FBAR, OVDP and the alphabet soup of offshore account compliance

Time is running short to disclose offshore accounts. Changes to the voluntary disclosure program could mean even higher penalties as the IRS and Department of Justice continue to investigate more foreign banks.

Add to that list of acronyms the Foreign Account Tax Compliance Act and complying with offshore disclosure requirements gets complicated. For U.S. taxpayers who own or have signatory authority over a foreign bank account, it is important to disclose the account even if no tax is owed.

The Internal Revenue Service requires a U.S. person (including permanent residents) with a financial interest in an offshore account, with a balance at any time of $10,000 or more, to disclose the account. A Report of Foreign Bank and Financial Accounts form, now known as FinCEN Form 114, needs to be filed electronically prior to June 30 each year.

Failure to file an FBAR

Penalties for failing to comply are some of the stiffest in the tax code. For example, a Florida jury recently approved a FBAR penalty of 150 percent of the highest account value in an undeclared foreign financial account.

The civil penalty for willfully failing to file the FBAR may be 50 percent of the highest account balance during the year. In this case, the penalties stacked up for violations from 2004, 2005 and 2006. Often a guilty plea will only result in a single year 50 percent penalty. A prison sentence is also possible for the willful failure to file.

Is there a way to avoid these penalties when you have yet to disclose a foreign account?

Streamlined procedure

To boost compliance, the agency recently announced an expanded streamlined reporting procedure for unreported foreign financial accounts. Taxpayers outside the U.S. will not pay a penalty. Taxpayers living in the U.S. are also now eligible for the first time and these individuals would pay a 5 percent offshore penalty.

All taxpayers who use the streamlined procedure must certify their failure to comply was non-willful. What is willful is often open to interpretation and it is a good idea to consult a knowledgeable tax attorney before using this disclosure route.

OVDP

In addition, the IRS is on its third round of the Offshore Voluntary Disclosure Program. Approximately 45,000 taxpayers have used the OVDP since 2009 to come into compliance. In June, the IRS announced changes to the 2012 OVDP.

Now taxpayers will need to provide additional information, but will be able to do so via electronic record submission. The reduced penalty for non-willful taxpayers moved to the streamlined procedure. A taxpayer will also need to submit all statements and pay the offshore penalty along with the application.

A major change to the program is an increase in the penalty from 27.5 percent to 50 percent. The increased penalty applies when an IRS or Department of Justice investigation of a financial institution becomes public before the taxpayer submits a pre-clearance OVDP request.

FATCA went into effect on July 1. This expansive law requires foreign financial institutions to share information with the IRS about their U.S. accountholders. Many foreign governments have reached an information-sharing agreement with the U.S. and almost 40,000 banks have agreed to comply.

It is unclear what the IRS will do once the information starts to come in from foreign banks. If you have a financial interest in a foreign account, now is the time to discuss compliance with a knowledgeable tax attorney and develop a disclosure strategy.

Keywords: Offshore accounts, IRS, FBAR penalties