Sam Brotman, JD, LLM, MBA August 24, 2014 6 min read

The OVDP Process – Part Four

Example of the Penalty Structure in the OVDP Process

The Criminal Investigative unit is charged with assessing the penalty structure. The structure itself is nonnegotiable and the examiner lacks discretion to make any adjustments. The following is an example prepared by the IRS[1]:

The values of OVDP assets are aggregated for each year and the offshore penalty is calculated at the applicable rate (either 27.5 percent or 50 percent) of the highest year’s aggregate value during the period covered by the voluntary disclosure.

If the taxpayer has multiple OVDP assets where the highest value of some OVDP assets is in different years, the values of OVDP assets are aggregated for each year and a single offshore penalty is calculated at the applicable rate of the highest year’s aggregate value.

For example, assume the taxpayer had the following amounts in a foreign financial account over the period covered by his voluntary disclosure. It is assumed for purposes of the example that the $1,000,000 was in the account before 2005 and was not unreported income in 2005.

Year Amount on Deposit Interest Income Account Balance
2005 $1,000,000 $50,000 $1,050,000
2006   $50,000 $1,100,000
2007   $50,000 $1,150,000
2008   $50,000 $1,200,000
2009   $50,000 $1,250,000
2010   $50,000 $1,300,000
2011   $50,000 $1,350,000
2012   $50,000 $1,400,000

 

(NOTE: This example does not provide for compound interest, and assumes the taxpayer is in the 35-percent tax bracket, does not have an investment in a Passive Foreign Investment Company (PFIC) and files a return but does not include the foreign financial account or the interest income on the return. This example further assumes that the taxpayer is subject to a 27.5 percent offshore penalty.)

Under the OVDP Process

If the taxpayer in the above example comes forward and his voluntary disclosure is accepted by the IRS, he faces this potential scenario:

He would pay $553,000 plus interest. This includes:

  • Tax of $140,000 (8 years at $17,500) plus interest,
  • An accuracy-related penalty of $28,000 (i.e., $140,000 x 20%), and
  • A miscellaneous offshore penalty of $385,000 (i.e., $1,400,000 x 27.5%).

If the taxpayer didn’t come forward, when the IRS discovered his tax and FBAR noncompliance, he would have to pay substantially more in penalties. The taxpayer would also be liable for interest and possibly additional penalties, and an examination could lead to criminal prosecution.

Outside the OVDP Process

The civil liabilities outside the Offshore Voluntary Disclosure Program potentially include:

  • The tax, accuracy-related penalties, and, if applicable, the failure-to-file and failure-to-pay penalties, plus interest, as described above,
  • FBAR penalties totaling up to $3,825,000 for willful failures to file complete and correct FBARs (2007 - $575,000, 2008 - $600,000, 2009 - $625,000, 2010 - $650,000, and 2011 - $675,000, and 2012 - $700,000),
  • The potential of having the fraud penalty (75 percent) apply, and
  • The potential of substantial additional information return penalties if the foreign financial account is held through a foreign entity such as a trust or corporation and required information returns were not filed.

Case Resolution in the OVDP Process

Assuming the taxpayers and the service can successfully negotiate all of the above twists and turns, the case will be resolved by a written agreement known as a closing agreement. The taxpayer will pay all taxes, interest, and penalties. In addition they will agree to abide by the tax laws going forward, and the matter will be resolved. As previously mentioned to date, $6.5 billion of tax revenue has been collected under the OVDP process and its predecessor programs. If an agreement cannot be reached, the taxpayer has the right to opt out of the program as discussed in the next section.

Questions about the OVDP process? Please give our office a call.

[1] http://www.irs.gov/Individuals/International-Taxpayers/Offshore-Voluntary-Disclosure-Program-Frequently-Asked-Questions-and-Answers-2012-Revised

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Sam Brotman, JD, LLM, MBA

Owner and Director of Legal
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