Foreign Nationals & Expats
Houston Tax Attorney
Is a Qualified Quiet Disclosure Ever a Good Option?
What is a Qualified Quiet Disclosure?
In a non-willful failure to file FBARs and report foreign income, a quiet disclosure can refer to either (a) becoming compliant with only the current year and not correcting prior years, or (b) filing amended returns and paying any related tax and interest for previously unreported offshore income or assets without otherwise notifying the IRS through the OVDP or streamlined program. The former is a procedure that is completely outside the offshore voluntary compliance options that are offered by the IRS and is a reckless option. The latter puts the client into compliance with the tax laws of the United States as they apply to overseas assets, and will for purposes of this article be identified as a “qualified quiet disclosure.” Essentially, you are filing FBARs and amended returns for the tax periods for which the FBAR and tax return statutes remain open.
What are the Risks Associated with Quiet or Qualified Quiet Disclosures?
The risk with a quiet disclosure is obvious – your previously uncorrected tax returns and FBARs can remain open for a number of years, and sometimes indefinitely.
The statute of limitations is extended to six years after a taxpayer’s return is filed if the taxpayer omits $5,000 from gross income attributable to a specified foreign financial asset, without regard to the reporting threshold or any reporting exceptions.
If the taxpayer fails to file or properly report an asset on Form 8938, the statute of limitations for the taxable year is extended until the taxpayer provides the required information. If the failure is due to reasonable cause, the statute of limitations is extended only with regard to the item or items related to such failure and not the entire tax year.
Source: IRS Explanation of Section 6038D Temporary and Proposed Regulations (link)
The risks with a so-called qualified disclosure are not immediately obvious. If your facts lend themselves to a strong reasonable cause statement, then a better alternative would be to include a reasonable cause statement per the Delinquent International Information Return Submission Procedures. You are submitting a reasonable cause statement, as part of your amended tax return, under penalties of perjury. You do not want to present incorrect facts in such a statement.
This could put some taxpayers in a bind. Let’s say an individual inherits a large amount of foreign assets but fails to disclose the assets to his accountant. The accountant fails to inquire about the accounts in a tax organizer. Reasonable cause might be a bit of a stretch. The non-compliance is over a 5 year period, over which period the taxpayer underreports taxable income by $10,000 in total. Let’s say his 5% misc. offshore penalty comes out to $50,000. This is obviously not an equitable solution.
Qualified quiet disclosures in a non-willfulness situation may make sense in such situations where the facts are not so strong, but where the amount of additional taxes owed on the return are quite small and where the 5% Title 26 Miscellaneous Offshore Penalty might be thousands or tens of thousand of dollars.
Essentially with a qualified quiet disclosure, the taxpayer is taking a gamble that in the event the IRS audits the return the result of the audit will be more favorable than an automatic assessment of a 5% Title 26 misc. offshore penalty assessment under the streamlined domestic offshore procedures. IRS examiner will consider the facts and circumstances of the particular case. Such factors will include the nature of the violation and the amounts involved.
Pros and Cons of Making a Qualified Quiet Disclosure
First, anyone with sufficient exposure to criminal or civil willfulness penalties should enter into the Offshore Voluntary Disclosure Program. Either a qualified quiet disclosure or a streamlined compliance filing in such a case would be reckless. If your OVDP was rejected, your attorney should determine the reason for the rejection. Ultimately, you may have no choice but to simply file the FBARs and amended returns as a “qualified” quiet disclosure.
When a non-willful client is considering a qualified quiet disclosure, it’s usually as an alternative to the streamlined domestic offshore procedures (SDOP). If the taxpayer qualifies for the streamlined foreign offshore procedures (SFOP), there’s really no upside to making a qualified quiet disclosure, as there are no penalties under SFOP.
Let’s compare the audit risk under a qualified quiet disclosure vs. streamlined domestic offshore procedures.
Situation 1: taxpayer fails to file FBARs or to report foreign income for several years. Assume that his failure is non-willful. What would happen in the event of an audit? If it was a qualified quiet disclosure, then the taxpayer could be subject to non-willful FBAR civil penalties that carry a penalty of up to $10,000 per year (unless there is reasonable cause). These are subject to mitigating factors which will reduce the potential maximum penalty. However, no non-willful FBAR penalties would be assessed if the taxpayer had entered into the streamlined domestic offshore procedures.
Situation 2: Same as the above but assume that during the audit the taxpayer’s non-compliance was found to be civilly willful. Regardless of whether the taxpayer makes a qualified quiet disclosure or enters into the SDOP, there is no protection against civil penalties where there is willfulness. In such an event, the taxpayer would be assessed a civil penalty that is equivalent to the greater of $100,000 or 50% of the balance in an unreported foreign account, per year, for a maximum of 6 years. Such a taxpayer should’ve entered into the OVDP.
Is a Qualified Quiet Disclosure an Option?
A qualified quiet disclosure involves a gamble – determining the risk of the IRS auditing the returns and determining the likelihood and amount of penalties being assessed. This risk of an audit for international non-compliance is unknown. We counsel taxpayers to either file under the streamlined procedures or draft a reasonable cause statement to file amended tax returns and FBARs. We have not come across any non-willful situations that fall outside these two methods of compliance.