The June 30, 2011 deadline looms near for filing 2010 tax year FBARs. For some taxpayers with previously undisclosed foreign financial accounts, however, a rather important decision must also be made. First, a quick reminder:
If the total maximum balances of all foreign bank accounts of a U.S. person during the tax year exceed $10,000, then that person must file the FBAR by June 30 of the following tax year.
Example: A U.S. person who deposited $150,000 into a United Kingdom bank account in her name in 2007 and has not touched the funds since then would almost certainly be required to file FBARs for 2007, 2008, 2009, and 2010.
The penalty for willfully failing to file the FBAR for a given tax year can be as high as the greater of $100,000 or 50% of the total balance of the foreign account per violation. Non-willful violations that the IRS determines were not due to reasonable cause are subject to a $10,000 penalty per violation. These possible penalties are separate and in addition to penalties that may be imposed for failing to report any taxable income associated with the account (e.g., failure to file, failure to pay, 20% accuracy-related penalty, etc.).
Many taxpayers don’t learn about the FBAR requirements until long after the filing deadline passes. In fear of facing such significant penalties, a taxpayer may think, “I’d rather risk IRS discovery of me than to voluntarily come forward.” In order to relieve the fear and encourage taxpayers to come forward, the IRS announced in February the launch of their 2011 Offshore Voluntary Disclosure Initiative (OVDI). The deadline for participating in the 2011 OVDI is August 31, 2011.
The purpose of the program is to bring taxpayers who have failed to disclose foreign accounts from past years and have not reported the associated tax into compliance with U.S. tax laws. If the taxpayer had already reported the tax associated with the account, then the taxpayer need not participate, and instead simply files delinquent FBARs for the appropriate years.
An advantage to disclosure via the 2011 OVDI is that if the taxpayer truthfully, timely, and completely complies with all program provisions, the IRS will not recommend criminal prosecution to the Department of Justice. A disadvantage to the program, however, is that IRS examiners and managers administering 2011 OVDI cases have no authority to negotiate different offshore penalties; in other words, those penalties are strictly mandatory. Participation in the 2011 OVDI is referred to as a “noisy” disclosure because the taxpayer comes forward knowing that penalties will be imposed.
What penalties do I speak of? No, not the FBAR penalties described above. Essentially, in lieu of the FBAR or other offshore-related information return penalties, the 2011 OVDI requires imposition of a penalty equal to 25% of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the period covered by the voluntary disclosure; the 2011 OVDI includes tax years 2003 through 2010. Again, the mandatory penalty is separate and in addition to any tax reporting penalties.
Because IRS agents handling OVDI cases have no discretion regarding offshore-related information return penalty imposition, taxpayers have considered alternative options for coming forward. At present, one popular option is known as the “quiet” disclosure.
The idea behind a “quiet” disclosure is this: The taxpayer won’t participate in the 2011 OVDI because she doesn’t want to guarantee penalty imposition. Instead, the taxpayer will just file her delinquent FBARs and amended (or original) U.S. tax returns reflecting the income associated with the offshore accounts, and let the IRS decide whether to impose the statutory FBAR penalties.
By making a “quiet” disclosure, a taxpayer runs the risk of being examined and potentially criminally prosecuted for all applicable years. The risk of criminal prosecution may be likely if, pursuant to the “quiet” disclosure, the taxpayer fails to fully disclose all foreign financial interests and associated taxes. For example, check out the case of Boston venture capitalist Michael Schiavo. Some possible criminal charges include tax evasion and filing a false return. Willfully failing to file an FBAR is also a violation subject to criminal penalties.
To be clear, I’ll reiterate: A significant difference between the 2011 OVDI and a “quiet” disclosure is that while FBAR and offshore-related information return penalties are mandatory under the 2011 OVDI, these penalties are merely discretionary under a “quiet” disclosure. An examiner reviewing a “quiet” disclosure has the ability to assess penalties in excess of those under 2011 OVDI, but may instead assess penalties for a lower amount, if at all. As you can see, although the penalties imposed on participants of the 2011 OVDI may be reasonably estimated, the same cannot be said for taxpayers making “quiet” disclosures.
A taxpayer faced with the decision between making a “noisy” or “quiet” disclosure should certainly consult a tax professional to review all facts and circumstances. There’s simply no “one size fits all” approach.
As a final note, for further discussion on this topic, be sure to check out Jack Townsend’s Federal Tax Crimes blog. It’s well worth the read.