On Nov. 29, 2018, the IRS released a memorandum that contains a new civil resolution framework for making both offshore and domestic voluntary disclosures received or postmarked after Sept. 28, 2018. The updated procedures follow a long-standing practice of the IRS to provide taxpayers with the opportunity to come into tax compliance and substantially lessen the risk of criminal prosecution. There are, however, many changes from the former 2014 Offshore Voluntary Disclosure Program (OVDP) that make this program less attractive. The new program includes changes to the disclosure period and the nature and size of the penalties imposed. It does, however, provide welcome clarity following the closure of OVDP. Nevertheless, acceptance into a voluntary disclosure arrangement is never assured and depends on the individual facts and circumstances involved in each case. Because of potential significant penalty exposure, taxpayers with unreported income (domestic or foreign) must carefully weigh their options as to how best to comply with their tax obligations, including taking advantage of voluntary disclosure mechanisms.

The objective of the IRS's voluntary disclosure practice is to provide U.S. taxpayers with unreported, or underreported, income or assets with the means to come into compliance with the law and potentially avoid criminal prosecution. As in prior voluntary disclosure programs, taxpayers under IRS criminal investigation are not eligible to participate in the updated voluntary disclosure program.

The updated voluntary disclosure program draws on the success of the earlier Offshore Voluntary Disclosure Programs announced in 2009, 2011, 2012 and 2014. However, the toll charges for entering successor programs have continued to rise. When the 2014 program terminated on Sept. 28, 2018, there was uncertainty as to how the IRS was going to apply its general voluntary disclosure practice going forward. The IRS memorandum addresses these questions. Importantly, the updated voluntary disclosure practice provides detailed guidance as to the procedures that the IRS will utilize and the nature of the penalties that they will assert under various circumstances, as well as for the consistent application of these procedures and penalties to all participants in the program.

The Process of Voluntary Disclosure

Taxpayers concerned that their conduct is willful or fraudulent may initiate voluntary disclosure by timely requesting pre-clearance from IRS Criminal Investigation (CI) to determine eligibility and, if eligible, receive a criminal clearance. The IRS memorandum sets out the procedural aspects of the program. CI will screen all voluntary disclosure requests covering both domestic and offshore to determine if a taxpayer is eligible to make a voluntary disclosure. To accomplish this, CI will require all taxpayers to submit a pre-clearance request on a forthcoming revision of Form 14457.

For all cases where CI grants pre-clearance, taxpayers must then promptly submit to CI all required voluntary disclosure documents using Form 14457. The taxpayer must provide information related to the applicant's noncompliance, including a narrative providing “the facts and circumstances, assets, entities, related parties and any professional advisers 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 IRS's Large Business & International division (LB&I) for case preparation before examination. CI will not process tax returns or payments. LB&I will forward cases for field assignment to the appropriate IRS Business Operating Division and Exam function for civil examination. All voluntary disclosures handled by examination will follow standard examination procedures.

In general, the IRS expects that voluntary disclosures will be resolved by agreement, presumably a Form 906 Closing Agreement, with full payment of all taxes, interest, and penalties for the disclosure period. Cooperation is a key requisite of the program. In the event a taxpayer fails to cooperate with the civil examination, the examiner may request that CI revoke preliminary acceptance. At this point, the taxpayer will receive little or no benefit for coming forward through a voluntary disclosure.

The IRS memorandum provides that the disclosure period will require examination up to the most recent six years (previously eight years for offshore disclosures), but can vary. If voluntary disclosure is not resolved by agreement, the IRS may expand the six-year disclosure period to include all noncompliant years. In cases where noncompliance involves fewer than six years, the voluntary disclosure must correct noncompliance for all tax periods involved. In addition, with IRS consent, taxpayers are allowed to expand the disclosure period to correct tax issues in years outside of their disclosure. Of significant import, the memorandum states that the IRS' Streamlined Filing Compliance procedures (Streamlined), the Delinquent FBAR submission procedures and the Delinquent International Information Return submission procedures are still available, although the memorandum notes that “they could be discontinued at any time.”

U.S Civil Penalties for Non-Compliance

Under the IRS's most recent OVDP, the taxpayer was required to pay the outstanding tax liability for the eight years within the disclosure period, as well as pay interest and a penalty on the nonpayment of tax. In addition, under OVDP the FBAR penalty was capped at 27.5 percent of the highest account balance in the foreign account during the period covered by the voluntary disclosure (this penalty was 50 percent if held at certain financial institutions publicly identified as being under investigation or cooperating with a government investigation). For all voluntary disclosures received after Sept. 28, 2018, the civil penalty cost has dramatically increased.

Section 6663 Civil Fraud Penalty or Section 6651 Civil Fraudulent Failure to File Penalty. For purposes of the IRS memorandum, both penalties are referred to as the civil fraud penalty and carry a penalty rate of 75 percent against the amount of increase in tax. Essentially, this means that the penalty for underpayments of tax has increased from 20 percent in most cases under OVDP to 75 percent in this new program. The penalty is applied to the one tax year with the highest tax liability. However, the memorandum permits an agent to apply the civil fraud penalty to more than one year during the disclosure period based on the facts and circumstances found by the examining IRS agent. Also, the IRS may apply the civil fraud penalty beyond six years if the taxpayer fails to cooperate and resolve the examination by agreement. Taxpayers may request a lower accuracy-related penalty, but must present evidence to support their requests. The IRS memo notes that the granting of lesser penalties is expected only in “exceptional” cases. This burden shift is unusual because under existing statute, the burden of proof in court to establish fraud in the case of income tax noncompliance, or willfulness in the case of FBAR noncompliance, is on the government, by clear and convincing evidence or a preponderance, respectively. However, the IRS effectively appears to shift the burden of proof to taxpayers administratively to establish that fraud and willful penalties are not appropriate under the circumstances. The IRS memo does not address the imposition of other civil penalties, such as penalties for late filing or late payment of taxes under §6651.

Willful FBAR Penalties. Willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM §§4.26.16 and 4.26.17. In most cases, the total penalty amount for all years under examination will be 50 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination. But willful FBAR penalties are subject to discretion and can reach 100 percent of the highest aggregate account balances. If the taxpayer's facts and circumstances warrant it, IRS agents may recommend a lower FBAR penalty. In addition, a taxpayer may request the imposition of non-willful FBAR penalties instead of willful penalties.

Failure to File Penalties for Information Returns. The IRS memo provides that penalties for the failure to file information returns will not be automatically imposed. Penalties related to excise taxes, employment taxes, and estate and gift taxes will be handled by IRS agents based upon the facts and circumstances with coordination from IRS subject matter experts.

U.S Criminal Penalties for Non-Compliance

If a taxpayer does not file under the voluntary disclosure or the Streamlined program, the taxpayer may face possible criminal charges which include, but are not limited to, tax evasion (IRC §7201), filing a false return (IRC §7206) and failure to file an income tax return (IRC §7203). A person convicted of tax evasion is subject to a prison terms of up to five years and a fine of up to $250,000. In addition, willfully failing to file an FBAR and willfully filing a false FBAR are both violations that are subject to criminal penalties under 31 U.S.C. §5322.

Right to Proceed in the IRS Appeals Office

The taxpayer who cannot reach agreement with the IRS now has the right to request an appeal with the IRS Office of Appeals. The opportunity to appeal unagreed cases is a welcome option for taxpayers who are dissatisfied with the results of the audit, but it remains to be seen how the appeals process will function under this program. It is also not entirely clear what the standard of review will be, and how “independent” Appeals will actually be, given the parameters of the program.

Benefits of the New Procedures

Although the civil penalties are significant, the updated voluntary disclosure procedures provide greater transparency. The new procedures should somewhat ease the concerns of taxpayers who wish to come into U.S. tax compliance, but have concerns about potential criminal liability. A timely voluntary disclosure and cooperation will help to insulate them from criminal prosecution, while allowing them to resolve their civil tax and reporting issues.

Conclusion

The IRS notes that it will continue to use tools besides voluntary disclosure to combat tax avoidance and evasion, including FATCA disclosures, taxpayer education, whistleblower leads, civil examination and criminal prosecution. The ability of U.S. taxpayers to unlawfully hide foreign bank accounts or cryptocurrency gains, without severe consequences, is approaching extinction. Anyone considering a voluntary disclosure submission must carefully examine all potential civil penalties and evaluate the risk of criminal prosecution and consider whether to use one of the other methods to correct prior noncompliance (i.e., Streamlined submission, qualified amended returns, delinquent submissions). If a taxpayer decides to come forward, he must plan on cooperating fully or risk having the voluntary disclosure application rejected. While the IRS memo provides some helpful guidance as to voluntary disclosure process after the close of OVDP, we would invite additional guidance in the future as to how the voluntary disclosure process will operate in practice. Taxpayers who are concerned about undisclosed cryptocurrency gains, unreported income or offshore accounts should strongly consider voluntary disclosure before either learning that the United States is investigating the financial institution or bank where they hold accounts or they themselves are being investigated.

Lawrence M. Hill is a partner and head of the federal tax controversy practice at Winston & Strawn in New York. Richard A. Nessler is of counsel to the firm.