Foreign Nationals & Expats
Houston Tax Attorney
- 1 OVDP vs. Streamlined
OVDP vs. Streamlined
Offshore Voluntary Disclosure Program vs Streamlined Filing Compliance Procedures
Clients with undisclosed foreign assets or unreported foreign income can become compliant through various offshore compliance options. Often the choice comes down to whether to file under the offshore voluntary disclosure program (OVDP) or streamlined domestic offshore procedures (SDOP).
When a client has undisclosed foreign accounts and has a reporting requirement, there are two things that should be determined first:
- Is there also unreported income? In the vast majority of cases there is also unreported income (usually interest). If there isn’t, then the client can submit FBARs under the Delinquent FBAR Procedures, or under the Delinquent International Information Return Submission Procedures. Otherwise, the client will need to become compliant under either the OVDP or streamlined procedures, discussed below.
- Is the failure to report the foreign accounts willful? This is an important consideration that needs to be made carefully. The OVDP carries a higher penalty, but offers the taxpayer an opportunity to avoid being criminally prosecuted. On the other hand, the streamlined procedures have much lower penalties but should only be used if the failure to comply was non-willful. Taxpayers filing under the streamlined procedures when their conduct shows willfulness can expose themselves to civil and criminal liability.
Offshore Voluntary Disclosure Program (OVDP)
Where the taxpayer has undisclosed foreign financial accounts and unreported income AND their failure to comply was willful, the taxpayer should make an offshore voluntary disclosure under the OVDP. The OVDP offers the taxpayer an opportunity to avoid criminal prosecution where there is willfulness.
The OVDP assesses a mandatory “miscellaneous Title 26 offshore penalty” of 27.5% on the highest account balance. If your financial institution is on the list of IRS’ Foreign Financial Institutions or Facilitator’s List, the penalty jumps to 50%. While 27.5% may seem high, it’s in exchange for not facing criminal prosecution.
In order to make a voluntary disclosure under OVDP, the disclosure must be truthful, timely, and complete.
Truthful: Taxpayer must show a willingness to cooperate with the IRS and make good faith arrangements to full-pay the tax, penalties, and interest that the IRS applies.
Timely: A disclosure is timely if it is received before the IRS has initiated a civil or criminal investigation and before the IRS has received information from a third party (e.g., a foreign bank) regarding potential noncompliance. Note that if the taxpayer has accounts with financial institutions that are on the IRS’ Foreign Financial Institutions or Facilitator’s List, the IRS is considered to be constructively aware of the taxpayer’s noncompliance and the taxpayer therefore does not qualify to make a voluntary disclosure.
Complete: Taxpayer should disclose all foreign accounts and income in the disclosure.
Prior to making a disclosure, taxpayers may request a preclearance letter from the IRS Criminal Investigation Lead Development Center. If the IRS has already learned of the taxpayer’s noncompliance then the preclearance letter will be rejected. A decision can take up to 30 days. If a preclearance letter is granted, the taxpayer has 90 days to fully comply with all the provisions in the letter.
Married individuals may choose to disclose under the OVDP either jointly or separately. In a community property state, each spouse owns a 1/2 undivided interest in each account, regardless of which spouse is titled on the account.
After the initial letters are submitted to the IRS, the IRS will respond back with a letter stating that if the taxpayer completely and truthfully submits documents required under the OVDP, the IRS will not recommend prosecution by the Department of Justice for noncompliance. Taxpayers have 90 days from the date of the IRS letter to submit the required documents. Additional time may be requested.
The OVDP submission will then be reviewed by the IRS and at the completion of the review, the IRS will propose a closing agreement (Form 906). The taxpayer must then sign the agreement or decide to opt out of the OVDP. If the taxpayer cannot full pay the additional tax, penalties, and interest, an installment agreement may be requested.
Streamlined Filing Compliance Procedures
The Streamlined Filing Compliance Procedures (SFPC) were created for taxpayers to comply with foreign account reporting requirements where their failure was not willful. Procedures under this program are simpler and carry a lesser penalty. However, where some foreign accounts were previously disclosed to the IRS, the penalty can actually be less under OVDP since the penalty base is calculated differently. In the vast majority of cases, however, penalties are much lower under the streamlined procedures.
There are two separate procedures under the SFCP – Streamlined Domestic Offshore Procedures (SDOP) and Streamlined Foreign Offshore Procedures (SFOP). If the US citizen or permanent resident was a non-resident of the US (physically outside the US for at least 330 full days) at any time during the three most recent years for which a tax return due date has passed, and where taxpayer’s bona fide residence is not the US, the taxpayer can file under the foreign SFCP program. Under the SFOP, there is no miscellaneous Title 26 Offshore Penalty. Otherwise, the taxpayer must file under the SDOP, which carries a miscellaneous Title 26 Offshore Penalty of 5% of the highest aggregate account balance for the covered 6 year FBAR period and the 3 year tax return period.
To file under the streamlined procedures, taxpayer must amend the three most recent tax returns and file any delinquent FBARs for the six most recent years. Additionally, the taxpayer must certify that the failure to report foreign assets and income was non-willful.
Note that this is the process for streamlined domestic offshore procedures (SDOP) but the process is similar for the streamlined foreign offshore procedures (SFOP).
- For each of the most recent 3 years for which the U.S. tax return due date has passed, submit a complete and accurate amended tax return using Form 1040X, Amended U.S. Individual Income Tax Return, together with any required information returns (e.g., Forms 3520, 3520-A, 5471, 5472, 8938, 926, and 8621).
- Include at the top of the first page of each amended tax return “Streamlined Domestic Offshore” written in red to indicate that the returns are being submitted under these procedures.
- Complete and sign a statement on the Certification by U.S. Person Residing in the U.S. You must submit an original signed statement and attach copies of the statement to each tax return and information return being submitted through these procedures. You should not attach copies of the statement to FBARs. Failure to submit this statement, or submission of an incomplete or otherwise deficient statement, will result in returns being processed in the normal course without the benefit of the favorable terms of these procedures.
- Submit payment of all tax due as reflected on the tax returns and all applicable statutory interest with respect to each of the late payment amounts. Your taxpayer identification number must be included on your check. You may receive a balance due notice or a refund if the tax or interest is not calculated correctly.
- Submit payment of the Title 26 miscellaneous offshore penalty as defined above.
- The documents listed above, together with the payments described above, must be sent in paper form (electronic submissions will not be accepted) to:
Internal Revenue Service
3651 South I-H 35Stop 6063 AUSC
Attn: Streamlined Domestic Offshore
Austin, TX 78741
- For each of the most recent 6 years for which the FBAR due date has passed, file delinquent FBARs according to the FBAR instructions and include a statement explaining that the FBARs are being filed as part of the Streamlined Filing Compliance Procedures. You are required to file these delinquent FBARs electronically. On the cover page of the electronic form, select “Other” as the reason for filing late. An explanation box will appear. In the explanation box, enter “Streamlined Filing Compliance Procedures.”
Offshore Voluntary Disclosure Program vs Streamlined Filing Compliance Procedures
The two major drawbacks of the OVDP are that (1) taxpayers are required to amend or file 8 years of the most recent tax returns and FBARs; and (2) taxpayers are subject to a much higher miscellaneous Title 26 penalty of 27.5% and a 20% accuracy-related penalty on any additional taxes assessed. In return, the taxpayer is protected from potential criminal prosecution. The streamlined procedures were created to be less punitive measures for taxpayers whose failure to report was not willful. Only 3 years of amended tax returns and 6 years of FBARs are required. However, filing under the streamlined procedures does not protect the taxpayer against criminal prosecution.
None of the above should scare a taxpayer into complying under the OVDP where their failure was not willful. Neither should a taxpayer choose the streamlined procedures where their conduct shows willfulness. The client should discuss pertinent facts with his or her attorney to determine the appropriate method for compliance.