IRS Reopens Offshore Disclosure Program: Should You Apply? – PART II
OVDI Disclosure or Silent Disclosure or Something Else?Last month, in Part I of this article, I described the details of the IRS Offshore Voluntary Disclosure Initiative program (“OVDI”) and the important changes made to the recently reopened 2012 version of the OVDI program. This month, in Part II, I discuss the factors that go into determining whether a taxpayer should enter the OVDI program to disclose previously undeclared offshore assets, or consider an alternative compliance method. Generally, whether a taxpayer enters the OVDI program or not depends on whether the taxpayer is in danger of being classified a willful non-filer, or has credible reasonable cause arguments, or falls in the large gray zone somewhere in between.
For those taxpayers at substantial risk of being treated a willful non-filer by the IRS, the OVDI fixed civil penalties, generally, are substantially lower than the potential maximum willful penalties. Therefore, filing under the OVDI generally should be a good deal for such taxpayers. For those few taxpayers who have strong reasonable cause arguments to avoid penalties completely, the fixed penalties of the OVDI program generally are not an attractive option. For the vast majority of taxpayers falling somewhere in between (clearly not willful, but no credible reasonable cause arguments), the decision of which course to follow is a difficult one of number-crunching and comparing all possible outcomes, followed by risk tolerance based choices between all possible outcomes.
For the taxpayers in this vast gray zone, the decision process is more difficult because of the IRS’ natural leverage in this situation. Many commentators and the National Taxpayer Advocate have noted how the IRS has unfairly enhanced its bargaining asymmetry by providing empty promises in FAQ 35 and the opt-out procedures. FAQ 35 states a taxpayer would not pay more penalties under the OVDI than he or she would under existing statutes. The OVDI opt-out procedures state taxpayers who choose to opt-out will not be treated in a negative fashion for opting-out. Many practitioners, however, have reported the opposite; that, IRS agents have threatened taxpayers indicating they may opt-out that doing so would result in a long and painful examination and that contrary to FAQ 35, the maximum penalties would be asserted against them rather than applying existing statutes pursuant to the Internal Revenue Manual’s published guidelines which, in most cases, would suggest a warning letter or a penalty less than the maximum allowable.
In other words, it appears the IRS is treating all filers as willful, or at least threatening to treat them as willful despite the strong likelihood the IRS would not be able to prove willfulness in most cases. Given this current posture from the IRS, it may be unreasonable to expect most taxpayers to assume the huge risk of massive penalties that could result from opting-out, and for practitioners to advise their clients to do so. Accordingly, many taxpayers in the gray zone who likely could do better under existing statutes (if fairly applied by the IRS) are pressured into staying in the OVDI and paying the applicable offshore penalty (i.e., 27.5 percent or 12.5 percent or 5 percent, as the case may be).
But clearly, not all taxpayers need enter the OVDI program and suffer the large fixed penalties. For those few who have strong reasonable cause arguments, perhaps a silent disclosure (or something in between a silent disclosure and the OVDI program) may be warranted, depending on the specific facts in question. The IRS continues to focus efforts on auditing silent disclosures, or at least the IRS says it is. The IRS has attempted to create a lot of media to discourage taxpayers from doing silent disclosures, and force everyone into a noisy disclosure, by appearing to be highly aggressive in auditing silent disclosures. Given the limited enforcement resources available to the IRS, I question whether this is a lot of sound and fury from the IRS, and whether its bark is bigger than its bite in this area. No doubt, taxpayers must be clearly aware, the IRS is getting more aggressive in auditing silent disclosures and, therefore, this option remains risky and may not be advisable for many taxpayers. I continue to believe, however, that a silent disclosure could be a preferred option for some taxpayers depending on their specific circumstances. The IRS will never succeed in its stated goal of forcing all taxpayers into a noisy disclosure.
Conclusion
The newly reopened OVDI program offers an opportunity to those taxpayers who continue to be non-compliant with reporting their offshore accounts. Whether this non-compliance is due to recalcitrance, or simply just now learning of the filing requirements and the OVDI program, should make a major difference in how taxpayers are treated under existing statutes, but appears to be irrelevant to the IRS in applying the OVDI program. For many, entering the OVDI could be the best option available after considering all factors and potential scenarios. Tax payers who continue their non-compliance are slowly running out of time and options. The IRS is aggressive about finding taxpayers with undeclared offshore assets, and has strengthened its tools to find such non-compliant taxpayers. Taxpayers with strong reasonable cause arguments, however, may question whether entering the OVDI program, at least as currently administered by the IRS, is the right course of action.
Taxpayers at high risk of being deemed a willful non-filer who think they can escape by starting to disclose going forward and hoping the standard six year statute of limitations expires before they get audited are exposing themselves to substantial risk. With new reporting rules now in force on taxpayers (and soon to be in force on foreign financial institutions), and given the IRS’ increased focus on this area in general, this approach likely will encounter a high failure rate. Further, it is possible the IRS could charge such taxpayers with civil fraud if they take active steps to conceal their prior year non-compliance as part of their current and future year compliance. In that case, such taxpayers could be audited at any time because no statute of limitations applies for civil fraud, and the possibility of criminal tax evasion charges would be very high as well.
Accordingly, given the high stakes involved, readers seeking to determine the advisability of entering the OVDI program or attempting a silent disclosure, or otherwise, should consult their tax adviser for an evaluation and advice on the best way forward.
Rahul P. Ranadive is admitted to the Florida and California bars and the U.S. Tax Court, and has practiced international and domestic tax planning focusing on high net-worth families with international ties for over 10 years. He is based in Miami, and can be reached at [email protected] or (305) 913-7128 or by visit www.gtecllp.com
The foregoing is not tax or legal advice and should not be relied upon as such. No attorney-client relationship is created or implied with any reader of this article. All taxpayers should seek independent advice from a qualified tax professional based on their individual circumstances.