Opting-out or Opting-in of OVDI

The IRS last week explained fully the possibility of opting-out of the OVDI and taxpayers’ taking their chances with an IRS examination, particularly where the non-disclosure of assets or income could be proved to not be “wilful”, and has also re-specified the conditions under which taxpayers making voluntary disclosures may qualify for a 5% offshore penalty.

For example, that reduced penalty could be applicable to taxpayers who did not open or cause the foreign bank account to be opened; have exercised minimal, infrequent contact with the account; have, except for a withdrawal closing the account and transferring the funds to an account in the US, not withdrawn more than USD1,000 from the account in any year for which the taxpayer was non-compliant; and can establish that all applicable US taxes have been paid on funds deposited to the account (only account earnings have therefore escaped US taxation). For funds deposited before January 1, 1991, if no information is available to establish whether such funds were appropriately taxed, it will be presumed that they were.

Even more important is the concept of electing out of the IRS program, which sounds counterintuitive. Opting out of the program can clearly make sense for some people. Up until now there’s been much nervous talk about the wisdom of electing out of the voluntary disclosure program. For example, suppose that you’re unsuccessful in trying to persuade the IRS that you should qualify for the reduced 5% penalty not the 25% penalty. You can always opt out of the program and take your chances with an examination. The IRS has published a separate guide titled Opt Out and Removal Guide for the 2009 OVDP and 2011 OVDI where the procedures for opting out are set forth.

The revised FAQs offer helpful guidance on the opt-out option. The newly revised FAQs illustrate the pros and cons of opting out with six examples. See FAQ 51. The first three examples describe situations in which it may be smart to opt out.
The first taxpayer mistakenly failed to report foreign income on his tax return but, because of foreign tax credits, had no tax deficiency relating to that income. Even if the first taxpayer properly reported it all, his foreign tax credits would have resulted in not additional US income tax. Electing to opt out would subject him to a much smaller FBAR penalty than the OVDI program’s 25% penalty. If the taxpayer shows the violation was due to reasonable cause, there might be no penalty at all.

However, opting out can also lead to worse situation. New FAQ 51.2 carries two examples showing disadvantages of opting out. FAQ 51.3 states that a case can still be referred to IRS’s Criminal Investigation Division. If you opt out of the 2011 OVDI, are audited, and found to have under-reported income and made false statements, you could be criminally prosecuted. The decision to “Opt-out” or stay in OVDI has become even more complicated. For some taxpayers Opting-out may be a more risky, but viable course of action. We are recommending to our clients to file for OVDI and then explore “Opt-out” as a possible election based on the IRS’ reaction (and proposed penalty assessment) to the OVDI applicaiton.

Patel Law Offices is a law firm dedicated to helping clients resolve complicated tax, criminal tax, and international tax problems. Our firm assists (and defends) clients and their advisors to legally disclose (and legitimze) foreign accounts.

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