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Analysis: IRS New Disclosure Program

On November 29, 2018, the IRS released a memorandum that addressed the process for all voluntary disclosures following the end of the Offshore Voluntary Disclosure Program (“OVDP”) on September 28, 2018. The new voluntary disclosure procedure provides uniformity to offshore and domestic voluntary disclosures.

The OVDP was initiated in 2009 and was designed to bring taxpayers with undisclosed foreign income, accounts and assets into U.S. tax compliance. Taxpayers who were eligible to participate in the OVDP and made timely voluntary disclosures were provided the opportunity to receive protection from criminal referrals and to resolve their civil tax and penalty obligations on a standardized framework.

The new procedures continue to provide taxpayers an ability to come into tax compliance and generally eliminates the risk of criminal prosecution but there are many changes from the former OVDP. Some of the changes are procedural, such as no longer requiring the filing of required tax returns and additional documents until an IRS agent is assigned to the case.  Other critical changes are more substantive, including changes to the disclosure period and the penalties imposed.

The Disclosure Period

The disclosure period is now 6 years (previously 8 years for offshore disclosures). However, IRS agents have the discretion to expand the 6-year disclosure period to include all noncompliant years. In addition, taxpayers also may be allowed to expand the disclosure period to correct tax issues in years outside of their disclosure. As with OVDP, taxpayers must file all required returns and reports for the disclosure period, and pay tax and interest on all previously unreported income.

Penalties

The civil penalty cost has increased substantially.

The presumed penalty for an underpayment of tax has increased from a 20 percent accuracy-related penalty to a 75 percent civil tax fraud penalty. The penalty is applied to the tax year during the disclosure period with the highest tax liability. Generally, taxpayers will be assessed a single civil penalty for fraud or for the fraudulent failure to file income tax returns. It is not clear whether other civil penalties will be imposed on the other years in the disclosure period. Taxpayers who wish to request the imposition of lower accuracy-related penalties may do so, but must present evidence to support their requests.

The penalty with respect to Foreign Bank Account Reports (“FBAR”) has also been changed under the new procedures. In most cases, the IRS will assert a willful FBAR penalty of 50 percent applied to the year with the highest aggregate balance of all unreported foreign financial accounts during the disclosure period. But willful FBAR penalties are subject to discretion and, accordingly, IRS agents may recommend a higher or lower penalty based on the taxpayer’s facts and circumstances. Taxpayers may again request the imposition of non-will FBAR penalties based on a showing of appropriateness.

Overall, the new IRS disclosure procedure seems less predictable and more severe than the OVDP, at least for taxpayers who do not have sympathetic facts. The procedure may be primarily attractive to taxpayers who are worried about their criminal exposure, since the disclosure may not offer significant reduction in penalties. Further, it may be harder to estimate the total tax liability for clients prior to submitting their voluntary disclosure application.

Other IRS Voluntary Disclosure Programs and Correction Procedures Remain Unaffected

The memorandum importantly states that the IRS’ Streamlined Filing Compliance Procedures, the Delinquent FBAR submission procedures, and the Delinquent International Information Return submission procedures are still intact, although the memorandum notes that “they could be discontinued at any time.” The memorandum also notes that taxpayers who did not commit any tax or tax related crimes and do not need the voluntary disclosure practice to seek protection from potential criminal prosecution can continue to use these programs or the amended return process to correct past mistakes.  These programs remain very important tools for our clients to seek tax compliance.