Key Considerations

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.

Willfulness

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.

 Conclusion

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.

Introduction

IRS announced a second Offshore Voluntary Disclosure Initiative (OVDI) for taxpayers with unreported foreign income or financial accounts. OVDI eliminates potential criminal prosecution for tax violators, but comes with steep penalties. Since the first initiative, which netted 15,000 disclosures, another 3,000 taxpayers have come forward.

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Because of the harsh set of penalties, OVDI will appeal primarily to tax cheats: those who willfully and repeatedly have violated the tax law.

Unfortunately, many taxpayers with inactive foreign accounts or minor amounts of foreign income could mistakenly enroll in OVDI out of an unrealistic fear of criminal prosecution.

Foreign Accounts

Taxpayers with foreign bank or financial accounts (totaling more than $10,000 at any time during the year) are required to file a Report of Foreign Bank and Financial Accounts, Form TD F 90-22.1 (FBAR) on or before June, 30 of the following year; there are no extensions. The deadline to report foreign accounts held in 2010 is just days away, June 30, 2011.

Note: When calculating the highest balance during the year for FBAR purposes, use the exchange rate at the end of the year.

Almost every type of financial account in which the taxpayer has signature authority, including joint accounts and accounts over which the taxpayer has a power of attorney, are considered foreign bank or financial accounts for FBAR purposes and must be reported.

Note: IRS considers annuities, IRA-type retirement accounts and cash value life insurance products to be foreign accounts.

Foreign Income

U.S. residents and citizens are taxed on, and must report, all foreign income. There are foreign tax credits and certain exclusions for foreign earned income that may be claimed, but all foreign source income must be reported.

OVDI addresses the failure to file FBARS or report foreign income from all sources. For instance, in addition to bank and financial account earnings, unreported business or investment income or profits, as well as real estate rents, are encompassed within the OVDI process.

Key ODVI Provisions

1. The penalty amount is raised to 25% (up from 20%) of the highest aggregate amount in all foreign accounts from 2003 to 2010. Some taxpayers will be eligible for 5% or 12.5% penalties.2. In general, the 5% penalty involves accounts which were not opened by the taxpayer; the taxpayer had minimal contact with the account; no more than $1,000 per year has been withdrawn; and there is no untaxed principal in the account. Also, non-residents who filed and paid taxes in the foreign country of residence and who earned less than $10,000 a year in U.S. source income may be eligible for the 5% penalty.

3. For those who do not qualify for the 5% penalty, the 12.5% penalty applies when the aggregate balance of all foreign accounts from 2003 through 2010 never exceeded $75,000.

4. Participants must file returns (or amend returns), pay back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties, by August 31, 2011. Under the first initiative, the period was six years.

5. A major exception: lf all foreign income has been reported but FBARs were not filed, there is no penalty for filing delinquent FBARs. This exception applies Form 3520 reporting failures of required foreign trust distributions, gifts and inheritances.

Eligibility

Disclosures under OVDI must be filed before IRS starts an inquiry, whether or not the scrutiny involves unreported foreign income or financial accounts. Thus, taxpayers under a current examination or investigation are ineligible for OVDI.