (“IRS FAQs”). The IRS’ FAQ examples provide some guidance on the decision whether to pursue the Offshore Voluntary Disclosure Program or opt out.
For instance, consider the following example from IRS FAQ # 51.2: Assume a U.S. citizen taxpayer failed to report the sale of an apartment building he owned in a foreign country in 2008, but has now disclosed the sale to the IRS. The apartment building had a value of $10 million and the taxpayer’s unreported gain on the sale was $6 million. The tax owed from the apartment sale was $2,100,000. The Taxpayer deposited all of the $10 million from the apartment sale into a foreign checking account that he had owned since 2008. The high balance in the taxpayer’s foreign account for 2008, and as of June 30, 2009—the date the taxpayer’s Form TD F 90-22.1 Report of Foreign Bank and Financial Accounts (“FBAR”) was due—was $10 million. Additionally, the taxpayer had held the apartment building in a foreign grantor trust. The taxpayer had created the trust in 2008 right before selling the apartment building, and transferred the building to the trust at that time. The taxpayer did not file the required Form 3520 Annual Return to Report Transactions with Certain Foreign Trusts and Receipt of Certain Foreign Gifts (“Form 3520”) with the IRS to report creating the trust and transferring property into the trust.
Result Under Offshore Voluntary Disclosure Program
According to the IRS, the Offshore Voluntary Disclosure Program penalty for the above example would be $2,750,000 (e.g., 27.5% of the $10 million highest foreign account balance). Also, the taxpayer would have to pay the $2,100,000 tax deficiency plus interest and a 20% accuracy-related penalty of $420,000. Thus, the total penalty under the Offshore Voluntary Disclosure Program would be $5,270,000. See IRS FAQ # 51.2.
Result by Opting Out of Offshore Voluntary Disclosure Program
According to the IRS, had the taxpayer elected to opt out of the Offshore Voluntary Disclosure Program in the above example, the IRS would have imposed an FBAR penalty of $5,000,000 for 2008. The IRS has authority to impose a penalty for willful failure to file an FBAR in an amount equal to the greater of: $100,000 or 50% of the highest account balance for the reporting year. Here, assuming the IRS could prove a willful failure to file, a 50% penalty on the checking account balance of $10 million as of June 30, 2009 is $5,000,000. Additionally, the taxpayer would owe the tax deficiency of $2,100,000 plus interest and applicable penalties for failure to file a return and/or failure to pay tax. Moreover, the taxpayer would be subject to FBAR penalties for all other open years during which the aggregate balance in the foreign checking account exceeded $10,000. Furthermore, the IRS may determine during examination of the taxpayer that the failure to report was due to fraud. In that case, the IRS would impose a 75% civil fraud penalty on the $2,100,000 tax deficiency, resulting in a penalty of $1,575,000. Finally, the taxpayer would be subject to a 35% penalty on the highest account balance in the foreign trust for failure to file the Form 3520, resulting in a penalty of $3,500,000 (35% of $10 million). Had the taxpayer opted out in this case, his overall liability would be either $11,020,000 or $12,175,000, depending on whether the IRS imposed the accuracy-related penalty or the civil fraud penalty, respectively, to his tax deficiency.
Thus, as you can see, opting out of the Offshore Voluntary Disclosure Program may not be the best option for some taxpayers. But, it is important to note that the above example is a simplified scenario. In some instances, taxpayers will qualify for reduced penalties due to mitigating circumstances, or will have other circumstances under which the 27.5% Offshore Voluntary Disclosure penalty would produce an unduly harsh result. Accordingly, it is important to have an experienced tax attorney evaluate your case to decide whether the Offshore Voluntary Disclosure Program is best for you, or whether opting out of the Offshore Voluntary Disclosure Program is more appropriate.
Nardone Law Group represents businesses and individuals in federal and state tax controversies, including the Offshore Voluntary Disclosure Program. If you have an undisclosed foreign account or entity, you should contact an experienced tax attorney today. Nardone Law Group’s tax lawyers and professionals have vast experience representing clients before the IRS. Our experienced tax lawyers will thoroughly review your case to determine what options and alternatives are available, including the Offshore Voluntary Disclosure Program. Contact us today for a consultation to discuss your case.