On September 28, the IRS ended its 2014 Offshore Voluntary Disclosure Program (“OVDP”). The IRS issued a memorandum—dated November 20, 2018—to announce its new Updated Voluntary Disclosure Practice rules. The IRS memorandum addresses the process for all voluntary disclosures (i.e., both domestic and offshore) following the closing of the 2014 OVDP. As such, please note that the IRS has discretion to use new procedures for any domestic voluntary disclosures that have not been resolved but were received on or before September 28, 2018. The IRS has stated that it will provide additional procedures and updates to the new disclosure procedures.
The stated objective of the new procedures is to provide taxpayers concerned that their conduct is willful or fraudulent, and that may rise to the level of tax and tax-related criminal acts, with a means to come into compliance with the law and potentially avoid criminal prosecution. Accordingly, the new procedures still allow a taxpayer to eliminate the risk of criminal prosecution.
Please note that the Streamlined Filing Compliance Procedures (“SFCP”) have not changed. Accordingly, the IRS explains that taxpayers who did not commit any tax or tax related crimes and do not need the voluntary disclosure practice to seek protection from potential criminal prosecution can continue to correct past mistakes using the SFCP procedures or by filing an amended or past due tax return.
Full Cooperation Expected
The IRS, in its memorandum, explains that the new voluntary disclosure procedures are only available to taxpayers who make a timely, voluntary disclosure and who fully and promptly cooperate with the IRS.
Criminal Investigation Procedures
The Criminal Investigation division of the IRS (“CI”) will screen all voluntary disclosure requests to determine whether a taxpayer is eligible under the new procedures.
1. Preclearance Request—the first step of the process will require the taxpayer to submit a preclearance request via an updated Form 14457. The updated Form 14457 will require taxpayers to provide a narrative statement disclosing a variety of facts related to the non-compliance.
2. Submission of All Required Documents—once preclearance is granted, a taxpayer must promptly submit all required voluntary disclosure documents to CI.
3. Case Preparation– 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 Large Business and International (“LB&I”) Austin unit for case preparation before examination.
4. LB&I Austin unit will establish the most recent tax year covered by the voluntary disclosure for examination.
5. LB&I Austin unit will forward cases for case building and field assignment to the appropriate units for civil examination. Taxpayer may nonetheless submit payments to the LB&I Austin unit before a field agent is assigned in order to prevent interest from accruing on any underpayments.
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. Notably, in the event a taxpayer fails to cooperate with the civil examination, the examiner may request that CI revoke preliminary acceptance.
Civil Resolution Framework
Six-Year Disclosure Period:
In general, voluntary disclosures will include a six-year disclosure period, instead of the eight-year disclosure period found in the prior iteration of the OVDP.
However, IRS examiners have discretion to expand the six-year disclosure period to the full duration of the non-compliance and may assert maximum penalties under the law with the approval of management. In addition, with the IRS’ review and consent, cooperative taxpayers may also be allowed to expand the disclosure period. As with the prior OVDP, taxpayers must submit all required returns and reports for the disclosure period.
The new procedures provide IRS examiners with much more discretion to assert penalties.
Fraud Penalty (I.R.C. § 6663) and Penalty for Fraudulent Failure to File (I.R.C. § 6651(f)):
The civil penalty for fraud or the civil penalty for the fraudulent failure to file income tax returns (i.e., 75 percent) will apply to the one (1) tax year with the highest tax liability, and not all six years.
However, please note that IRS 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. In addition, IRS examiners may apply the civil fraud penalty beyond six years if the taxpayer fails to cooperate and resolve the examination by agreement.
A taxpayer may argue for a lower accuracy-related penalty than the 75 percent civil fraud penalty. However, the IRS stated that imposition of lesser penalties will likely be exceptional.
With regard to unfiled or incorrect FBARs, the IRS will generally assess willful FBAR penalties (i.e., 50 percent of the highest aggregate balance of all unreported foreign-financial accounts during the disclosure period or $100,000, whichever is greater). Note, however, that the IRS may not be limited to that amount.
However, a taxpayer is not precluded from requesting the imposition of lesser penalties. Moreover, the IRS has noted that granting requests for the imposition of lesser penalties is expected to be exceptional. 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.
Failure to File Informational Returns:
Penalties for the failure to file information returns (e.g. Forms 5471, 5472, 8865, 3520-A) will not be automatically assessed. Instead, the IRS examiner will take into account the application of other penalties (e.g. civil fraud penalty and willful FBAR penalty) and resolve the examination by agreement. This likely means that if a large FBAR penalty has been assessed, penalties for failure to file informational returns may not be assessed given the totality of the circumstances.
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.
Taxpayers retain the right to request an appeal with the IRS Office of Appeals.
In sum, the Updated Voluntary Disclosure Practice rules announced by the IRS leave much discretion to the individual IRS examiners, and may provide for severe penalties for taxpayers who do not have favorable facts on their side. Notwithstanding, the new procedures will remain to be attractive to those taxpayer with potential criminal exposure.
The full text of the Interim Guidance Memo LB&I-09-1118-014, Updated Voluntary Disclosure Practice can be found at the following website: https://www.irs.gov/pub/spder/lbi-09-1118-014.pdf.