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Offshore Voluntary Disclosure Program (OVDP) – From a different Angle

Due to numerous requests for insight and guidance concerning the Offshore Voluntary Disclosure Program (OVDP) that was initiated in 2012, I wanted to compose a practical article that, instead of merely regurgitating IRS pronouncements, will outline some of the main features for the OVDP and analyze some of the options that exist for American expats who are deciding whether to enter the program.

Background
In part as a response to the IRS prosecution of wealthy Americans who evaded taxes with the help of UBS AG (located in Switzerland) and the information obtained from the disclosures of former UBS banker Bradley Birkenfeld in 2007, the IRS created the first offshore disclosure initiative in 2009 as a means of “encouraging” U.S. taxpayers to come forward and report previously undisclosed income. Known as the 2009 OVDP, the initiative relied on three main tools to accomplish its goals:
1. Threat: The IRS would throw the book at tax evaders they discovered first,
2. Opportunity: The IRS would go easy on tax evaders who come forward before IRS discovers them and provide information that might lead to the discovery of other tax evaders.
3. Fear: The tax evaders could not know if the IRS already knew about their evasion and was about to prosecute (thereby preventing access to OVDI). Due to increasingly sophisticated and advanced investigation techniques, OVDP participation by other US taxpayers, international cooperation among foreign governments and banks via FATCA, and the offer of huge rewards to “whistle-blowers” who turn over information about their tax evading clients, the IRS was able to exponentially improve its ability to track down U.S. taxpayers who continued to evade income tax via the utilization of foreign financial accounts or foreign entities. All of which further strengthened the fear factor element of the OVDP.
The success of the program resulted in the IRS effectively renewing the program in subsequent years and, ultimately, collecting over $4 billion dollars in tax revenue through the end of 2011. In 2012, the IRS decided to eliminate any deadline and, with a few small changes, make the program open ended.
Overview
Main features of the current Offshore Voluntary Disclosure Program
Urban legend has it that famed bank robber, Willie Sutton, was once asked why he robbed banks and he answered “because that’s where the money is.” Similarly, the OVDP program is primarily focused on the main vehicles for overseas tax evasion — unreported foreign financial accounts and unreported foreign entities. Regarding the former, OVDP attacks one of the most common means of evading taxes — namely, depositing unreported and untaxed income (i.e. “dirty money”) into a foreign bank account and/or omitting investment income earned from the foreign financial account from subsequent tax returns. The OVDP enables a tax evader to come forward, pay a special, reduced OVDP penalty, and report previously undisclosed foreign financial accounts- while eliminating the risk of criminal prosecution for tax evasion and, also, avoiding the usual penalties for FBAR and form 8938 non-compliance.
This feature is very significant since FBAR penalties can range from painful ($10,000 penalty per account per year of unreported foreign bank accounts that cumulatively exceeded a $10,000 USD balance at any point during the year) to excruciating (the greater of either a $100,000 penalty or 50% of the maximum account balance – per account per year of unreported foreign bank accounts that cumulatively exceeded a $10,000 USD balance at any point during the year).
In contrast, OVDP penalties are generally based on the degree of willful tax evasion and, depending upon severity, are limited to either 27.5%, 10%, or 5% of the maximum foreign account balances during the period of years covered by OVDP. As an illustration, a tax evader that maintained a $100,000 Swiss savings account whose interest earned and existence was willfully unreported would normally be subject to a penalty of over $100,000 and potential criminal proceedings if the IRS caught him first. In contrast, entry into OVDP would result in a penalty of just $27,500- resulting in a “savings” of $72,500 while avoiding any criminal prosecution.
The second major focus of OVDP is unreported foreign entities. In many tax evasion schemes, US taxpayers have attempted to shelter their foreign income by harboring it under the umbrella of a foreign trust, corporation, or partnership and then not reporting the entity to the IRS on their annual tax return (relying on the inherent difficulties that the IRS would have in discovering the connection between those entities and the US taxpayers).
Due to the IRS’s above mentioned improvements in investigative techniques, more tax evaders have concluded that the risk of being caught outweighs the cost of entering OVDP. In particular, the penalties of being caught willfully not reporting a foreign trust, corporation, or partnership along with one’s tax return can range from $10,000-$50,000 per entity per tax year. In contrast, entry into OVDP would result in the same 27.5%, 10%, and 5% penalties mentioned above. As an illustration, a tax evader that omitted filing form 5471 for a foreign corporation that was created to avoid reporting $40,000 of foreign earned farming income to the IRS could be subject to a $50,000 penalty per year of being unreported. In contrast, entrance into OVDP could result in penalties of $5,000 or less depending on the circumstances.
Key Rules
1. The special 27.5%/10%/5% penalty applies to all assets related to tax evasion. This means that a Van Gogh painting purchased with monies gained via tax evasion would be included in the asset pool that is used for the calculation.
Additionally, a savings account opened in Switzerland with post-tax income that has interest income that is not reported to the IRS on purpose would result in that account being included in the OVDP penalty calculation. In contrast, a non-interest bearing checking account with a million dollars (that was derived from after-tax income) would not be included in the OVDP calculation nor would it be subject to FBAR penalties if it were accidentally not reported to the IRS.
2. The OVDP only covers the most recent 8 tax years. If the first five years were all devoid of any tax evasion, the penalty would only apply to the maximum asset balances in the the remaining years.
3. The OVDP penalty applies to all tax evasion-related assets that may be indirectly owned by the taxpayer. For example, if the taxpayer owned a $500,000 house bought with “dirty money” and, also, is the sole beneficiary of a foreign trust fund that maintained a million dollar savings account (whose income was not reported), the OVDP penalty would apply to the $1,500,000 of assets owned (directly and indirectly) by the taxpayer.
Options
Someone who faces the possibility of penalties and/or criminal prosecution for tax evasion that involved foreign financial accounts and foreign entities should carefully consider whether OVDP presents the best option for resolving his or her tax problems. While OVDP normally offers a less expensive and less risky route to tax resolution, there are circumstances where the standard penalty regime can deliver lower penalties. For instance, a taxpayer who owns a million dollar house in Paris that is rented for $50,000 (and collects a $20,000 deposit in a French bank account) and then willfully does not report the bank account or the income – the standard penalties may be limited to $15,000 ($10,000 penalty for not filing an FBAR and about $5,000 of back taxes for the rental income). In contrast, the OVDP penalty would be $275,000. However, situations involving foreign financial accounts normally benefit more from OVDP participation.
If you are considering joining the OVDI, then you should read this article highlighting your options regarding unfiled FBAR forms

https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers
https://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program
https://www.irs.gov/Individuals/International-Taxpayers/Options-Available-to-Help-Taxpayers-With-Offshore-Interests

Due to numerous requests for insight and guidance concerning the Offshore Voluntary Disclosure Program (OVDP) that was initiated in 2012, I wanted to compose a practical article that, instead of merely regurgitating IRS pronouncements, will outline some of the main features for the OVDP and analyze some of the options that exist for American expats who are deciding whether to enter the program.

Background
In part as a response to the IRS prosecution of wealthy Americans who evaded taxes with the help of UBS AG (located in Switzerland) and the information obtained from the disclosures of former UBS banker Bradley Birkenfeld in 2007, the IRS created the first offshore disclosure initiative in 2009 as a means of “encouraging” U.S. taxpayers to come forward and report previously undisclosed income. Known as the 2009 OVDP, the initiative relied on three main tools to accomplish its goals:
1. Threat: The IRS would throw the book at tax evaders they discovered first,
2. Opportunity: The IRS would go easy on tax evaders who come forward before IRS discovers them and provide information that might lead to the discovery of other tax evaders.
3. Fear: The tax evaders could not know if the IRS already knew about their evasion and was about to prosecute (thereby preventing access to OVDI). Due to increasingly sophisticated and advanced investigation techniques, OVDP participation by other US taxpayers, international cooperation among foreign governments and banks via FATCA, and the offer of huge rewards to “whistle-blowers” who turn over information about their tax evading clients, the IRS was able to exponentially improve its ability to track down U.S. taxpayers who continued to evade income tax via the utilization of foreign financial accounts or foreign entities. All of which further strengthened the fear factor element of the OVDP.
The success of the program resulted in the IRS effectively renewing the program in subsequent years and, ultimately, collecting over $4 billion dollars in tax revenue through the end of 2011. In 2012, the IRS decided to eliminate any deadline and, with a few small changes, make the program open ended.
Overview
Main features of the current Offshore Voluntary Disclosure Program
Urban legend has it that famed bank robber, Willie Sutton, was once asked why he robbed banks and he answered “because that’s where the money is.” Similarly, the OVDP program is primarily focused on the main vehicles for overseas tax evasion — unreported foreign financial accounts and unreported foreign entities. Regarding the former, OVDP attacks one of the most common means of evading taxes — namely, depositing unreported and untaxed income (i.e. “dirty money”) into a foreign bank account and/or omitting investment income earned from the foreign financial account from subsequent tax returns. The OVDP enables a tax evader to come forward, pay a special, reduced OVDP penalty, and report previously undisclosed foreign financial accounts- while eliminating the risk of criminal prosecution for tax evasion and, also, avoiding the usual penalties for FBAR and form 8938 non-compliance.
This feature is very significant since FBAR penalties can range from painful ($10,000 penalty per account per year of unreported foreign bank accounts that cumulatively exceeded a $10,000 USD balance at any point during the year) to excruciating (the greater of either a $100,000 penalty or 50% of the maximum account balance – per account per year of unreported foreign bank accounts that cumulatively exceeded a $10,000 USD balance at any point during the year).
In contrast, OVDP penalties are generally based on the degree of willful tax evasion and, depending upon severity, are limited to either 27.5%, 10%, or 5% of the maximum foreign account balances during the period of years covered by OVDP. As an illustration, a tax evader that maintained a $100,000 Swiss savings account whose interest earned and existence was willfully unreported would normally be subject to a penalty of over $100,000 and potential criminal proceedings if the IRS caught him first. In contrast, entry into OVDP would result in a penalty of just $27,500- resulting in a “savings” of $72,500 while avoiding any criminal prosecution.
The second major focus of OVDP is unreported foreign entities. In many tax evasion schemes, US taxpayers have attempted to shelter their foreign income by harboring it under the umbrella of a foreign trust, corporation, or partnership and then not reporting the entity to the IRS on their annual tax return (relying on the inherent difficulties that the IRS would have in discovering the connection between those entities and the US taxpayers).
Due to the IRS’s above mentioned improvements in investigative techniques, more tax evaders have concluded that the risk of being caught outweighs the cost of entering OVDP. In particular, the penalties of being caught willfully not reporting a foreign trust, corporation, or partnership along with one’s tax return can range from $10,000-$50,000 per entity per tax year. In contrast, entry into OVDP would result in the same 27.5%, 10%, and 5% penalties mentioned above. As an illustration, a tax evader that omitted filing form 5471 for a foreign corporation that was created to avoid reporting $40,000 of foreign earned farming income to the IRS could be subject to a $50,000 penalty per year of being unreported. In contrast, entrance into OVDP could result in penalties of $5,000 or less depending on the circumstances.
Key Rules
1. The special 27.5%/10%/5% penalty applies to all assets related to tax evasion. This means that a Van Gogh painting purchased with monies gained via tax evasion would be included in the asset pool that is used for the calculation.
Additionally, a savings account opened in Switzerland with post-tax income that has interest income that is not reported to the IRS on purpose would result in that account being included in the OVDP penalty calculation. In contrast, a non-interest bearing checking account with a million dollars (that was derived from after-tax income) would not be included in the OVDP calculation nor would it be subject to FBAR penalties if it were accidentally not reported to the IRS.
2. The OVDP only covers the most recent 8 tax years. If the first five years were all devoid of any tax evasion, the penalty would only apply to the maximum asset balances in the the remaining years.
3. The OVDP penalty applies to all tax evasion-related assets that may be indirectly owned by the taxpayer. For example, if the taxpayer owned a $500,000 house bought with “dirty money” and, also, is the sole beneficiary of a foreign trust fund that maintained a million dollar savings account (whose income was not reported), the OVDP penalty would apply to the $1,500,000 of assets owned (directly and indirectly) by the taxpayer.
Options
Someone who faces the possibility of penalties and/or criminal prosecution for tax evasion that involved foreign financial accounts and foreign entities should carefully consider whether OVDP presents the best option for resolving his or her tax problems. While OVDP normally offers a less expensive and less risky route to tax resolution, there are circumstances where the standard penalty regime can deliver lower penalties. For instance, a taxpayer who owns a million dollar house in Paris that is rented for $50,000 (and collects a $20,000 deposit in a French bank account) and then willfully does not report the bank account or the income – the standard penalties may be limited to $15,000 ($10,000 penalty for not filing an FBAR and about $5,000 of back taxes for the rental income). In contrast, the OVDP penalty would be $275,000. However, situations involving foreign financial accounts normally benefit more from OVDP participation.
If you are considering joining the OVDI, then you should read this article highlighting your options regarding unfiled FBAR forms

https://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers
https://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program
https://www.irs.gov/Individuals/International-Taxpayers/Options-Available-to-Help-Taxpayers-With-Offshore-Interests

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