The IRS’ international tax crackdown is alive and well in 2012. The U.S. has made strides in breaking bank secrecy laws in Switzerland and other foreign jurisdictions, prompting many clients to withdraw funds from Swiss banks. The U.S. continues to mine data received under previous voluntary disclosures and recently asked Switzerland for information regarding former clients of Credit Suisse.

The government also continues to pursue legal cases against foreign banks that helped U.S. taxpayers hide assets and income and against the individuals themselves. In an attempt to avoid criminal prosecution, some Swiss banks have provided the U.S. with names of their employees who may have worked with U.S. clients. Clients of UBS, HSBC, Credit Suisse, and Wegelin & Co. have recently been convicted for issues related to failing to report foreign accounts and income. In this uncertain climate, the IRS has issued two new sets of guidance for taxpayers who may wish to come into compliance with their U.S. tax and reporting obligations.

Updated FAQs for 2012 OVDP

The IRS has recently provided additional guidance on its Offshore Voluntary Disclosure Program (“OVDP”), which was reopened in January 2012. At the same time, the IRS announced that it has collected over $5 billion from taxpayers who participated in similar programs in 2009 and 2011.

Over 1,500 voluntary disclosures have already been submitted under the 2012 OVDP, which is substantially similar to the 2011 OVDI. The main differences are that the maximum penalty on unreported accounts has been raised from 25% to 27.5%, and that unlike the two previous programs, the 2012 OVDP currently does not have a deadline for submissions. However, the IRS has stated that it can change the terms of the OVDP at any time.

The first piece of new guidance was issued in the form of updated Frequently Asked Questions (“FAQs”) under the OVDP, which have been a key source of guidance under all three voluntary disclosure programs. Some of the new FAQs explain the following:

  • Taxpayers who have a Canadian Registered Retirement Savings Plan (RRSP), Registered Retirement Income Fund (RRIF), or other similar Canadian plan, and who did not make a timely election to defer U.S. income tax on undistributed income earned in the account, may apply for an extension of time to make that election under the OVDP.
  • Taxpayers who have a foreign retirement or pension plan (other than those listed above) should contact the OVDP hotline if they believe the plan should be excluded from the offshore penalty base.
  • When spouses both wish to participate in the OVDP, they may do so jointly or separately.
  • If a taxpayer has undisclosed domestic income in addition to his/her undisclosed foreign income, the domestic income must also be disclosed during the OVDP.
  • Certain taxpayer groups that have or had accounts at certain foreign financial institutions may be ineligible to participate in the OVDP due to U.S. government investigations of those institutions.
  • A taxpayer who appeals a foreign government’s decision to provide account information to the U.S. can become ineligible to participate in the OVDP unless he/she informs the U.S. Attorney General of the appeal.

New Compliance Procedures for U.S. Citizens and Dual Citizens Living Abroad

In addition to announcing the updated FAQs providing information about the OVDP, the IRS also announced new procedures to help U.S. citizens residing overseas, including dual citizens, come into compliance with their U.S. tax obligations. These procedures are effective beginning September 1, 2012, and they are separate from the OVDP procedures.

U.S. citizens are required to file a U.S. income tax return every year to report their worldwide income, regardless of how long they have lived outside the U.S. or whether they owe any U.S. tax. They must also file a Form TD F 90-22.1 (“FBAR”) for any year in which they had a financial interest in or signature authority over foreign financial accounts exceeding $10,000 in aggregate. The IRS is aware that some U.S. citizens and dual citizens living abroad have failed to file the required U.S. tax returns and FBARs, and that some of these taxpayers recently became aware of their requirements and would like to meet them.

The IRS has announced the new procedures to allow “low-risk” taxpayers to come into compliance without facing penalties. The new procedures are available to U.S. taxpayers who have lived outside the U.S. since January 1, 2009 and who have not filed a U.S. tax return during that period. Applicants must be considered low-risk, and all tax returns filed must show less than $1,500 in tax due for each year. Amended returns generally may not be filed through these procedures, as they will be considered high-risk and subject to examination. The IRS’ review will be expedited, and no penalties or follow-ups will occur, for those taxpayers who are low-risk.

Applicants must file late tax returns, including all information returns (i.e. Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts, or Form 5471, Information Return of U.S. Persons With Respect To Certain Foreign Corporations), for the past 3 years. They must also file late FBARs for the past 6 years. All taxes and interest must be paid with the submitted tax returns, and the taxpayer must also file a special questionnaire. The questionnaire provides information regarding the taxpayer’s eligibility for the streamlined procedures, the existence and location of the taxpayer’s financial accounts and entities, the taxpayer’s tax advisors, and background on the taxpayer’s tax situation.

The new procedures do provide for relief from the failure to timely elect deferral of income from certain retirement or savings plans (where permitted under a treaty). In order to qualify, taxpayers will need to submit the following:

  • A request for an extension of time pursuant to an identified treaty provision;
  • Form 8891, U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans, for each tax year and each plan, with a description of the plan (for Canadian plans only); and
  • A dated and taxpayer-signed (under penalties of perjury) statement explaining the events that led to the failure to make the election, events that led to the discovery of the failure, and where the taxpayer relied on a professional advisor, an explanation of the nature of the tax advisor’s engagement and responsibilities.

A taxpayer’s risk level will rise, according to the IRS, if any of the following apply:

  • Any of the returns submitted through the program claims a refund;
  • There is material economic activity in the U.S.;
  • The taxpayer has not declared all of his/her income in his/her country of residence;
  • The taxpayer is under audit or investigation by IRS;
  • FBAR penalties have been previously assessed against the taxpayer or if he/she has previously received an FBAR warning letter;
  • The taxpayer has a financial interest or authority over a financial account(s) located outside his/her country of residence;
  • The taxpayer has a financial interest in an entity or entities located outside his/her country of residence;
  • There is U.S. source income; or
  • There are indications of sophisticated tax planning or avoidance.

Taxpayers who pose a higher compliance risk are not eligible for the streamlined procedures. They will be subject to a more thorough review and potentially will be subject to audit, which could cover more than 3 years. Tax, interest, and penalties may be imposed in accordance with U.S. tax law where appropriate.

Taxpayers who use these new procedures instead of the OVDP will not be afforded protection from criminal prosecution, so those taxpayers who are concerned about prosecution should consider entering the OVDP. Once a submission is made under these procedures, the taxpayer may not make a submission under the OVDP. A taxpayer who is ineligible to enter the OVDP is also ineligible for these new procedures.