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No Form 5471 and Form 3520 Penalties – Q&A 18 of the OVDP

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In my practice I have encountered situations where a taxpayer has delinquent Form 5471 or Form 3520, but there is no additional tax liability associated with the delinquent forms. In these situations, a natural questions arises on how to best deal with this situation.

One of the options is to follow Q&A 18 of the Offshore Voluntary Disclosure Program (OVDP) Rules. (This program is now discontinued). In very limited circumstances, Q&A 18 allows a small number of eligible taxpayers escape Form 5471 and Form 3520 penalties.

Background Information

Form 5471 is used by the IRS to satisfy the informational reporting requirements of 26 U.S.C. § 6038 (“Information reporting with respect to certain foreign corporations and partnerships”) and 26 U.S.C. § 6046 (“Returns as to organization or reorganization of foreign corporations and as to acquisitions of their stock”). It must be filed by certain U.S. citizens and residents who are officers, directors, or shareholders in specified foreign corporations, if various requirements are met. Failure to file Form 5471 may result in the imposition of steep penalties (see this article for more details).

Form 3520 (Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts) is used by U.S. persons (and executors of estates of U.S. decedents) to report certain transactions with foreign trusts, ownership of foreign trusts under the rules of IRC §§ 671 through 679, and receipt of certain large gifts or bequests from certain foreign persons. Failure to file Form 3520 may result in very heavy penalties.

Q&A 18

Q&A 18 of the OVDP Rules provides a potentially zero-penalty option for non-compliant taxpayers who failed to file tax information returns, such as Form 5471 and Form 3520.

From the outset, it is important to understand that Q&A 18 has a very limited application. It is only relevant in the situation where the taxpayer failed to file Forms 5471 or Forms 3520, but he reported and paid tax on all their taxable income with respect to all transactions related to the foreign corporations or foreign trusts. The IRS is not likely to impose a penalty for the failure to file the delinquent Forms 5471 and 3520 if there are no underreported tax liabilities and the taxpayer has not previously been contacted regarding an income tax examination or a request for delinquent returns.

Whether Q&A 18 applies to your particular situation is a question that should be determined by an international tax attorney experienced in the area of voluntary disclosures. NOTE: IRS OVDI & OVDP Programs are closed. If your attorney determines that this OVDP provision is applicable in your situation, the attorney should file delinquent information returns with the appropriate service center according to the instructions for the form and attach a statement explaining why the information returns are filed late. Note that the Form 5471 should be submitted with an amended return showing no change to income or tax liability. The attorney should further include at the top of the first page of each information return “OVDI – FAQ #18” to indicate that the returns are being submitted under this procedure.

Amended Return Shows Additional Income Unrelated to Form 5471

An interesting question arises in situations where amended tax returns do show additional income, but the income is not in any way related to Form 5471. While your attorney should carefully review the nature and source of the income, it is possible that Q&A 18 will still apply assuming all other requirement of Q&A 18 are met.

Contact Sherayzen Law Office for Voluntary Disclosure Help with Tax Information Returns

It must be remembered that this article is produced for educational purposes only and does not constitute legal advice; only your tax attorney can determine whether Q&A 18 applies to your situation and how to best comply with its requirements.

Note: The OVDP has been discontinued. If you have undisclosed foreign business entities or foreign trusts, contact Sherayzen Law Office for help. Our experienced international tax team will thoroughly review your case, assess your information tax return (Form 5471, 8865, 3520, et cetera) liability, identify the available voluntary disclosure options and implement the agreed-upon strategy (including preparation of all legal and tax documents).

2012 OVDP: The Voluntary Disclosure Period

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One of the most critical aspects of the 2012 Offshore Voluntary Disclosure Program (2012 OVDP) are the rules pertaining to the voluntary disclosure period – i.e. what years are involved in calculating the Offshore Penalty and for how many years back should the tax returns be amended (with the corresponding consequences for the additional tax due with interest and penalties). These rules have been greatly expanded and elaborated since 2011 OVDI.

The general rule is that the voluntary disclosure period for the applicants to the 2012 OVDP involve the most recent eight tax years for which the due date has already passed. Critically important is to realize that the eight year period does not include current years for which there has not yet been non-compliance. For example, for taxpayers who submit a voluntary disclosure prior to April 15, 2012 (or other 2011 due date under extension), the disclosure must include each of the years 2003 through 2010 in which they have undisclosed foreign accounts and/or undisclosed foreign entities.

For the fiscal-year taxpayers must include fiscal years ending in calendar years 2003 through 2010. For taxpayers who disclose after the due date (or extended due date) for 2011, the disclosure must include 2004 through 2011.

For disclosures made in successive years, any additional years for which the due date has passed must be included, but a corresponding number of years at the beginning of the period will be excluded, so that each disclosure includes an eight year period.

For taxpayers who establish that they began filing timely, original, compliant returns that fully reported previously undisclosed offshore accounts or assets before making the voluntary disclosure, the voluntary disclosure period will begin with the eighth year preceding the most recent year for which the return filing due date has not yet passed, but will not include the compliant years. For example, in hypothetical where a taxpayer who historically filed income tax returns omitting the income from a foreign investment account, but who began reporting that income on his timely, original tax and information reporting returns for 2009 and 2010 without making a voluntary disclosure, and who filed a voluntary disclosure in January 2012, the voluntary disclosure period will be 2003 through 2008.

Understanding the rules of the voluntary disclosure period allows a taxpayer to plan the time of his disclosure according to his circumstances. Of course, such a benefit is only available in cases where there is sufficient time for such planning.

Contact Sherayzen Law Office for Help with 2012 OVDP

If you have undisclosed foreign account or foreign entities and you plan to enter the 2012 OVDP, you should contact Sherayzen Law Office for help with your voluntary disclosure. Our experienced international tax firm will thoroughly analyze your case, assess your FBAR liability as well as other applicable penalties, identify the options available in your case, and work with you every step of the way until your voluntary disclosure is finished.

Offshore Accounts Disclosure and John Doe Summons

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If a taxpayer is about to conduct a voluntary disclosure of his offshore accounts, a question arises about his eligibility to do so in a situation where the IRS already served a “John Doe” summons or made a treaty request seeking information that may identify a taxpayer as holding an undisclosed foreign account or undisclosed foreign entity. The answer is that it depends on the timing of the disclosure.

Background Information

In an earlier article, I discussed the Offshore Voluntary Disclosure Program (OVDP) now closed eligibility requirements. Specifically, I discussed the timeliness eligibility requirement of IRM 9.5.11.9 and how a failure to satisfy this requirement will prevent the taxpayer from conducting a voluntary disclosure.

Under IRM 9.5.11.9, a voluntary disclosure is timely if it is received by the IRS before either of the following events occurs:

(a) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation. Notice, it is not relevant whether the IRS has initiated a civil examination which is not related to undisclosed foreign accounts or undisclosed foreign entities – either of the two, civil examination and criminal investigation, will prevent OVDP participation;

(b) the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;

(c) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or

(d) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

General Analysis

For the purposes of this essay, John Doe summons and treaty requests most likely fit the situation described in paragraph (b). Hence, the main criteria regarding the taxpayer’s eligibility to conduct voluntary disclosure of his offshore accounts in such situations would be whether the IRS already received information under the John Doe summons, treaty request or other similar action and whether the information is sufficiently specific.

For example, the mere fact that the IRS served a John Doe summons, made a treaty request or has taken similar action does not make every member of the John Doe class or group identified in the treaty request or other action ineligible to participate.

On the other hand, if the IRS or the U.S. Department of Justice already obtained information under a John Doe summons, treaty request or other similar action that provides evidence of a specific taxpayer’s noncompliance with the tax laws or FBAR reporting requirements, that particular taxpayer will become ineligible for OVDP and Criminal Investigation’s Voluntary Disclosure Practice.

Contact Sherayzen Law Office for Help With Offshore Voluntary Disclosure

Based on the analysis above, it is evident that a taxpayer concerned that a party subject to a John Doe summons, treaty request or similar action will provide information about him to the IRS should apply to make a voluntary disclosure as soon as possible.

This is why you should contact Sherayzen Law Office. Our experienced international tax law firm can help you with the entire voluntary disclosure process, including initial assessment of your FBAR liability, determination of available voluntary disclosure options, preparation of all of the required legal and tax documents, and rigorous representation of your interests during your negotiations with the IRS.

Offshore Voluntary Disclosure Eligibility Criteria

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Generally, unless ineligible under specific rules, U.S. taxpayers who have undisclosed offshore accounts or assets and meet certain requirements are eligible to apply for IRS Criminal Investigation’s Voluntary Disclosure Practice and the OVDP penalty regime. In this article, I will only strive to broadly outline the 2012 OVDP (Offshore Voluntary Disclosure Program) and 2014 OVDP (closed) general eligibility criteria, but the issue of the eligibility should be carefully analyzed in light of your individual circumstances by an international tax attorney experienced in the IRS voluntary disclosure programs.

The Types of Juridical Persons Eligible to Participate in the OVDP

Individual U.S. taxpayers as well as entities (such as corporations, partnerships and trusts) are eligible to make a voluntary disclosure, assuming all other eligibility requirements are met.

Requirements of IRM (Internal Revenue Manual) 9.5.11.9 Must Be Met

In order to participate in the 2012 OVDP, a U.S. taxpayer must meet all requirements of IRM 9.5.11.9. In general, IRM 9.5.11.9 spells out five voluntary disclosure eligibility requirements.

1. Voluntary Disclosure Must Be Truthful

It is the most basic requirement of the voluntary disclosure – an OVDP participant cannot lie to the IRS during the voluntary disclosure. Generally, I try to go over the entire case of my clients in order to make sure that there is not even an appearance of the disclosure being anything less than truthful.

2. Voluntary Disclosure Must Be Complete

You cannot do a partial voluntary disclosure; an OVDP participant must disclosure all of his failings to comply with U.S. tax laws to the IRS. Therefore, the taxpayer who participates in the voluntary disclosure must strive to uncover any past non-compliance committed during the OVDP disclosure period. Unfortunately, such process requires reliance to a certain degree on the memory of the clients about events that may have happened some time ago and such memory may have lost its accuracy. Another major obstacle is the assumption often made by clients that certain facts are not important and they never disclose them, but which later turn out to be critical to the case.

As an attorney, I strive to test every part of my client’s case in order to make sure that there are no hidden issues and the IRS cannot disallow OVDP participation due to incomplete disclosure. Fortunately, the long experience of with numerous clients in this area greatly helps in uncovering the potential problems and allows for a more effective voluntary disclosure process.

3. Voluntary Disclosure Must Be Timely

A voluntary disclosure is timely if it is received by the IRS before either of the following events occurs:

(a) the IRS has initiated a civil examination or criminal investigation of the taxpayer, or has notified the taxpayer that it intends to commence such an examination or investigation. Notice, it is not relevant whether the IRS has initiated a civil examination which is not related to undisclosed foreign accounts or undisclosed foreign entities – either of the two, civil examination and criminal investigation, will prevent OVDP participation;

(b) the IRS has received information from a third party (e.g., informant, other governmental agency, or the media) alerting the IRS to the specific taxpayer’s noncompliance;

(c) the IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer; or

(d) the IRS has acquired information directly related to the specific liability of the taxpayer from a criminal enforcement action (e.g., search warrant, grand jury subpoena).

This is why time is so crucial in voluntary disclosures – it may make all the difference in what type of penalties you will be facing. This is also why it is so important for the taxpayers who found out about their non-compliance with U.S. tax laws to contact Sherayzen Law Office as soon as possible to discuss the voluntary disclosure options.

4. Cooperation During Voluntary Disclosure

The taxpayer must show a willingness to cooperate (and does in fact cooperate) with the IRS in determining his correct tax liability. Failure to do so will render the taxpayer ineligible to conduct voluntary disclosure.

5. Good-Faith Payment Arrangement

The taxpayer must make good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable. The OVDP terms require the taxpayer to pay the tax, interest, and accuracy-related penalty, and, if applicable the failure to file and failure to pay penalties with their submission. However, it is possible for a taxpayer who is unable to make full payment of these amounts to request the IRS to consider other payment arrangements.

The burden is on the taxpayer to establish inability to pay, to the satisfaction of the IRS, based on full disclosure of all assets and income sources, domestic and offshore, under the taxpayer’s control. Assuming that the IRS determines that the inability to fully pay is genuine, the taxpayer must work out other financial arrangements, acceptable to the IRS, to resolve all outstanding liabilities, in order to be entitled to the penalty relief under the OVDP.

Per Se Ineligibility

Even if the requirements of of IRM 9.5.11.9 are met, there are certain “per se” ineligibility categories of taxpayers which will prevent such taxpayers from participating in the 2012 OVDP:

First, if a taxpayer appeals a foreign tax administrator’s decision authorizing the providing of account information to the IRS and fails to serve the notice as required under existing law (see 18 U.S.C. 3506) of any such appeal and/or other documents relating to the appeal on the Attorney General of the United States at the time such notice of appeal or other document is submitted, the taxpayer will be ineligible to participate. This OVDP provision closes one of the 2011 OVDI loopholes that allowed some U.S. taxpayers to appeal certain foreign decisions and not to inform the U.S. Department of Justice about it (as required by law), while maintaining their voluntary disclosure eligibility.

Second, the IRS may announce that certain taxpayer groups that have or had accounts at specific financial institutions will be ineligible due to U.S. government actions in connection with the specific financial institution. Such announcements will provide notice of the prospective date upon which eligibility for specific taxpayer groups will be posted to the IRS website. This possibility builds a tremendous pressure on non-compliant U.S. taxpayers, because there is constant fear that their voluntary disclosure eligibility will be taken away by an IRS action irrespective of the IRM 9.5.11.9 compliance.

Third, the IRS voluntary disclosure practice does not apply to taxpayers with illegal-source income.

Contact Sherayzen Law Office for Help With Your Offshore Voluntary Disclosure

The voluntary disclosure eligibility criteria is complex and it is best to consult an attorney experienced in voluntary disclosures with respect to whether you are eligible to conduct voluntary disclosure under your particular circumstances.

This is why your first step should be to schedule a consultation with a Sherayzen Law Office attorney. Our international tax firm is highly experienced in voluntary disclosures and they can help you with an entire voluntary disclosure process, including initial assessment of your FBAR liability, determination of available voluntary disclosure options, preparation of all of the required legal and tax documents, and rigorous representation of your interests during your negotiations with the IRS.

Offshore Voluntary Disclosure Program: Advantages and Disadvantages

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2012 Offshore Voluntary Disclosure Program (2012 OVDP) now closed may offer tremendous benefits to certain types of taxpayers, but it may not be as beneficial in other circumstances. Whether to enter the 2012 OVDP is a decision that should be made by the taxpayer only after he had an opportunity to discuss this matter in depth with an experienced attorney who specializes in offshore voluntary disclosures. In this article, however, I wish to outline some of the broader considerations with respect to entering into the 2012 OVDP in order to provide some background information to the readers so that they can understand better their attorney’s advice.

Background Information

2012 OVDP was announced by the IRS barely four months after the end of the wildly-successful 2011 OVDI (Offshore Voluntary Disclosure Initiative). However, the actual terms of the program were not announced until much later, June 26, 2012.

2012 OVDP brought in tougher terms than 2011 OVDI (for example, the highest penalty category is 27.5% instead of 25% as it was under 2011 OVDI rules), closed some 2011 OVDI loopholes and created a more complex and detailed set of rules. 2012 rules also clarified many heretofore obscure procedures and contained new features that may benefit certain classes of taxpayers, especially those who owned Canadian retirement accounts.

The basic structure of 2012 OVDP, however, remains largely similar to 2011 OVDI. It still has three penalty levels (27.5%, 12.5% and 5%), highly demanding information disclosure requirements and general rigidness with respect to its terms.

General Cost-Benefit Considerations

There are actually three general analytical steps with respect to benefits and drawbacks of entering into the 2012 OVDP. First, the extent of current liability exposure of the taxpayer outside of the 2012 OVDP. Second, the estimate of the OVDP liability of the taxpayer and comparison of OVDP versus non-OVDP exposure (here, an attorney would also explore the non-tax aspects of the OVDP disclosure such as the comfort level of the taxpayer with the invasive nature of the OVDP requirements). Finally, whether 2012 OVDP is the best route to proceed vis-a-vis alternative voluntary disclosure options.

Since the first and the third steps are outside of the scope of this article, I will concentrate on the calculation of advantages and disadvantages of entering of the 2012 OVDP versus non-OVDP exposure. It should be remembered, however, that this calculation will depend heavily on the individual circumstances of each case.

Primary Advantages of the 2012 OVDP

2012 OVDP enjoys five primary advantages over non-OVDP options. First, it is an official IRS program with a virtual certainty (though, according to the IRS, not a 100% guarantee) of elimination of criminal prosecution.

Second, 2012 OVDP provides a taxpayer with an opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues at the same time. This is the case because OVDP rules assess one single Offshore Penalty with respect to all information returns – Forms 5471, 8865, 926, 3520, FBARs, et cetera. This can highly advantageous for the taxpayer, because, outside of the OVDP, he will have to deal with the penalties associated with each form.

Moreover, paying one single penalty may represent huge savings over paying penalties outside of the OVDP. The IRS provides a hypothetical example where a taxpayer would pay, outside of the 2012 OVDP, $4,543,000 (plus interest) in tax, accuracy-related penalty, and FBAR penalty on a single $1,000,000 account with the undisclosed income of $50,000 per year. This is not even counting the additional penalties and jail time in case the IRS decides to initial a criminal prosecution. On the other hand, in the same example, a taxpayer would pay only $518,000 plus interest under the 2012 OVDP rules (assuming 27.5% offshore penalty category).

Third, 2012 OVDP rules provide for a certain flexibility where the taxpayer’s attorney can look for strategies to lower the Offshore Penalty further if the circumstances of the case allow for such possibility. Therefore, despite its overall rigidness, the OVDP does take some individual circumstances into the account. However, it is important to point out that much of this flexibility is likely to be achieved only securing the agreement of the IRS agent in charge of your case, his manager and the technical analyst – this is a very hard achievement even for an experienced attorney (though, unfortunately, there are a number of cases where the taxpayers’ representatives failed to even try to achieve this goal) and it puts very strict limits on the OVDP flexibility.

Fourth, 2012 OVDP limits the taxpayer’s liability to eight years and the IRS will not look further absent extraordinary circumstances. Outside of the OVDP, the IRS does have an argument that failure to file certain information returns may keep the statute of limitations open to IRS examination with respect to affected tax returns.

Finally, 2012 OVDP provides a definite closure to the case. At the end of the OVDP process, Form 906 (the Closing Agreement) is signed by the taxpayer and the IRS by which both sides agree to the terms of the Agreement and the case is over (absent extraordinary circumstances, such as fraudulent claims by the taxpayer during the voluntary disclosure process).

Primary Disadvantages of the 2012 OVDP

2012 OVDP also has numerous disadvantages. First, this is a very rigid program with numerous requirements. The side-effect is that the OVDP process can be an expensive one for the taxpayer when it comes to legal and accounting fees.

Second, despite having some flexibility with respect to the calculation of penalties, OVDP rules are not likely to be sensitive to major circumstances of a taxpayer’s case, such as non-willfulness of his conduct. While it is never officially stated, the OVDP unofficially incorporate the assumption that the OVDP applicants acted willfully in its Offshore Penalty structure and there is no reasonable cause that can explain their failure to comply with U.S. tax laws. This often leads to a result where innocent taxpayers with smaller cases or taxpayers who live overseas (and for one reason or another do not satisfy the requirements of the 5% penalty category) can be highly penalized under the OVDP structure.

Third, related to the preceding paragraph, the OVDP penalty structure may actually impose a higher penalty on a taxpayer where IRS is not able to establish the willfulness of the taxpayer’s conduct. This is a highly complex calculation that should be made by an attorney, but, generally, the higher the chances of the taxpayer to establish non-willfulness, the less appealing the OVDP penalty structure is likely to be. This is especially true where OVDP Offshore Penalty includes the assets that would not otherwise either be subject to penalty outside of the OVDP or be subject to a much lower penalty.

Fourth, 2012 OVDP has no real appeal structure in place – in most cases, the IRS agent’s decision is final. If you do not like it, the only real recourse is to opt-out with its murky consequences (it may still be an option depending on the individual circumstances of the case, especially when the taxpayer should not have been in the OVDP program in the first place). The only exception is having a full examination of the tax return and an appeal maybe filed with respect to any tax and penalties imposed by the IRS on examination, but the IRS decisions on the terms of the OVDP closing agreement is almost never subject to an appeal. Such dependance on the good will of an IRS agent in charge of the case naturally produces certain anxiety among the OVDP applicants and constitutes a major drawback of entering into the program.

Finally, 2012 OVDP may take a fairly long time to complete (there are still some 2009 OVDP cases open in 2013). The IRS does try to process the cases as soon as possible, but it has few resources and its agents are overwhelmed with the number of cases pending on their desks. On the average, a taxpayer should expect about a fifteen to eighteen-month process between the acceptance into the OVDP and the final resolution of the case.

Contact Sherayzen Law Office for Help with Your Offshore Voluntary Disclosure

This article merely outlines some of the main consideration with respect to the 2012 OVDP. The actual cost-benefit calculation is much more complex and will vary wildly depending on the individual circumstances of each case.

This calculations and the probabilities with respect to each disclosure option should be done by an international tax attorney experienced in the offshore voluntary disclosures.

This is why you should contact Sherayzen Law Office for help with your voluntary disclosure. Our international tax firm is highly experienced in the voluntary disclosure process. We will thoroughly examine the circumstances of your case, assess your penalties under the various disclosure scenarios, prepare all of the required legal documents and tax forms, and rigorously represent your interests during negotiations with the IRS.