It’s Finally Here: The IRS Bible for Voluntary Disclosures

As many will remember, the Offshore Voluntary Disclosure Program (OVDP) closed on September 28th with the promise that the Internal Revenue Service (IRS) would issue new guidance on voluntary disclosures made after that date.  The guidance just arrived in the form of a 5-page Memorandum by Kristen B. Wielobob, Deputy Commissioner for Services and Enforcement, re Voluntary Disclosure Practice (LB&I-09-1118-014 dated 11/20/18 and with an expiration date of 11/20/2020).

A lot has changed, and not for the better, in my view! I’ve summarized some of the more salient points below:

1.  The guidance memorandum addresses the process to be applied to all voluntary disclosures (regardless if domestic or offshore) that follow the closure date of the OVDP on September 28, 2018.  No exceptions – the guidance is now the Bible for all kinds of voluntary disclosures.  It should be remembered that long before any OVDP program was initiated, voluntary disclosure had been a long-standing practice of the IRS as a means to provide taxpayers with criminal issues an opportunity to come into compliance with the law and potentially avoid criminal prosecution.  All offshore voluntary disclosures conforming to the requirements of “Closing the 2014 Offshore Voluntary Disclosure Program Frequently Asked Questions and Answers” FAQ 3 received or postmarked by September 28, 2018 will be handled under the procedures of the 2014 OVDP. For all other voluntary disclosures (non-offshore) received on or before September 28, 2018, the Service has the discretion to apply the procedures outlined in this memorandum.

2.  The guidance reiterates that voluntary disclosures are appropriate for taxpayers with exposure to potential criminal sanctions.  The guidance mentions “willful” or “fraudulent” conduct that “may rise to the level of tax and tax-related criminal acts” as being of the type for which a voluntary disclosure is called for. Many times taxpayers are not sure where they “fit” on the “willful” or “fraudulent” continuum and question whether their particular facts may tip the scales of justice over to the criminal side.  Without question, experienced tax counsel should be sought, and second opinions considered.

As with the now-closed OVDP, taxpayers must file all required tax and information returns for the disclosure period, and must pay tax and interest on all previously unreported income.

3.  FBAR violations are clearly included and covered by the guidance memorandum.  The memorandum provides that the IRS will assert willful FBAR penalties on taxpayers entering the program. FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17.   I will note here that the law is a bit unsettled on the issue of the maximum permissible “willful” FBAR penalty. Specifically, the point of contention is whether the willful FBAR penalty for a particular calendar year must be capped at $100,000, or whether it can be assessed at 50 percent of the highest balance of the unreported foreign-financial account(s). Of course, the IRS takes the latter position (i.e., no $100,000 cap)!

Under the FBAR penalty mitigation guidelines issued by the IRS, (see Exhibit 4.26.16-1) FBAR penalties are subject to discretion (including “willful” FBAR penalties).  This means that IRS agents may recommend a higher or lower penalty based on particular facts involved in the taxpayer’s case.  Pursuant to these guidelines, in no event can the aggregate willful penalties exceed 100% of the highest aggregate balance of all accounts to which the violations relate during the years at issue. Under the new procedure, taxpayers may request the imposition of non-willful FBAR penalties if their facts may justify these lower penalties.

4.  The guidance reminds us that for those without criminal exposure, the IRS has other procedures. These include filing amended returns (that may be qualified amended returns avoiding the accuracy related penalties) and the special procedures for correcting offshore filings outside OVDP (such as the Streamlined Foreign Offshore (or Domestic) Procedures, Delinquent International Information Return Procedures or the Delinquent FBAR Submission Procedures .

5.  In order to start the voluntary disclosure process, the taxpayer must submit a preclearance request to Criminal Investigation (CI) by fax or mail. Once the pre-clearance hurdle is cleared, the taxpayer will be notified.  Preclearance will be pursuant to “a forthcoming revision of Form 14457.” The version of Form 14457, “Offshore Voluntary Disclosure Letter” that had been used in the now defunct OVDP, is here.

6.  The guidance memorandum states that “IRM 9.5.11.9 will continue to serve as the basis for determining taxpayer eligibility [for voluntary disclosure].”

Under this section of the IRM, “[a] voluntary disclosure occurs when the communication is truthful, timely, complete, and when:

A taxpayer shows a willingness to cooperate (and does in fact cooperate) with the IRS in determining his/her correct tax liability.

The taxpayer makes good faith arrangements with the IRS to pay in full, the tax, interest, and any penalties determined by the IRS to be applicable.”

With regard to timeliness of the disclosure, which is most important the IRM states:

“A disclosure is timely if it is received before:

  • 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.
  • 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.
  • The IRS has initiated a civil examination or criminal investigation which is directly related to the specific liability of the taxpayer.
  • 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).”

IRM 9.5.11.9 can be found here.

7.  The forthcoming Form 14457 will require information related to taxpayer noncompliance, including a narrative providing the facts and circumstances, assets, entities, related parties and any professional advisors involved in the noncompliance. Once CI has received and preliminarily accepted the taxpayer’s voluntary disclosure, CI will notify the taxpayer of preliminary acceptance by letter and simultaneously forward the voluntary disclosure letter and attachments to the LB&I Austin unit for case preparation before examination. CI will not process tax returns or payments. All voluntary disclosures will follow “standard examination procedures”. Examiners must develop cases, use appropriate information gathering tools, and determine proper tax liabilities and applicable penalties; taxpayers are required to promptly and fully cooperate. In general, the IRS expects that voluntary disclosures will be resolved by agreement with full payment of all taxes, interest, and penalties for the disclosure period. In the event a taxpayer fails to cooperate with the civil examination, the examiner may request that CI revoke preliminary acceptance.

Those considering a voluntary disclosure must clearly understand that entry into the program means a full examination of the tax years in issue.  Taxpayers will absolutely need an experienced tax advocate when making a voluntary disclosure.  With the prior IRS voluntary disclosure programs a full examination did not automatically result.  This no longer the case. From now on, every taxpayer that voluntarily discloses will be subject to such examination.  Bearing in mind that criminal prosecution may be on the horizon if the taxpayer is considered “uncooperative” it is clear that an experienced tax professional is needed.

8. The new civil resolution framework is cut and pasted below with my comments in brackets:

“a) In general, voluntary disclosures will include a six-year disclosure period [VLJ comment:  Recall the OVDP required an 8 year disclosure period]. The disclosure period will require examinations of the most recent six tax years. Disclosure and examination periods may vary as more fully described below.  [VLJ comment: Bear in mind that while in general, the disclosure period has been reduced from eight years to six years, the IRS agent examining the case will have discretion to expand that six-year disclosure period to include all non-compliant years. This is a very scary proposition.]

Penalties

i. In voluntary disclosures not resolved by agreement, the examiner has discretion to expand the scope to include the full duration of the noncompliance and may assert maximum penalties under the law with the approval of management. [VLJ comment:  IRS is flexing its admittedly strong muscles here. Taxpayers with many years of “bad acting” with their tax matters, will not want the IRS to go back further than six years and will certainly not want the maximum penalties to be assessed.  It’s doubtful any taxpayer will goad an IRS agent into taking such an action].

ii. In cases where noncompliance involves fewer than the most recent six tax years, the voluntary disclosure must correct noncompliance for all tax periods involved.

iii. With the IRS’ review and consent, cooperative taxpayers may be allowed to expand the disclosure period. Taxpayers may wish to include additional tax years in the disclosure period for various reasons (e.g., correcting tax issues with other governments that require additional tax periods, correcting tax issues before a sale or acquisition of an entity, correcting tax issues relating to unreported taxable gifts in prior tax periods).

b) Taxpayers must submit all required returns and reports for the disclosure period.

c) Examiners will determine applicable taxes, interest, and penalties under existing law and procedures. Penalties will be asserted as follows:

i. Except as set forth below, the civil penalty under I.R.C. § 6663 for fraud or the civil penalty under I.R.C. § 6651(f) for the fraudulent failure to file income tax returns will apply to the one tax year with the highest tax liability. For purposes of this memorandum, both penalties are referred to as the civil fraud penalty.

[VLJ comment: This is a significant change from the prior OVDP, which did not apply the 75% civil fraud penalty, but instead used its own unique separate penalty framework.  For those needing the basics, the civil fraud penalty set forth in I.R.C. 6663 applies when a taxpayer files a fraudulent tax return; when any part of an understatement of tax can be attributed to fraud, then a penalty equaling 75 percent of the underpayment of tax can be imposed. The I.R.C. 6651(f) fraudulent failure to file penalty is a counterpart of the I.R.C. 6663 civil fraud penalty. When the IRS determines that the failure to file was due to fraud, the failure to file penalty is increased from 5 percent per month to 15 percent per month, up to a maximum of 75 percent of the tax due.  The penalties are commonly referred to as the 75%  civil fraud penalty.

Under the OVDP generally, for each of the 8 years in the OVDP time period the taxpayer was subject to the normal “failure to file” and “failure to pay” penalties; in place of all other tax or information return penalties that might otherwise be applicable, a 27.5% “in lieu” penalty was assessed on the highest aggregate offshore account / asset value in any year covered by the OVDP. The 27.5% penalty was applied only to that single “highest” year. The 27.5% penalty could be increased to 50% when involving particular financial institutions or facilitators.]

ii. In limited circumstances, examiners may apply the civil fraud penalty to more than one year in the six-year scope (up to all six years) based on the facts and circumstances of the case, for example, if there is no agreement as to the tax liability. [VLJ comment:  This is pretty ambiguous as it is based on the “facts and circumstances”. I remind readers that with the prior OVDPs the IRS was accused of the old “bait and switch” tactics.  One has to tread very carefully!]

iii. Examiners may apply the civil fraud penalty beyond six years if the taxpayer fails to cooperate and resolve the examination by agreement.

iv. Willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17. [VLJ comment: The relevant IRM sections are here, and here, respectively].  See the earlier section of this post at point 3, which provides more detail on the FBAR penalty.

v. A taxpayer is not precluded from requesting the imposition of accuracy related penalties under I.R.C. § 6662 instead of civil fraud penalties or non-willful FBAR penalties instead of willful penalties. Given the objective of the voluntary disclosure practice, granting requests for the imposition of lesser penalties is expected to be exceptional. [VLJ comment: The emphasis was added by me. You can see where this is going. Don’t expect leniency in the new program. You will not find it]. Where the facts and the law support the assertion of a civil fraud or willful FBAR penalty, a taxpayer must present convincing evidence to justify why the civil fraud penalty should not be imposed.

vi. Penalties for the failure to file information returns will not be automatically imposed. Examiner discretion will take into account the application of other penalties (such as civil fraud penalty and willful FBAR penalty) and resolve the examination by agreement. [VLJ comment: While the penalties will not be “automatically” imposed, you can bet the IRS will use these potential sky-high dollar penalties to strong-arm the taxpayer to accept the deal!]

vii. Penalties relating to excise taxes, employment taxes, estate and gift tax, etc. will be handled based upon the facts and circumstances with examiners coordinating with appropriate subject matter experts.

viii. Taxpayers retain the right to request an appeal with the Office of Appeals. [VLJ comment: In the prior OVDP, taxpayers able to reach an agreement with the IRS were issued closing agreements. Taxpayers who could not reach agreement with the IRS under the OVDP were not provided the opportunity to request an appeal with the Office of Appeals.  Instead such taxpayers had the option to withdraw from OVDP (“opt-out”), in which case, their matter would be handled under standard audit process. Unfortunately, in practice, some taxpayers who opted-out of OVDP found themselves subject to maximum willful FBAR and civil fraud penalties.  Because of this, many taxpayers were afraid to “opt-out”.]

d) The Service will provide procedures for civil examiners to request revocation of preliminary acceptance when taxpayers fail to cooperate with civil disposition of cases.” [VLJ comment: if a taxpayer proceeds with voluntary disclosure under the new procedure, the taxpayer will be assigned to an examiner for civil examination.  If he fails to cooperate with the examiner, the taxpayer should be prepared to accept the fact that criminal liability remains a distinct possibility.]

My Observations

IRS enforcement activities are in full swing, especially as such activities relate to unreported offshore assets. The new Voluntary Disclosure guidance may come as a welcome relief to persons who now regret missing the boat for the OVDP, but from the sounds of things, the costs for waiting will now be much higher.  Taxpayers along with their representatives should be weighing the pros and cons of the new procedures and figuring out potential penalties by using them. It will be interesting to hear from other practitioners if they begin using these new procedures.  Those with criminal issues related to virtual or crypto-currencies should also be looking at these new procedures. IRS officials recently dispelled the rumor that a separate voluntary disclosure program might be in the pipeline for virtual currency matters.

Published November 30, 2018

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