The Do’s and Don’ts of Foreign Account Disclosure - US Taxes and the IRS

May 1st 2014

US taxpayers who failed to report foreign financial activity to the Internal Revenue Service (IRS) have received notices from the IRS about their non-compliance. Over the last few years, the IRS has made advances in the problem of tax evasion by US taxpayers (citizens and residents) with foreign accounts. All US taxpayers with foreign accounts of $10,000 and over are required to report their fbar filings and file tax returns regardless of whether they live in the United States or overseas.  Majority of taxpayers are not tax evaders and are simply unaware that they are supposed to disclose foreign accounts. However, the IRS has adopted a blanket approach to non-compliant taxpayers which naturally, has many people nervous about filing the FBAR and suffering the penalties imposed by the IRS. Unfortunately, the Foreign Bank and Financial Account Reporting Requirements remain ambiguous, and sometimes downright confusing to taxpayers.

The IRS advises taxpayers to voluntarily disclose foreign tax transgressions or face full prosecution, which could range from penalties to actual prison time.  To encourage voluntary disclosure of unreported foreign accounts, the IRS introduced the Offshore Voluntary Disclosure Incentive (OVDI), now called the Offshore Voluntary Disclosure Program (OVDP). The OVDP is a way to come clean with the IRS and pay a fixed penalty.

OVDP: The Offshore Voluntary Disclosure Program (OVDP) offers taxpayers the opportunity to file taxes on previously unreported offshore accounts and receive a significantly reduced penalty on past taxes. By self-reporting, paying taxes and penalties, non-compliant taxpayers can avoid civil and possibly, criminal prosecution. Some have called the OVDP a bully-move by the IRS, and advise taxpayers to be fully aware of the specifics before entering the program. For example: By entering the OVDP, taxpayers agree to several requirements including: waiving their constitutional right against self-incrimination (5th Amendment), unreasonable search and seizure (4th Amendment); and excessive fines (8th Amendment). In addition, the OVDP does not offer full protection from prosecution because the IRS can remove a participant from the program at any time, and use the information provided by the participant during the OVDP process against them.

Quiet Disclosure: An alternative to the OVDP is a Quiet Disclosure. In Quiet Disclosures, taxpayers file amended tax returns and FBARs on any unreported foreign activity and maintain compliancy in the future tax years. In Quiet Disclosure, the taxpayer actually doesn’t report any illegal activity or omission to report and pay taxes on foreign accounts, they just quietly pay it. Ultimately, it is trying to fix the problem without the knowledge of the IRS. However, according to the IRS, “a quiet disclosure is no disclosure at all.” In 2013, the Government Accountability Office (GAO) published a report that suggested the IRS needs to pay more attention to the rampant number of Quiet Disclosures.  Quiet Disclosures are not recommended and carry a great risk for the taxpayer.

Qualified Quiet Disclosure or OVDP Opt-Out: The Qualified Quiet Disclosure, also called the OVDP Opt-Out, is a third option that offers taxpayers a way to become compliant. With this option, taxpayers can file past tax returns on their foreign accounts and pay their penalties, and still avoid the highly rigid, punitive and expensive penalties associated with the OVDP. In this situation, a participant signs up for the OVDP, reports all offshore accounts, files past tax returns on those accounts, and basically clears themselves of suspicion. Once all the information has been disclosed to the IRS, and the process is in its last stage, the participant opts out of the OVDP program. The Qualified Quiet Disclosure offers the taxpayer constitutional protections that are removed when a taxpayer signs up for the OVDP. In addition, taxpayers can avoid the stringent and hefty penalty structure of the OVDP.  With the Qualified Quiet Disclosure, a taxpayer still has the right to protect his interests and contest penalties by the IRS. It should be noted that the Qualified Quiet Disclosure is NOT the same as the Quiet Disclosure. Unlike the Quiet Disclosure, which is not approved by the IRS, the Qualified Quiet Disclosure is recognized as a viable alternative.

Both individual and corporate taxpayers are responsible for remaining tax compliant on their domestic and international foreign accounts.  However, until recently, many individuals were unaware that reporting foreign bank and financial accounts to the IRS was mandatory regardless if they resided in the US or overseas. They remain uncertain of the consequences of missed filings. It should be further noted that many foreign banks, including Swiss banks, are now cooperating with the US Treasury. This allows the US government to discover non-compliant taxpayers. It is better for almost any taxpayer to come forward voluntarily than to be dragged into court.

Klueger & Stein, LLP advises clients that however unpleasant the process may be, it is important to be proactive in resolving the issue. We explore our clients’ options and work with each client to determine the best course of action based on their unique circumstances.