1. Don’t Panic: ODVI is not for most taxpayers who innocently or mistakenly failed to file FBARS, or had negligible amounts of interest income earned in their foreign bank accounts. Paying a 25% penalty for non-willful violators is draconian.Remember, there is no automatic penalty; the maximum penalty for the non-willful failure to file an FBAR is $10,000 per year, starting in 2005, and there is reasonable cause exception to penalties. If however, you’ve deliberately sent large of dollars to a secret offshore account, seriously consider ODVI, since IRS is aggressively searching to find you and if they do, expect a criminal investigation.
2. Don’t Fall for Scare Tactics: The web abounds with misinformation and scare tactics. Compounding this, many tax professionals are clueless about the nuances of foreign tax and reporting requirements and may attempt to frighten taxpayers into retaining them, usually with dire predictions of jail time and financial ruin for simple failure to file an FBAR.
Make sure your tax professional understands the concepts willfulness and reasonable cause (discussed below) as well as foreign income (and the credits and exclusions thereto) in relation to your particular situation.
3.Reasonable Cause Exception: Taxpayers may assert “reasonable cause” for failing to timely file an FBAR to avoid penalties. Taxpayers who have reported and paid taxes (if any) on their foreign income and who recently learned of the FBAR requirement, may generally rely on the reasonable cause exception.
4.Checking the Box “No” on Schedule B: Taxpayers who falsely checked the box “no” on Schedule B of Form 1040 – the section which asks whether you have a foreign bank account – could be in willful violation of the reporting requirements, it depends on the reasons why the box was checked no.
These cases are challenging because there is an indication that a taxpayer may have attempted to deceive IRS, although checking the box no is not determinative of whether a taxpayer was acting willfully (see the discussion below).
5.Violation of Other Tax Reporting Requirements. OVDI will eliminate other penalties arising from the failure to file tax forms involving foreign financial accounts, ownership in a foreign company, distributions from a foreign trust and receipt of gifts or inheritances (over $100,000).
However, these forms may contain a reasonable cause exceptions that could reduce or eliminate the penalties without resort to OVDI.
Applying for OVDI may depend on whether there has been a willful violation of the law with respect to the non-filing of FBARS or failure to disclose and pay taxes on foreign income. Willful is a legal concept and generally requires an affirmative act to evade or avoid a known legal requirement. Inadvertent neglect is not willfulness.
In a recent case, United States v. Williams, 2010 U.S. Dist. LEXIS 90794 (ED VA 2010), a taxpayer sent $7.0 million to a Swiss bank account, checked the box “no” on Schedule B of Form 1040 and pled guilty to one count of tax fraud. IRS claimed the taxpayer willfully violated the FBAR filing requirements, but the court disagreed.
The court noted that the taxpayer eventually filed the FBARS, an act that negated willfulness because it showed the taxpayer was not hiding assets from the government. The court stated that willfulness meant a knowing or reckless violation of a standard, not just a couples instances of inadvertent neglect.
Thus, the failure to disclose foreign bank accounts does not automatically amount to willfulness, even if the box on Schedule “B” to Form 1040 is checked no – it depends on the facts and circumstances of each case.
Taxpayers who have no reportable income from foreign accounts, such as non-interest bearing bank accounts, employee stock savings accounts or 401K type retirement accounts, should file the delinquent FBARS, together with a reasonable cause explanation describing a lack of willfulness to eliminate penalties. The same is true with respect to filing a delinquent Form 3520.
In contrast, those who have willfully failed to report taxable income from foreign accounts or willfully failed to file FBARS, the choice is more difficult; either enroll in the OVDI program and pay the steep price, thereby avoiding the possibility of criminal prosecution and even larger penalties, or take your chances.