Undisclosed foreign accounts or income can trigger big civil penalties, conceivably even criminal prosecution. Since 2009, many foreign accounts and income came within the IRS's enormous offshore enforcement efforts. Nearly 10 years on, not everyone has entered the IRS Offshore Voluntary Disclosure Program (OVDP). The program is closing, but there is still time to get in under the wire. The OVDP involves a formulaic deal where at least the penalties are capped. The program isn't perfect, but it is a finite way of getting beyond the fear of discovery and prosecution. And with FATCA, the IRS now has an easy time finding just about anyone's account, no matter how cleverly hidden. That's why stepping forward before it is too late is safest.
For most people, paying the taxes, interest and penalties, even on up to 8 years as the OVDP requires, is not so bad. It is the bigger account-based penalty in the OVDP that is the hardest to swallow. It can be either 27.5% or 50% of the highest value of your account over the 8 year period. That penalty is simply part of the OVDP. Yet if you enter the OVDP, the prospect of opting out can be worth considering, before you pay all the penalties and sign the closing agreement. Enter the program to opt out? It sounds odd, and it certainly isn't for everyone. But on the right facts, it can make a world of difference to the bottom line.
The opt-out election is irrevocable, and is typically made after the IRS has calculated a proposed miscellaneous offshore penalty. That might be a year or more after you enter the program. By then, you will have fully complied and fixed all of your errant reporting. You have also paid all the taxes and interest you owed, plus penalties on your under-reporting. But the biggest penalties are based on the size of your account, and that is what can be at stake in an opt out. Of course, an opt out carries risks too. The IRS may assess civil fraud penalties or information return penalties. The IRS can also interview the taxpayer, although most interviews are over the phone.
According to the Taxpayer Advocate Service, over 1,000 taxpayers opted out of the 2009 and 2011 offshore voluntary disclosure programs. One thing it meant was delays. For 2009 opt-outs, the IRS took about 590 days to close the case after the opt-out election. For 2010 OVDI opt-outs, the IRS took a more streamlined 129 days. Most reported opt-outs involved small dollars, which seems counter-intuitive. For some tax lawyers, the situation is the reverse, where most opt outs they handle involve big money. After all, the incentives to opt-out seem much higher if large dollars are at stake.
If you might pay a $50,000 penalty in the OVDP, opting out probably can't save you too much, even if you end up with non-willful penalties. A $500,000 penalty within the OVDP, however, may make opting out hard to resist, particularly if you have good facts and no evidence of willfulness or evasion. If you face a $1M penalty or higher, it may be even more compelling. On the other hand, potential FBAR penalties can be high. If the maximum account balance exceeds $1 million, a willful FBAR penalty could be the greater of $100,000 or 50% of the account balance. The taxpayer can argue that FBAR penalties are inappropriate after opting-out. However, the IRS can conceivably seek FBAR penalties per account, per year.