Introduction to the Offshore Voluntary Disclosure Program (OVDP)
In the early 2000s, the United States initiated a campaign targeting almost 8 million US citizens and green card holders living abroad.
This campaign, led by the IRS, aimed to enforce tax compliance among US citizens and green card holders living abroad.
Central to this campaign was the Offshore Voluntary Disclosure Program (OVDP), designed to bring non-compliant taxpayers into compliance.
IRS Agents in Panama
In Panama, where I currently reside, IRS agents were dispatched across the country to locate non-compliant US taxpayers.
Some of these agents openly carried firearms, creating an intimidating environment for many expats.
This aggressive enforcement raised awareness among US persons living abroad about their tax obligations and the potential consequences of non-compliance.
Tax Obligations for US Expats
The United States is unique among major countries in that it requires its citizens and green card holders living abroad to pay US taxes and fulfill the same reporting responsibilities as those living in the country.
This includes reporting any non-US bank, securities, or other financial accounts if their total value exceeds $10,000.
Failure to file these forms can result in severe penalties, including large fines and potential criminal charges.
Severe Penalties and Compliance Challenges
The penalties for failing to file the Foreign Bank Accounts Report (FBAR) are particularly harsh.
- For willful violations, the civil penalty is the greater of $100,000 or 50% of the total balance of the foreign account.
- Non-willful violations carry a $10,000 penalty per account per year.
- Additionally, US persons who create or fund foreign trusts or business entities must make extensive disclosures, with severe penalties for non-compliance.
Expats Caught in the Crossfire
Many expats, even those who thought they were compliant, were caught in this campaign.
For instance, a US citizen who had lived in Canada for many years contacted us after receiving a $20,000 bill from the IRS.
Because he had hired a big-name US accounting firm to prepare his tax returns each year, at a cost of more than $5,000 annually, he believed he was 100% compliant with all US tax and reporting obligations. He never owed any US tax because taxes in Canada are higher than in the US.
The issue was a Canadian educational savings plan account for his daughter, which he failed to report on the FBAR. The IRS fined him $10,000 for two years of negligent reporting.
Limited Ways to Avoid Penalties
Until June 18, 2014, there were limited ways to avoid these penalties.
If you had no underreported tax liabilities, you could file delinquent FBARs with no penalty.
Non-resident taxpayers deemed “low compliance risk” by the IRS could also receive favorable treatment if they lived outside the US and owed less than $1,500 in income tax per year, with waived penalties, though they still had to pay taxes and interest for three years.
Offshore Voluntary Disclosure Program (OVDP)
Otherwise, the best option for avoiding severe penalties was to come forward under the IRS’s Offshore Voluntary Disclosure Program (OVDP).
By signing up for this program, the IRS promised not to prosecute for criminal tax evasion or impose its most severe civil penalties. Instead, participants had to pay 27.5% of the highest aggregate account values for the eight years prior to disclosure.
This calculation method significantly increased the severity of the penalty. For example, due to the global economic downturn in 2008-2009, an unreported international account worth $1 million in 2007 might have been worth only $600,000 at the end of 2012. Yet, the 27.5% penalty would be assessed against the entire $1 million for 2007, effectively raising the sanction to nearly 50% ($275,000 of $600,000). This is in addition to penalties for subsequent years.
A Revised OVDP for Expats
Recognizing the undue harshness of the original Offshore Voluntary Disclosure Program on non-resident US persons, IRS Commissioner John Koskinen announced a revision to the program on June 18, 2014.
The revised OVDP allows expats to disclose their foreign accounts and pay back taxes for the previous three years without penalties.
Resident Americans could also disclose offshore accounts with a reduced 5% penalty instead of 27.5%.
Proving Non-Willfulness
To benefit from the revised OVDP, expats must certify that their failure to comply was non-willful. But it’s challenging to prove non-willfulness.
A recent US court decision clarified that the 50% penalty for willful violations could be imposed for each year of non-disclosure, potentially exceeding the total account balance. This underscores the importance of accurately certifying the nature of past non-compliance.
Note: US persons who held accounts at a number of foreign banks and other companies already under investigation by the IRS are not eligible for this program.
FATCA Compliance
Adding to the complexity is the Foreign Account Tax Compliance Act (FATCA), which came into effect on July 1, 2014.
FATCA requires Foreign Financial Institutions (FFI) to report accounts owned by US taxpayers or face a 30% withholding tax on US payments.
The IRS has asked many banks to review accounts retroactively, increasing the likelihood of “willful” violation accusations.
Need Help?
Given the complexities and severe penalties associated with non-compliance, it is crucial for US expats with unreported offshore income or accounts to consult a qualified attorney. This ensures attorney-client privilege, protecting your discussions. An attorney can then work with an accountant to prepare necessary returns and decide on participation in the Offshore Voluntary Disclosure Program.
Since 1984, we’ve helped more than 15,000 customers and clients protect their wealth using proven, low-risk domestic and offshore planning. To see if our planning is right for you, please book in a free no-obligation call with one of our Associates. You can do that here.
