2011 Offshore Voluntary Disclosure Initiative – There’s a New (FBAR) Game in Town


CAUTION:  This Update is only a superficial summary and may not be relied upon for guidance as to any particular, real life situation.  We have included links to information on the IRS web site about the 2011 IRS “Voluntary Disclosure” program discussed in this Update.  Nevertheless, we think it is imperative to seek professional advice.

I. Introduction and Recent History
While there are exceptions, federal law requires (i) US citizens, (ii) US residents, and (iii) those in and doing business in the US (defined as “US Persons” for FBAR purposes) to disclose the existence of a financial interest in, or signature authority over, financial accounts in foreign countries – the so-called “FBAR” disclosure requirement.  In addition to the disclosure requirement, income from such foreign accounts (regardless of amount) is generally subject to US taxation.
As indicated, the obligation is to disclose the existence of “a financial interest in or signature authority over” any “financial accounts” in “foreign countries”.   The apparent simplicity of those phrases belies the difficulty of determining to whom and to what property the disclosure requirement applies.  In addition to the obvious situation where a US citizen owns a savings account in a bank in Switzerland, consider these few examples:

  • Residential real estate located in a foreign country (even if the property is not rented out) may or may not be subject to disclosure.
  • Certain beneficiaries of domestic trusts that hold a foreign bank account are subject to disclosure.
  • Individuals named under a power of attorney where the principal owns a foreign account may need to disclose.

In 2009 Treasury (i) announced an intention to step-up enforcement of these laws and  (ii) offered a temporary voluntary disclosure program that limited financial exposure and granted protection from criminal prosecution.  The 2009 voluntary disclosure program ended in October 2009.

Perhaps encouraged by the success of their 2009 voluntary disclosure program, the US Treasury, on February 8, 2011, announced a new disclosure initiative.  The 2011 Offshore Voluntary Disclosure Initiative (the 2011 OVDI) again provides a very important (and likely last) opportunity for US Persons to file late disclosures and pay back taxes with greatly reduced financial penalty and protection from criminal prosecution.

The IRS has also made efforts to obtain lists of depositors and annual income data from foreign banks.  The IRS’ success in obtaining depositor information from the Swiss bank UBS has been widely publicized.  It is also known that this effort is continuing at banks in various countries.

II. Timely Disclosure

Disclosure is made on Form TD F 90-22.1 (the “FBAR Form”).  The form is required to be completed and filed annually with the US Treasury, and must be received (not postmarked) by June 30 of each year for the prior calendar year.  Note that there are questions regarding foreign accounts on the income tax return itself, but merely answering these questions does not constitute the required disclosure.  The FBAR Form is a form separate and apart from the income tax return, and is to be filed separately from the income tax return.

III. The 2011 OVDI

The 2011 OVDI provides that US Persons who have not filed required FBAR Form(s) and have not reported the income from foreign accounts (provided they are accepted into the program and comply with all documentation and payment requirements by August 31, 2011) will incur the following:

  • Financial penalty equal to 25% (and in some cases 12.5% or 5%) of the single highest balance in the financial accounts between 2003 and 2010;
  • Payment of all income taxes on income not reported between 2003 and 2011;
  • Payment of interest and penalties on the payment of such back income taxes;
  • Payment of other applicable penalties; and
  • Protection from criminal prosecution.

Contrast the 2011 OVDI program terms with the full gamut of potential penalties under the federal statute.  Note that while the 2011 OVDI, by its terms, can only look back to 2003, enforcement outside of the program may look back as many years, apparently, as the examiner determines is appropriate:

  • Financial penalty equal to 50% of the highest balance of the financial accounts for each  prior applicable year;
  • Payment of all income taxes on income not reported for all prior applicable years;
  • Payment of interest and penalties on the payment of such back income taxes;
  • Payment of other applicable penalties; and
  • Possible criminal prosecution.

Consider this simple example:

John (a US citizen) opened a checking and savings account in Canada in 2005.  The deposits have fluctuated, but the highest balance during each year in US dollars (using the end of year conversion rate) is as indicated.  The set penalties under the 2011 OVDI, and the potential penalties outside the program, are as follows:

Note 1:  Plus back taxes, interest and penalties for each applicable year.
Note 2:  Calculated as 25% of $400,000 (the highest single balance during the period from 2005 thru 2010).
Note 3:  Calculated as the greater of (i) $100,000 or (ii) 50% of each year’s highest balance.

As the reader can see, protection from criminal prosecution, greatly reduced financial exposure, and relative certainty of result make a compelling argument for disclosing formerly undisclosed accounts under the 2011 OVDI.  In all cases, unpaid income tax, interest and penalties will be due as well (although the potential penalties outside the 2011 OVDI are greater).

IV. Documentation Required for Successful Participation in the 2011 OVDI

Once accepted into the 2011 OVDI (not all taxpayers will qualify) a substantial amount of documentation needs to be prepared and provided to the IRS by August 31, 2011.  The complete list is provided by the IRS and can be seen at… http://www.irs.gov/businesses/international/article/0,,id=235699,00.html – See Q&A #7.

V. “Informal” Voluntary Disclosure

The IRS, on an ongoing basis, encourages and entertains “informal” voluntary disclosures.  Any US Person who does not qualify for the 2011 OVDI (or who chooses not to participate) is well-advised to pay back taxes and penalties, and file delinquent FBAR forms, before the IRS comes a-knocking.  One must imagine that even an “informal” voluntary disclosure will offer a better result for the taxpayer than an examination initiated by IRS.  The author believes that they mean business.

VI. Conclusion

The laws regarding disclosure of foreign accounts and payment of income tax on income from foreign accounts are here to stay.  The Treasury’s stated mission “…to enhance U.S. national security, deter and detect criminal activity, and safeguard financial systems…”4 (not to mention increased tax revenue) is serious business.

The IRS’ efforts to obtain foreign account information from co-operating foreign banks and governments will provide them the data to implement their plans to initiate prosecutions on a going-forward basis.  The IRS has informed income tax return preparers that they may not, under the IRS’ rules of practice, prepare income tax returns for taxpayers that they know have refused to comply with the FBAR rules.

The 2011 OVDI offers a very brief opportunity to avoid potentially full prosecution, and most certainly will provide each participant a better result than would occur if the IRS initiates an action.  One can expect that any US Person under examination for any reason will be cross-checked against the IRS’ growing database of taxpayers who have foreign accounts.

Any US Person who has any connection to any foreign accounts should consult qualified counsel to determine what steps should be taken.

Notations – This advisory focuses on the ownership of, financial interest in, or signature authority over, financial accounts in foreign countries.  There are many other types of required disclosures.   The IRS’ listing of required disclosures may be helpful – see Q&A #5 at http://www.irs.gov/businesses/international/article/0,,id=235699,00.html.  We also note that you should make no decisions based on this advisory.  This paper is intended merely to alert the reader to the existence of these requirements and to the 2001 OVDI.  The rules are involved, the applicable definitions complex, and each situation presents unique issues.  For the IRS’ explanation of the initiative, refer to http://www.irs.gov/newsroom/article/0,,id=234900,00.html?portlet=7.

Dated:  3/9/11

This Update is intended only to provide generalized information.  It is not intended to provide information or advice with respect to specific situations.  To address real life, specific situations you should obtain appropriate professional assistance. 

Under the rules of the Supreme Judicial Court of Massachusetts, this may be considered advertising.