When Can a Taxpayer Use the Streamlined Filing Procedures to Disclose Unreported Foreign Assets?

Bryan C. Skarlatos, Esq.
Published Date:
May 1, 2015

Many taxpayers have foreign assets that they have not reported on prior years’ tax returns, and they have several options to address this noncompliance. Such taxpayers can ignore the problem; begin reporting the foreign assets going forward, starting with the current returns; file amended returns to correct the prior years’ returns; make a full-blown voluntary disclosure and pay huge penalties equal to 27.5%, and sometimes 50%, of the unreported assets in order to avoid criminal prosecution and even larger penalties; or use the IRS’s streamlined filing procedures to correct the prior noncompliance, while paying smaller penalties equal to 5% of the unreported assets or, in some cases, no penalty at all.

As discussed in this author’s previous article in The TaxStringer, ignoring the problem is not a good idea because it will only get worse. Filing accurate tax returns for the current year and going forward is a viable option, but it does nothing to protect against an audit of the prior years’ returns; similarly, quietly filing amended returns also does nothing to protect against an audit or investigation. The only choices that provide some protection against a civil audit—or even a criminal investigation—are the Offshore Voluntary Disclosure Program (OVDP) or the IRS’s streamlined filings procedures.

The Importance of Willfulness

Why would taxpayers seeking protection against an audit or investigation choose the OVDP and pay 27.5% of their foreign accounts when simply using a streamlined procedure to become compliant would result in a 5% penalty, or even no penalty at all in the case of a nonresident taxpayer? The answer has to do with willfulness—that is, an intentional violation of a known legal duty.

The OVDP imposes larger penalties because it protects against criminal prosecutions or huge Report of Foreign Bank and Financial Accounts (FBAR) penalties, both of which are based on willfulness. If the taxpayer’s failure to report the foreign assets may have been willful, such that the taxpayer is at risk of a criminal prosecution or huge FBAR penalty, then the taxpayer might need the protection of the more expensive OVDP. The streamlined procedures are only for those taxpayers who are not at risk of criminal prosecution or huge FBAR penalties; thus, the streamlined procedures apply only to those taxpayers who can certify under penalties of perjury that they did not willfully fail to report the undisclosed foreign assets.

Willfulness is a purely subjective test, which means that the IRS must be able to prove that taxpayers really believed that they were violating the law by failing to report foreign assets. If taxpayers honestly believed that they did not have to report the foreign assets, then they did not act willfully, no matter how unreasonable that belief might have been.

When determining what the taxpayer honestly believed, it is necessary to consider the concept of “willful blindness”; this describes a situation in which taxpayers purposely make themselves blind to the requirements of the law. In the context of unreported foreign assets, this can mean that the circumstances were such that a taxpayer should have been aware that the foreign assets were reportable, but the taxpayer chose not to ask an accountant or seek other advice about the reporting requirements for foreign assets.

Circumstances indicating that a taxpayer willfully failed to report a foreign account or was willfully blind to the reporting requirements include items like the location of the unreported bank account. For example, was it in a bank-secrecy jurisdiction, such as Switzerland or the Channel Islands? If so, that could indicate intent to hide the account. Conversely, a good reason for having a foreign bank account, such as an inheritance from a foreign relative, can provide an innocent rationale for maintaining such an account.

Another factor that could indicate willfulness is the use of a corporation, trust, numbered account, or pseudonym to hide the taxpayer’s identity. Why would innocent taxpayers balk at putting their name on the account? Similarly, if a taxpayer avoided paying a large amount of tax in connection with the account, it would provide a strong motive for willfully keeping the account secret.

The Role of Tax Preparers

One factor upon which the IRS places great emphasis is whether the taxpayer spoke to a tax return preparer about the foreign account. In most audits or investigations, the IRS will want to speak to the return preparer to understand whether the taxpayer said anything about the account and what—if any—advice the preparer gave the taxpayer. The IRS will be skeptical of any taxpayer who claims to have not thought it was important enough to raise with a return preparer or other tax professional.

Before a taxpayer can sign the nonwillfulness certification under penalties of perjury, as required by both of the streamlined procedures, the taxpayer must thoroughly analyze the issues of willfulness and willful blindness. A tax practitioner who represents a taxpayer seeking to make a streamlined certification must help that taxpayer honestly evaluate the circumstances surrounding the failure to report the foreign account, including the circumstances described above. If the taxpayer and the practitioner cannot provide clear and detailed explanations for why the taxpayer had the foreign account but failed to report it and failed to advise a return preparer or otherwise seek professional advice, then the taxpayer might not be eligible for the more lenient streamlined procedures. In this case, the taxpayer must choose between pursuing a full-blown OVDP submission or considering the other options mentioned above.

The Takeaway

When a practitioner encounters a taxpayer with unreported foreign assets, one of the first and most important factors to consider is whether the IRS believes that the taxpayer acted willfully. If there are indicia of willfulness, then the taxpayer is not eligible to use the streamlined procedures and, more importantly, the taxpayer could be at risk for criminal prosecution or huge civil penalties. In such cases, the OVDP is usually a more appropriate choice, even though it could cost the taxpayer much more through higher penalties and professional fees. The less expensive streamlined filing procedures make sense only if the taxpayer is truly innocent. 

scarlatosBryan C. Skarlatos, Esq., represents clients in tax audits, civil tax litigation, sensitive tax issues, criminal tax investigations, voluntary disclosures and IRS whistle-blower matters. He is also an adjunct professor at NYU School of Law where he teaches a course on tax penalties and he has taught several courses on tax procedure, penalties and ethics to various offices of the IRS. Mr. Skarlatos is co-chair of the annual NYU Tax Controversy Forum and chair of the annual Practicing Law Institute program on "Nuts and Bolts of Tax Penalties." Mr. Skarlatos regularly speaks and publishes articles on the topics of civil tax litigation, tax penalties and criminal tax prosecutions. He has been the chair of several tax committees at the American Bar Association, New York State Bar Association and New York City Bar Association and he is an elected Regent in the American College of Tax Counsel. He can be reached at bskarlatos@kflaw.com.

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