Understanding Offshore Disclosure
The IRS has two offshore disclosure programs to bring taxpayers with undisclosed foreign accounts into compliance with the tax laws: The Offshore Voluntary Disclosure Program (OVDP) and the Streamlined OVDP procedures. Rather than cumulative penalties for failure to disclose the offshore account the taxpayer pays one penalty of 27 and a half percent of the highest outstanding balance of undisclosed assets. Penalties in the Streamlined OVDP for U.S. resident taxpayers are five percent of the highest balance. The benefits and requirements for each program are different. The taxpayer should determine the distinctions before selecting which program to enter.
The OVDP program is for individuals who cannot meet the non-willfulness standard outlined below. While the penalty is higher, the program assures taxpayers accepted into the program that they will not be prosecuted for any tax crime provided they make full disclosure.
Individuals selecting the Streamlined Program must certify under penalties of perjury that their non-compliance was not willful and provide specific reasons for their non-compliance. Under Streamlined Procedures the returns are subject to audit and if the IRS determines that the taxpayer’s conduct was willful then the IRS could pursue criminal penalties or civil penalties in excess of the 27 and a half percent penalty under OVDP.
Understanding the definition of willfulness is important in determining which program to select. Willfulness requires a facts and circumstances inquiry into the taxpayer’s conduct and state of mind and only the taxpayer can determine whether their conduct was non-willful. Traditionally the definition of willfulness in a criminal tax case meant, “[A] voluntary, intentional violation of a known legal duty,” U.S. v. Pomponio, 429 U.S. 10(1976). This required more than negligence or careless disregard. U.S. v. Bishop, 412 U.S. 346 (1973). Furthermore, willfulness meant that the taxpayer specifically intended to violate the law. Cheek v. U.S., 498 U.S. 192 (1991).
The Internal Revenue Manual (IRM) definition of willfulness in the context of offshore compliance is also a “voluntary, intentional violation of a known legal duty.” IRM 184.108.40.206.5.3. The IRM provides that the person’s knowledge of the reporting requirement and conscious choice not to comply with the requirement establishes willfulness absent reasonable cause. The taxpayer can demonstrate a lack of willfulness by establishing that the failure to report the offshore accounts was due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the law. A taxpayer can also demonstrate a lack of willfulness by showing reasonable cause for the non-compliance. Reasonable cause requires that the taxpayer exercise ordinary business care and prudence but due to circumstances beyond his control is unable to comply. Reasonable cause might be present in circumstances where the taxpayer relied on tax professionals or was unable to comply because of the taxpayer’s illness or illness in his family, casualties, natural disasters, or the inability to obtain records.