Identifying PFIC investments may be tricky. Determining whether an investment is a PFIC requires some knowledge about the investment, and OVDI taxpayers are unlikely to know anything about their account investments. There is typically no way to definitively determine whether an investment is a PFIC based on account statements. Taxpayers are left with some guesswork in identifying PFICs and can expect pushback from civil agents about which investments the taxpayer chooses to treat as PFICs. Any back and forth with the agent on this issue quickly drives up costs for the taxpayer.
Alternative method computations are still complex. While the alternative method is indisputably simpler than the computations that would be required under the standard PFIC regime, the computations are nevertheless complex and require taxpayers to spend more on accounting services than they would without the PFIC computations. This is compounded where the statements are complex or statements are missing.
Accounting software is not designed to do alternative method computations. One factor that drives up computation costs is the reporting method that the OVDI prescribes. Taxpayers are to compute their PFIC liability outside the context of their amended return and then add the PFIC liability to their total tax-regardless of whether that total is regular tax or AMT. Most accountants use tax preparation software that doesn't do this computation-it typically requires an override to display the PFIC liability on the return.
There are no shortcuts. Consistent with the standard PFIC regime, the alternative method requires taxpayers to compute the PFIC tax on an investment-by-investment basis. The IRS did not allow taxpayers to aggregate PFIC investments under the 2009 OVDP for the sake of administrative simplicity, and it appears that they will not allow aggregation under the 2011 OVDI.
There may be continuing complications. Taxpayers who retain their PFIC investments must remain on the mark-to-market method for post-OVDI years.
Cost of computations may outstrip underlying PFIC tax. Taxpayers with small offshore accounts or who had little invested in PFICs may find that the cost of computing the additional PFIC liability will be higher than the additional PFIC tax owed under the alternative regime.
While none of these considerations-either alone or in combination-are likely to counsel taxpayers to attempt to compute their PFIC liability using the standard regime, taxpayers should nevertheless be aware of these pitfalls and expenses.
Opting Into The 2011 OVDI
Some 3,000 taxpayers opted for voluntary disclosure even after the October 2009 date had passed for the 2009 OVDP. The IRS is allowing voluntarily disclosing taxpayers who missed the 2009 OVDP deadline to elect into the 2011 OVDI. We suspect that in the vast majority of cases, the most economical route for these taxpayers will be to elect into the 2011 OVDI.
There are, however, may be some issues that will crop up for taxpayers who elect into the 2011 OVDI. One issue is that those taxpayers may have already submitted substantial filings and the IRS may require them to resubmit a separate application that complies with the 2011 OVDI package requirements. Practitioners hope that taxpayers will be able to opt in more simply, like with a letter to the IRS.
Another possible issue involves the 25% penalty on the highest aggregate account balance. The penalty-calculation issue described above-that the IRS may include disclosed accounts in penalty calculations-is more likely to arise for taxpayers who have voluntarily disclosed before opting into the 2011 OVDI because it is likely that those taxpayers have already filed FBARs for 2009 or 2010 or both before opting into the 2011 OVDI. Those taxpayers should be aware that despite the patent unfairness of including timely-disclosed accounts in the penalty calculation, the IRS may nevertheless try to include disclosed accounts from 2009 or 2010 in computing the 25% penalty.
How Will The IRS Administer The 2011 OVDI?
A host of case-specific factors will determine whether taxpayers who opt into the 2011 OVDI incur the same level of administrative expense and burden as those who elected the 2009 OVDP: how quickly the taxpayer can obtain bank records, whether the taxpayer has kept records herself, the number of accounts and volume of account activity, whether the taxpayer can complete the package before other taxpayers, whether the taxpayer has the PFIC issue, etc. An important factor that will determine the administrative burden associated with 2011 OVDI participation is the manner in which the IRS administers the program. There have been meaningful delays for 2009 OVDP participants, some of which have yet to have their case assigned to revenue agents. Part of the problem appears to be that the IRS did not anticipate the volume of participation in the 2009 OVDP.
The IRS is more optimistic about its ability to efficiently process cases in the 2011 OVDI. The IRS has represented that for the 2011 OVDI, it is "handling [the] processing of the voluntary disclosures in centralized units" for the sake of efficiency and that it "has taken certain steps to improve our efficiency in processing cases." The IRS has also stated that it has made efforts to centralize the pre-clearance process (the process by which a taxpayer can determine whether she is already under IRS investigation before making a voluntary disclosure). While the IRS has undoubtedly improved its processes after the 2009 OVDI and we are optimistic that things will move more quickly in this go around, taxpayers hoping for a swift and inexpensive resolution on the civil side would be wise to temper their expectations.
Zehnle, Dixon and Mosley are attorneys with the law firm of Miller & Chevalier in Washington D.C.