Failure to Conduct Voluntary Disclosure: Possible Penalties

The IRS just instituted a new voluntary disclosure program for taxpayers who have offshore accounts or assets and who failed to properly report them to the IRS and pay appropriate U.S. taxes. It is called 2011 Offshore Voluntary Disclosure Initiative (“2011 OVDI”). While 2011 OVDI is not available for everyone and some particular circumstances of a case may determine whether it is advisable to go through this program, this new voluntary disclosure program offers a great chance for taxpayers to bring their tax affairs in order and virtually eliminate the possibility of criminal prosecution.

However, what may happen if a taxpayer who should have voluntarily disclosed his offshore income and assets, but fails to do so through 2011 OVDI and the IRS discovers the noncompliance through later examination? This article addresses the common types of penalties that a taxpayer may be subject to in cases where IRS identifies noncompliance with U.S. tax laws before the taxpayer goes through the voluntary disclosure process.

Penalties in General

In general, if the IRS finds out that a taxpayer is not in compliance with U.S. tax laws and fails to voluntarily disclose his offshore assets and foreign bank accounts, the taxpayer may be subject to severe civil and criminal penalties. In additional to accuracy related penalties, the fraud-related penalties, FBAR penalties, and foreign asset reporting penalties (with interest) may be imposed. Combined, all of these penalties and interest may exceed the actual value of nondisclosed assets and foreign bank accounts. In the worst-case scenario, a criminal prosecution may be launched against the noncompliant taxpayers.

Finally, the voluntary disclosure process – which would otherwise be a far less painful way to deal with this problem – is automatically unavailable for taxpayers as soon as they are under civil examination of the IRS.

Let’s discuss the penalties in detail.

Accuracy-Related and Failure to File and Pay Penalties

An accuracy-related penalty on underpayments is imposed under IRC § 6662. Depending upon which component of the accuracy-related penalty is applicable, a taxpayer may be liable for a 20 percent or 40 percent penalty.

If a taxpayer fails to file the required income tax return, a failure to file (“FTF”) penalty may be imposed pursuant to IRC § 6651(a)(1). The penalty is generally five percent of the balance due, plus an additional five percent for each month or fraction thereof during which the failure continues may be imposed. The total penalty will not exceed 25 percent of the balance due.

If a taxpayer fails to pay the amount of tax shown on the return, a failure to pay (“FTP”) penalty may be imposed pursuant to IRC § 6651(a)(2). The penalty may be half of a percent of the amount of tax shown on the return, plus an additional half of a percent for each additional month or fraction thereof that the amount remains unpaid, not exceeding the total of 25 percent of the balance due.

Fraud Penalties

Fraud penalties may imposed under IRC §§ 6651(f) or 6663. Where an underpayment of tax, or a failure to file a tax return, is due to fraud, the taxpayer is liable for penalties that may essentially amount to 75 percent of the unpaid tax.

FBAR Penalties

Read this article discussing the penalties that may be imposed as a result of a taxpayers failure to file the FinCEN Form 114 formerly Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as an “FBAR”).

Other Penalties

Depending on a particular fact pattern, additional penalties may be imposed for failure to file Form 926, 3520, 3520-A, 5471, 5472, and 8865.

Criminal Prosecution

In the worst-case scenario, a criminal prosecution may be launched by the IRS. Huge penalties and potential jail time are the possible in case of tax evasion.

Contact Us to Let Us Help You

Sherayzen Law Office can help. We are a tax firm based in Minnesota who has helped taxpayers throughout the United States to disclose offshore assets, foreign bank accounts and unreported foreign income to the IRS, avoiding the nightmare scenarios for our clients.

For many taxpayers, 2011 OVDI is a chance to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. A voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues.

If you believe that you may not be in full compliance with U.S. tax laws, the worst course of action is to do nothing and wait for the IRS to discover your noncompliance. Once this happens, your options are likely to be severely limited and the penalties a lot higher. Therefore, call or e-mail us NOW to let us help you with your tax problems. Remember, all calls and e-mails are confidential and attorney-client privileged.