"I'm from the IRS and I'm here to help you."
Yes, the above is one of life's big lies. But several years ago, it looked as if they actually intended to help if you had an offshore tax problem.
In 2009, the IRS introduced the Offshore Voluntary Disclosure Program (OVDP). The program was designed to encourage US taxpayers to come forward with information about previously undisclosed offshore bank accounts, in exchange for reduced penalties.
But in its 2011 Annual Report to Congress, the IRS Taxpayer Advocate Service (TAS) accused the agency of engaging in a bait and switch with respect to the 2009 OVDP. In the program, participating taxpayers were first required to pay all back taxes and interest due on unreported offshore income for tax years 2003–2008. In addition, they had to pay a minimum of 20% of the peak aggregate balance of all unreported offshore accounts during those years.
The IRS encouraged taxpayers to participate in the program by emphasizing the much heavier penalties for non-compliance. Yet, the IRS also claimed that under no circumstances would a taxpayer entering the OVDP be required to pay a penalty greater than would be required under existing statutes.
These claims turned out to be big fat fibs.
In the report, the TAS described how taxpayers with only minor reporting violations and who owed no delinquent tax were herded into the 2009 OVDP. But once enrolled, the penalties were much heavier than they would have otherwise been subjected to.
Consider a taxpayer with an offshore account whose peak value between 2003–2008 was $100,000 but who paid all taxes due on income it generated. Under the 2009 OVDP, the taxpayer would have paid a penalty of $20,000. Yet, according to the IRS's own FAQ, taxpayers who filed delinquent reporting forms but owed no tax would generally face no penalty.
Well, some things never change. Earlier this month, details emerged of another IRS offshore tax-compliance con job, this one related to an initiative the IRS calls its "Streamlined Filing Compliance Procedures" (SFCP).
Here's how the SFCP was supposed to work: Back in 2013, the IRS decided that non-resident taxpayers who were a "low compliance risk" would be eligible for more favorable treatment than the OVDP offered. Then in 2014, the agency extended the SFCP to US-resident taxpayers. In these cases, the IRS waived all civil and criminal penalties, but SFCP participants still had to pay taxes and interest going back three years. US-resident taxpayers entering the SFCP also had to pay a fine equal to 5% of the highest aggregate balance of their offshore accounts for the preceding three years.
To date, about 30,000 taxpayers have taken advantage of the SFCP. But unfortunately, as with just about everything the IRS does, there was – and is – a catch. The IRS gives no guarantee that you won't be prosecuted in the future. And to qualify for the SFCP, you must demonstrate that your failure to report and/or pay tax on your offshore accounts and earnings was "non-willful." That requires you to bare your soul to the IRS in what the agency calls a "reasonable cause statement."
In this statement, you try to convince the IRS that you had a good excuse not to comply with the offshore tax and disclosure requirements. But you're also admitting that you've committed a crime. If the IRS doesn't accept your cause as reasonable, it won't necessarily waive any penalties. Possible penalties include:
A civil penalty of $10,000 per unreported offshore account for each year you neglected to file Form 114 (until 2013, known as Form TD F 90-22.1); and
Beginning with the 2011 tax year, a civil penalty of $10,000 for each year you failed to file Form 8938.
If the IRS believes you "willfully" failed to file these forms, it can use your reasonable cause statement to impose:
A civil penalty of 50% of the highest value of offshore accounts you hold for any year in which you failed to file Form 114; (Until 2013, form TDF 90-22.1)
Fraud penalties up to 75% of any unpaid tax;
A failure-to-file penalty up to 25% of any unpaid tax for each year you didn't file a tax return at all; and
An accuracy-related penalty for underpayments of tax up to 40% of any tax due.
To understand the impact of this penalty framework, consider the case of Carl Zwerner. In 2014, a federal jury imposed a fine of $2.24 million against Zwerner for failing to file Form TD F 90-22.1 for three years. Yet the highest balance of these accounts in the years in question was only $1.55 million. Keep in mind that the $2.24 million penalty was in addition to back taxes, interest, and penalties that Zwerner already paid for the earnings in this account.
It could have been worse; the original IRS assessment against Zwerner came to a whopping $3.5 million. The IRS also didn't seek criminal penalties, including possible imprisonment, against him.
You can probably see how the flimflam games work for the SFCP. After you file your statement of reasonable cause, the IRS rejects it.
And for the first time, the IRS now has access to thousands of pages of once-secret records obtained from 80 banks in Switzerland. These records came to the IRS through its "Swiss Bank Program," in which the agency gave Swiss banks a path to avoid criminal liability in exchange for providing detailed information on accounts held by US taxpayers. The banks also were required to pay penalties totaling more than $1.3 billion.
We're "taking all of that data and scrubbing it for leads," says Nanette Davis, a trial attorney in the Justice Department's tax division. Davis claims that with some taxpayers who enrolled in the SFCP, "[W]e could indict this case tomorrow."
Feeling hustled, anyone?
If you're in this situation – or if you have done nothing about unreported offshore income or accounts – consult with a qualified tax attorney, not an accountant. This arrangement provides attorney-client privilege for your discussions. The tax attorney can then retain an accountant to prepare the necessary returns and decide whether you should participate in the OVDP.
In the meantime, while it's plain to see the IRS is doing everything in its power to discourage Americans from investing overseas, it's more important than ever to diversify internationally. You'll gain access to investments simply not available in the US and pay for them with US dollars trading at multi-year highs against other currencies. Offshore investments also offer asset protection, privacy from anyone other than the IRS, and reduced portfolio risk.
While I'm sure the IRS doesn't like it when I say this, there's never been a better time than now to "go offshore."