Key Highlights to Tax Professionals of New Offshore IRS Programs
Insight June 23, 2014
The Good News:
The existing "Streamlined" procedure for non-resident, non-compliant taxpayers has been expanded significantly to permit many more non-filers to qualify for full abatement of penalties. Like the existing procedure, the new procedure (available here) requires taxpayers to file tax returns for the three most recent years and to file foreign bank account reports (FBARs) for the six most recent years. The new procedure eliminates the requirement that the taxpayer's unreported tax liability not exceed $1,500 and widens participation to those who are amending previously filed tax returns. The new procedure also eliminates the risk assessment process and an associated questionnaire under which many taxpayers who were identified as having indications of tax avoidance (e.g., bank accounts outside of the taxpayer's country of residence) were ineligible for the Streamlined procedure. Under the new procedure, taxpayers will merely be required to certify under penalties of perjury that their non-compliance was not willful and provide a reason for the failure to comply.
There is also a new Streamlined procedure for U.S.-resident taxpayers whose failure to report offshore assets and income was not willful. Taxpayers who qualify for this procedure will pay a penalty equal to 5% of the unreported offshore assets.
Those who did not file FBARs but properly reported the income from such accounts on their tax returns can avoid the Streamlined procedure and simply file the FBARs. But this may not be wise for someone who has accounts which possibly have not been properly reported (e.g., PFICs, Keren Hishtalmut).
The Bad News:
The OVDP for taxpayers who willfully failed to report offshore assets remains in effect, and the 27.5% penalty continues to apply in many cases. However, certain voluntary disclosures filed on or after August 3, 2014 will face a 50% penalty on the maximum value of unreported assets. The higher penalty will apply to accounts held at institutions or through facilitators that have been the subject of a public disclosure, and that either:
- Are or have been under investigation by the IRS or the U.S. Department of Justice;
- Are cooperating with the IRS or the Department of Justice in connection with reporting of U.S. account holders, or:
- Have been identified in a court-approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a "John Doe summons").
The option of a 5% OVDP penalty for certain nonresidents will disappear as of July 1.
Taxpayers who are considering a voluntary disclosure should seriously consider acting before August 3rd to avoid the higher penalties.
Under transition rules, a taxpayer who entered OVDP before July 1 is entitled to use Streamlined even without opting out of OVDP. On or after July 1, a taxpayer must choose between Streamlined and OVDP and cannot opt out of one into the other. Therefore, a taxpayer who is unsure whether he would be considered negligent or willful should weigh entering OVDP before July 1.
The new Streamlined procedure presents a number of problems.
Loss of Streamlined Treatment
First, taxpayers must provide “complete and correct”(new or amended) tax returns for the previous three years. Some accountants avoid reporting PFICs or taking Keren Hishtalmut gains into income even after they are liquid (“nazil”). If the IRS believes that the tax returns are not filed in good faith, it could deny the taxpayer Streamlined treatment, resulting in FBAR negligence penalties.
Second, the draft questionnaire requires one to provide specific reasons for the“failure to report all income, pay all tax, and submit all required information returns, including FBARs.” A taxpayer must be careful to provide reasons which imply negligence but not willful blindness, which is treated as criminal willfulness. In a Streamlined Q&A session reported at Tax Notes Today (6/23/14), the IRS said: “The concept of willfulness is well documented in the case law,” and “We're depending on the practitioners to help the clients work their way through what the risk is of criminal prosecution and significant penalties.”
Internal Revenue Manual 18.104.22.168.5.3 states:
An example that might involve willful blindness would be a person who admits knowledge of and fails to answer a question concerning signature authority at foreign banks on Schedule B of his income tax return. . . . The failure to follow-up on this knowledge and learn of the further reporting requirement as suggested on Schedule B may provide some evidence of willful blindness on the part of the person. For example, the failure to learn of the filing requirements coupled with other factors, such as the efforts taken to conceal the existence of the accounts and the amounts involved may lead to a conclusion that the violation was due to willful blindness. The mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish that the FBAR violation was attributable to willful blindness.
The IRS view of willful blindness has been strengthened by the court ruling in the Williams case, which is discussed in this article.
Many taxpayers living in Israel have not as yet complied with FBAR obligations because they were afraid of negligence penalties. They may have closed accounts, shifted assets to nonresident alien spouses or taken other evasive actions. Ironically, because the IRS has removed the negligence penalties for those in the Streamlined program, the IRS now has a greater incentive to argue that taxpayers in the grey area were willfully blind. Therefore, there is a greater need for attorney-client privilege, because there is no accountant-client privilege in criminal matters.
Liability of Tax Professionals
Further, the draft certification, in describing the “specific reasons for failure to report” states: “If you relied on a professional advisor, provide the name, address, and telephone number of the advisor and a summary of the advice.” It is often the case that a client used a professional to prepare his tax return, and in 2010, for example, the professional began to advise the client to file an FBAR. The client will often have filed FBARs for 2010 forward, but not for 2009 back, because the client was afraid of negligence penalties. Until now, the client might have subsequently filed the prior FBARs and written a reasonable cause excuse blaming his accountant, without naming the accountant and without admitting that the accountant told him in 2010 to file for back years. With the new rule, if the client blames the accountant, he must name him. The accountant is in danger of losing his right to prepare returns if the IRS determines that the accountant has made this mistake with regard to many clients. This motivates the accountant to claim that in 2010 he did advise the client to file back FBARs. Note also that the statement is made under penalties of perjury, implying that if it is misleading, Streamlined treatment would be jeopardized. Moreover, tax advisors who help prepare a false document will violate Code section 7207 (submission of a false document).
Burden of Proof Shifts to Taxpayer
Last, it seems that under this program, it is the taxpayer and (instead of the government in a court case) that will have the burden of proving and persuading the IRS that he was "nonwillful" in his noncompliance.