In an earlier article, I discussed the advantages of the Streamlined Domestic Offshore Procedures (“SDOP”) in the year 2020. Among the advantages, I mentioned the SDOP Miscellaneous Offshore Penalty (hereinafter “SDOP Penalty”), but never explained this concept. The focus of this article is on the 2020 SDOP Penalty and how one generally should calculate it.
It is important to keep in mind that this is an educational article which aims to provide a general overview of the calculation of the Miscellaneous Offshore Penalty in common situations. In providing this general overview of the 2020 SDOP Penalty, the article necessarily glosses over some complex issues that may change the determination of the Penalty in a particular case. In order to calculate your SDOP Penalty properly, the readers should contact Sherayzen Law Office, an experienced international tax law firm, for a legal advice based on their specific facts and circumstances
2020 SDOP Penalty: Background Information
In 2014, the IRS created SDOP as a way to mitigate the harshness of the IRS Offshore Voluntary Disclosure Program (“OVDP”) for non-willful taxpayers. Not only did SDOP offer a shorter voluntary disclosure period and less paperwork than OVDP, but it also replaced the OVDP multi-layered penalty structure with a lower Miscellaneous Offshore Penalty. This SDOP Miscellaneous Offshore Penalty (hereinafter “SDOP Penalty”) stills exists in 2020 and its calculation methodology is still the same (with the exception of a few clarifications provided by the IRS at a later time).
2020 SDOP Penalty: General Description
A taxpayer who utilizes the Streamlined Domestic Offshore Procedures to make the voluntary disclosure of his foreign assets and foreign income must pay a 5% SDOP Penalty. This penalty is paid in lieu of the penalties associated with the delinquent filings of FBARs, Forms 8938, Forms 5471 and other information returns.
The calculation of the SDOP Penalty is very different from calculation of penalties in other offshore voluntary disclosure programs in terms of its time period and the determination of the penalty base. Let’s explore each of these factors separately.
2020 SDOP Penalty: Time Period
The SDOP Penalty equals to 5% of the highest aggregate balance/value of the end-of-year taxpayer’s penalty base (see below) in any of the years in the covered tax return period and the covered FBAR period. Generally, “covered tax return period” is the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed. “Covered FBAR period” means the most recent six years for which the FBAR due date has passed.
Thus, usually, SDOP Penalty is imposed on the past six years covered by the FBAR statute of limitations. However, this is not always the case; in some cases the three-year tax covered tax return period does not completely overlap with the six-year covered FBAR period.
2020 SDOP Penalty: Penalty Base
The concept of “penalty base” is one of most critical considerations in any voluntary disclosure. Generally, penalty base means the assets that are subject to a penalty. Hence when I refer to the SDOP penalty base, I mean the assets which are subject to the SDOP Penalty.
Generally, the SDOP Penalty applies to any foreign financial asset in a given year within the covered SDOP time period if one of the following is true:
- The asset should have been, but was not, reported on an FBAR (FinCEN Form 114) for that year;
- The asset should have been, but was not, reported on a Form 8938 for that year; or
- If the asset was properly reported for that year, but gross income in respect of the asset was not reported in that year.
A foreign financial asset that falls within any one of these three categories should be added to the penalty base.
There are two more important features of the SDOP Penalty base that need to be taken into account. First, the definition of “foreign financial assets” includes not only foreign bank and financials accounts listed on FBAR, but also all foreign financial assets reportable on Form 8938. This means that many more assets in addition to foreign financial accounts may be subject to the SDOP Penalty, including assets listed on Forms 5471 and 8865.
Moreover, the SDOP Penalty base covers more exotic foreign financial assets such as: certain forms of indebtedness issued by a foreign person (such as a note, bond, debenture, an interest in a foreign trust, foreign swaps, foreign options, foreign derivatives, et cetera. The exact determination of what assets should falls in the SDOP Penalty base should be made by an international tax attorney.
The second important feature of the SDOP Penalty is the potential divorce between income tax noncompliance and penalty imposition. Unlike the 2014 OVDP (which closed in 2018), the SDOP Penalty applies to assets which never produced any income. In other words, a bank account that was not reported on FBAR would still be included in the SDOP Penalty base even if it never produced any income.
2020 SDOP Penalty: Calculation of Highest Aggregate Value of Assets
The 2020 SDOP Penalty is imposed on highest aggregate balance/value of a taxpayer’s foreign financial assets that are included in the SDOP Penalty base during the years in the covered tax return period and the covered FBAR period. The calculation of the “highest balance/value” is a three-step process.
First, for each relevant year, you need to determine the end-of-year value of each asset included in the Penalty base. Such value should be in US dollars.
Second, aggregate the end-of-year values/balances per each year in the covered tax return period and the covered FBAR period.
Finally, select the highest aggregate balance/value from among those years and calculate the 5% value of this balance. This is your 2020 SDOP Penalty.
Contact Sherayzen Law Office for Professional Help with Your Offshore Voluntary Disclosure Under Streamlined Domestic Offshore Procedures
If you have undisclosed foreign accounts or any other foreign assets, you should contact Sherayzen Law Office for professional help with your offshore voluntary disclosure. We have helped hundreds of US taxpayers with their offshore voluntary disclosures, including Streamlined Domestic Offshore Procedures, and we can help you!