There are a few zinger penalties in the 2011 OVDI. The 25% penalty to foreign assets is one example. Under the program, any foreign assets acquired with funds that should have been taxed but were not (for example, assets purchased with skimmed business receipts) are added to the penalty computation based on the highest fair market value of the assets during the OVDI years. Similarly, foreign income-producing assets whose income was not reported in filed tax returns are also subject to the 25% penalty at their highest fair market value between 2003 and 2010.
This penalty calculation alone substantially ups the ante for disclosing taxpayers and often drives taxpayers to reject disclosure and "take their chances." What makes this feature of the 25% penalty particularly galling is the absence of any foundation in the law to support it. What the OVDI is extracting as a "miscellaneous tax penalty" is grounded in the penalty that could be imposed under the Bank Secrecy Act for failure to file Report of Foreign Bank and Financial Accounts (FBARs) or for filing erroneous or incomplete FBARs. Because this statute only applies to foreign financial accounts, and not to foreign assets like art and real estate, the penalty imposed under the Bank Secrecy Act could not be applied to these non-financial assets as a matter of law.
This presents another zinger with the 2011 OVDI program: the inability to achieve a reduced penalty on foreign accounts and assets under circumstances outside of those allowing for the reduced 5% or 12.5% penalty. Under the 2009 OVDI program, the IRS took the following position in IRS FAQ 35: "Under no circumstances will a taxpayer be required to pay a penalty greater than what he would otherwise be liable for under existing statutes." This term was initially interpreted and applied by IRS examiners to reduce the penalty under OVDI if the taxpayer established non-willfulness regarding the FBAR filing or reasonable cause. Late in the processing of 2009 disclosures, however, the IRS withdrew from applying this principle, much to the chagrin of affected taxpayers and their representatives. The IRS FAQs under the second 2011 initiative, FAQ 50, which, in part, reiterates the spirit of old FAQ 35, added new and different language to the FAQ, as follows:
"Examiners will compare the amount due under this offshore initiative to the tax, interest, and applicable penalties (at their maximum levels and without regard to issues relating to reasonable cause, willfulness, mitigation factors, or other circumstances that may reduce liability) for all open years that a taxpayer would owe in the absence of the 2011 OVDI penalty regime."
The effect of this new language is generally to eliminate most situations from achieving a reduced penalty based on reasonable cause, special circumstances and non-willful failures.
There are numerous other issues that often surface during the voluntary disclosure process. These may involve interests in foreign entities such as corporations, foundations and trusts, co-owned accounts (often with foreigners who are not U.S. taxpayers), estate and gift tax issues affecting U.S. executors and trustees, and transferred accounts indicating the possibility of double-counting assets for penalty purposes. These situations make careful consideration of each taxpayer's particular facts and circumstances imperative before a final decision to opt into the 2011 OVDI should be made. Of course, in any case, one needs to make sure that the taxpayer qualifies for the OVDI program. If not, the taxpayer's options may be limited.
For taxpayers who clearly engaged in fraudulent conduct, the 2011 OVDI remains a good option and a good deal to avoid criminal prosecution and to minimize penalties. For those whose situations are less clear cut, however, the 2011 OVDI program may or may not be the best approach to fixing a foreign account problem.
Barbara T. Kaplan is a shareholder of the international law firm of Greenberg Traurig LLP and chair of its New York tax department. She concentrates her practice in tax controversy, tax litigation and criminal tax matters.