OVDP Penalty Refund – Setting Aside the Closing Agreement on the Theory of Duress
In this 4 part series, we will examine whether there are any circumstances in which an OVDP participant who paid an offshore penalty may file an administrative claim for a refund and ultimately, whether they can utilize the theory of duress to civilly litigate for that refund. The focus of this first segment is on the history of the IRS’s targeted offshore voluntary disclosure programs.
Just over five years ago, the Internal Revenue Service (IRS) offered the first of three offshore voluntary disclosure programs for individuals with undisclosed foreign financial accounts. Since this announcement, the IRS has threatened severe civil and criminal penalties against U.S. taxpayers with undisclosed foreign financial accounts.1 These threats have not been limited to individuals who utilized offshore accounts to evade the payment of U.S. taxes and have been targeted at just about anyone with a foreign financial account that has not been properly disclosed. Additionally, the threats caused an almost hysterical reaction in U.S. taxpayers with foreign financial accounts that were not timely disclosed on a Foreign Bank Account Report, Form TD F 90-22.1 (FBAR) (now FinCEN Form 114), resulting in a rush to enter into one of the IRS’s targeted offshore disclosure programs.
Under the 2009 Offshore Voluntary Disclosure Program (OVDP), participating taxpayers were required to pay taxes on interest earned from undisclosed foreign financial accounts for the previous six years, as well as pay an accuracy-related penalty on any tax liabilities resulting from those six years. Further, participants of the 2009 OVDP were assessed a 20 percent penalty on the aggregate highest balance in their offshore accounts during the 2003 through 2008 time period. This 20-percent penalty was referred to as a miscellaneous penalty under Title 26 of the United States Code.2 The 2009 OVDP program was timed to profit from the publicity about IRS’ crackdown on Swiss bank accounts, particularly those held at Union Bank of Switzerland (UBS).
The next Offshore Voluntary Disclosure Initiative (OVDI) was announced by the IRS on February 8, 2011. Under the 2011 OVDI, individuals were assessed a 25 percent penalty on the highest aggregate account balance or asset value for the tax years 2003 through 2010.3 For those participants that had offshore accounts totaling less than $75,000, the penalty was reduced to 12.5 percent. Participants could also qualify for a 5 percent penalty if: a) the taxpayer did not open or cause the account to be opened, unless the bank required that a new account be opened rather than making an ownership change to the existing account upon the death of the account’s owner; b) the taxpayer exercises “minimal, infrequent contact with the account,” e.g., to request an account balance or update account holder information such as a change in address; c) the taxpayer has not withdrawn more than $1,000 from the account in any year covered by the voluntary disclosure, with the exception of a withdrawal closing the account and transferring the funds to an account in the U.S.; and d) the taxpayer can establish that all applicable U.S. taxes have been paid on funds deposited in the account.
The latest OVDP was announced by the IRS in 2012. The 2012 OVDP program is identical to the 2011 OVDI, except that the highest penalty rate was increased from 25 percent to 27.5 percent and the years covered under the program were updated.
Since the 2009 OVDP was announced, over 39,000 taxpayers have participated in one the of three voluntary disclosure programs. At last count, the IRS has collected over $5.5 billion dollars in tax, interest, and penalties.4 From the IRS’ point of view, the targeted offshore voluntary disclosure programs have been a huge success. With that said, many have been critical of the offshore disclosure programs as being overly harsh and inflexible towards participants who did not understand that they had a legal duty to disclose foreign financial accounts on an FBAR and other little known reporting requirements.
Over the last several years, taxpayers have become far more knowledgeable in the area of international tax disclosures. Now, the term FBAR has become a household name. Not only have taxpayers become more mature in their understanding of foreign financial account disclosures, taxpayers with previously undisclosed foreign financial assets realize that participation in a targeted offshore voluntary disclosure program is not for everyone. Furthermore, anecdotal evidence suggests that at least some taxpayers are considering other ways, short of participating in the 2012 OVDP, as a solution to their prior foreign income reporting problem.5 In most cases, this means making a so-called “quiet disclosure” to the IRS. In some cases, this strategy may permit a taxpayer to avoid any penalties associated with not timely disclosing a foreign financial account on an FBAR. In the next segment of this series, we will go on to explore the IRS’s position on disclosures made outside of the OVDP structure.
- The 2009 targeted offshore program was specifically targeted to individuals who utilized foreign financial accounts to avoid paying U.S. taxes. The first true offshore voluntary disclosure initiative was in 2003. That initiative was related to an offshore credit card project the IRS pursued starting in 2000. The program was designed to allow taxpayers to step forward and ‘clear up their tax liabilities.’ The program provided that the IRS would “in appropriate circumstances, impose the delinquency penalty under Section 6651, the accuracy-related penalty under Section 6662, or both penalties against taxpayers that participate in the Offshore Voluntary Compliance Initiative. The program waived the fraud penalty, the fraudulent failure-to-file penalty, and certain information return penalties otherwise applicable to participating taxpayers. In addition, participating taxpayers would not be criminally prosecuted.
- The participants of the 2009 OVDI were required to execute a Form 906 entitled “Closing Agreement on Final Determination Covering Specific Matters.” Under the terms of the closing agreement, the participant must agree to pay a miscellaneous penalty under Title 26 of the United States Code.
- See IRS 2011 Offshore Voluntary Disclosure Initiative Frequently Asked Questions and Answers, Note 35 (Feb 4, 2013), available at http://www.irs.gov/Businesses/International-Businesses/2011-Offshore-Voluntary-Disclosure-Initiative-Frequently-Asked-Questions-and-Answers, which states in relevant part: The offshore penalty is intended to apply to all of the taxpayer’s offshore holdings that are related in any way to tax non-compliance. The penalty applies to all assets directly owned by the taxpayer, including financial accounts holding cash, securities or other custodial assets; tangible assets such as real estate or art; and intangible assets as patents or stock or other interests in a U.S. or foreign business. If such assets are indirectly held or controlled by the taxpayer through an entity, the penalty may be applied to the taxpayer’s interest in the entity or, if the Service determines that the entity is an alter ego or nominee of the taxpayer, to the taxpayer’s interest in the underlying assets. Tax noncompliance includes failure to report income from the assets, as well as failure to pay U.S. tax that was due with respect to the funds used to acquire the asset.
- See GAO Report GAO-13-318 (Apr. 26, 2013), available at http://www.gao.gov/products/GAO-13-318
- The IRS 2012 Offshore Voluntary Disclosure Initiative (OVDI): Is It Really Such A Good Deal For You? Is It Really For Everyone? By Richard J. Sapinsky, Esq. & Lawrence S. Horn, Esq.
For more information, contact Moskowitz, LLP.