Robinson Brog Leinwand Greene Genovese & Gluck, P.C. - New York City Business Litigation Attorneys

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Federal Voluntary Disclosure Programs

by Scott Ahroni

Taxpayers that have not timely reported their income, failed to accurately report their income or have undisclosed foreign accounts or assets should strongly consider using one of the IRS’ Voluntary Disclosure Programs to come into compliance with their tax reporting and foreign information return reporting requirements.

The IRS provides taxpayers that have failed tax reporting or foreign information reporting delinquencies with several options to come into compliance. Those options are as follows:

  • The Updated Voluntary Disclosure Practice
  • The Streamlined Filing Compliance Procedure
  • The Delinquent International Information Return Submission Procedure; and
  • The Delinquent FBAR Submission Procedure

Taxpayers also have the option of simply filing their delinquent tax and foreign information returns or amending previously filed returns. This is commonly referred to as a Quiet Disclosure. In the past, the IRS has frowned upon the use of the Quiet Disclosure but recently has publicly endorsed the use of the Quiet Disclosure option.

Each formal voluntary disclosure program, as well as the Quiet Disclosure, offers taxpayers with advantages and disadvantages. All options should be reviewed and considered in light of the taxpayer’s particular facts and circumstances. Taxpayers that have failed to file returns, report income or foreign assets should work with competent tax counsel to assist them in reviewing these options and determining which is best for their particular case.

General Eligibility Requirements For the Voluntary Disclosure Program
In general, in order to participate in any of the voluntary disclosure programs, a taxpayer’s disclosure must meet certain eligibility requirements. Those requirements are as follows:

  • The submission must be timely
  • The source of the disclosure must not come from illegal activity
  • The taxpayer(s) must cooperate with Taxing Agency to determine tax liability and compliance reporting,
  • The taxpayer(s) must Cooperate in investigating others who aided in the noncompliance,
  • The taxpayer(s) must submit all required returns, information returns, and reports for the disclosure period, and
  • The taxpayer(s) must make good faith arrangements to pay in full, the tax, interest, and any penalties

A disclosure is timely if it is received before:

  • A civil examination or criminal investigation of the taxpayer has begun, or the taxing agency 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 them to the taxpayer’s noncompliance; and
  • The IRS has acquired information directly related to the noncompliance of the taxpayer from an enforcement action (e.g., search warrant, summons, grand jury subpoena).

There are instances when a taxpayer may be unsure whether they are eligible for entrance into the voluntary disclosure program. For example, a taxpayer may have received a “soft letter” from the IRS indicating that their return was incorrectly filed, or income was inaccurately reported. Taxpayers should consider the advantages and disadvantages of submitting a pre-clearance letter, as further discussed below, if there is any doubt as to whether a submission is “timely”.

The source of the disclosure must not come from illegal activity. This requirement ensures that the IRS is not “cleaning” illegal source funds. The determination of whether income is from legal sources is based on Federal and not State laws.

Updated Voluntary Disclosure Practice
The updated voluntary disclosure practice (“UVDP”) is a form of voluntary disclosure which is specifically designed for taxpayers with exposure to potential criminal liability or substantial civil penalties due to willful failure(s) to file tax returns, report income and/or report foreign accounts and foreign assets.  The UVDP combines the IRS’s domestic voluntary disclosure program with the now defunct Offshore Voluntary Disclosure Program.

The UVDP allows a taxpayer to voluntarily contact the Internal Revenue Services’ Criminal Investigations (CI) Division in advance of filing tax and/or foreign information returns to reduce the likelihood of criminal prosecution.   It is important to note, however, that submission into the UVDP “creates no substantive or procedural rights for taxpayers”1 and will not “guarantee immunity from prosecution.”2  However, in practice, once the IRS has cleared a taxpayer for entrance into the UVDP, and such submission is truthful, timely and complete, CI will generally not pursue a criminal investigation or recommendation to the Department of Justice for prosecution. 

In order to participate in the UVDP, the IRS requires all taxpayers to submit Form 14457, Voluntary Disclosure Practice Preclearance Request and Application. Form 11457 requires taxpayers to provide general information related to their noncompliance, including information related to previously unreported foreign financial accounts, foreign assets and foreign entities. If the IRS issues a pre-clearance, the taxpayer is required to provide a narrative of their willful failures and identify all related parties and any professional advisors involved in the noncompliance. With regard to the “narrative”, Form 14457 states, in relevant part, the following:

The Noncompliance narrative must include a thorough discussion of all Title 26 and Title 31 willful failures to report income, pay tax, and submit all required information returns and reports. Explain the roles the professional advisor(s) named above had in your noncompliance.

Under the updated procedures, taxpayers that agree to participate in the voluntary disclosure program, will generally be required to file original and/or amended income tax returns and delinquent foreign information returns, including FBARs, for the most recent  six tax years beginning with the most recent tax year in which the due date for the filing the taxpayer’s income tax returns has passed, with extensions. However, if the taxpayer was fully tax compliant for any of the last six years within the disclosure period, the taxpayer is exempt from submitting returns for the compliant year(s). In certain instances, the six-year disclosure period may be expanded. Those instances include (1) when the taxpayer has not agreed to resolve all tax and tax related noncompliance through an agreement with the IRS or (2) when cooperative taxpayers 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).

The updated voluntary disclosure procedures require the taxpayer to pay all additional taxes due with applicable penalties and interest for the years within the disclosure period. Penalties will be asserted as follows:

  • In general, the civil penalty for fraud or the fraudulent failure to file penalty will apply to the one tax year with the highest tax liability in the disclosure period. In limited circumstances, examiners may apply the civil fraud penalty to more than one year in the disclosure period (up to all six years) if, for example, the taxpayer fails to cooperate and resolve the examination by agreement. The civil fraud penalty is generally equal to 75% of the underpayment of tax due as shown on the tax return.
  • Willful FBAR penalties will be asserted in accordance with existing IRS penalty guidelines under IRM 4.26.16 and 4.26.17. The willful FBAR penalty is generally equal to the greater of $100,000 or 50% of the highest maximum values of the undisclosed foreign accounts. Under the IRM guidelines, the IRS may recommend a penalty that is higher or lower than 50 percent of the highest aggregate account balance of all unreported foreign financial accounts based on the facts and circumstances. In no event will the total penalty amount exceed 100 percent of the highest aggregate balance of all unreported foreign financial accounts during the years under examination. 
  • A taxpayer may request that the accuracy related penalties under I.R.C. § 6662 be imposed rather than the civil fraud penalty or that the non-willful FBAR penalties be imposed instead of the willful penalty. With regard to FBAR penalty mitigation, one of the mandatory requirements is that “IRS did not determine a fraud penalty against the person for an underpayment of income tax for the year in question due to the failure to report income related to any amount in a foreign account.”3 The IRS has stated that granting requests for the imposition of lesser penalties is expected to be exceptional.
  • Penalties for the failure to file information returns will not be automatically imposed. Rather, the examiner will have 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.
  • 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.

If the taxpayer disagrees with the examiner’s determinations, including the imposition of penalties, the taxpayer has a right to submit an appeal to the IRS’ Office of Appeals.
As discussed above, the UVDP requires taxpayers to admit to willful/fraudulent noncompliance during the disclosure period.  As such, taxpayer’s should only use the UVDP if they believe  they have committed a fraud or were willfully noncompliant in (1) failing to timely file any outstanding income tax returns, (2) failing to timely pay any of their outstanding income taxes, and/or (3) failing to timely file any foreign information returns.  If taxpayers believe that they have not committed a “fraud” or were not “willfully noncompliant”, strong consideration should be given to other voluntary disclosure options as further discussed below.

Willful or fraudulent conduct is usually defined as an intentional wrongdoing, on the part of a taxpayer, with the specific purpose of evading a tax known or believed to be owing.4  Tax fraud requires both:

  • a tax due and owing; and
  • Fraudulent intent.

Intent is distinguished from inadvertence, reliance on incorrect professional advice, honest difference of opinion, negligence, or carelessness.5 Fraud will generally involve one or more of the following elements: deception, misrepresentation of material facts, false or altered documents, evasion (e.g. diversion or omission), or conspiracy. Some common “badges of fraud” include6:

  • Understatement of income (e.g., by omissions of specific items or entire sources of income, failure to report substantial amounts of income received);
  • Fictitious or improper deductions (e.g., overstatement of deductions, personal items deducted as business expenses);
  • Accounting irregularities (e.g., two sets of books, false entries on documents);
  • Acts of the taxpayer evidencing an intention to evade tax (e.g., false statements, destruction of records, transfer of assets);
  • A consistent pattern over several years of underreporting taxable income;
  • Implausible or inconsistent explanations of behavior;                    
  • Failure to cooperate with the examining agent;
  • Concealment of assets;
  • Engaging in illegal activities (e.g., drug dealing), or attempting to conceal illegal activities;
  • Inadequate records; and
  • Dealing in cash.

The Streamlined Filing Compliance Procedure
As an alternative to the UVDP, the IRS offers taxpayers with deficiencies related to foreign income or unreported foreign assets the option of using the Streamlined Filing Compliance Procedure to come into compliance with their foreign reporting obligations. The Streamlined Filing Compliance Procedure is for individual taxpayers, including estates, whose failures to report foreign financial assets and pay all tax due in respect of those foreign assets did not result from willful conduct on their part.

The Streamlined Filing Compliance Procedure has two different programs, the Streamlined Domestic Offshore Procedure and the Streamlined Foreign Offshore Procedure. Both Streamlined Procedures require taxpayers to file the most recent 3 years of income tax returns and most recent 6 years for FBARs beginning with the most recent tax year in which the due date has passed. Both programs also require taxpayers to certify that their failure to report income and foreign financial assets resulted from non-willful conduct.

Streamlined Domestic Offshore Procedure   
The Streamlined Domestic Offshore Procedure provides for a reduced offshore penalty of 5% of the highest aggregate value of any previously undisclosed foreign assets for the years covered by the Domestic Streamlined Procedure.  According to the IRS, the valuation date for each year is December 31.7 No other penalties are imposed under the Streamlined Domestic Offshore Procedure.

In order to be eligible for the streamlined domestic offshore procedure, you must satisfy the following requirements:

  • The residency requirement as further detailed below;
  • Previously filed Form 1040, U.S. individual Income Tax Return, for each of the most recent 3 years for which the due date (including properly applied for extensions) with regard to such income tax returns has passed;
  • Failed to report income and pay taxes from foreign financial assets or foreign financial accounts or file information returns for foreign financial assets;
  • The IRS must not have initiated a civil examination or criminal investigation of your returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets and
  • Such failures to report and/or pay taxes or file information returns were the result of non-willful conduct. 

Residency Requirement
In order to satisfy the residency requirement, you must either be a U.S. citizen, a U.S. lawful permanent resident, or satisfy the substantial presence test.  In addition, for the most recent three years for which a U.S. tax return due date (or properly applied for extended due date) has passed, you must have had (1) a U.S. abode and (2) were physically present in the United States for at least 35 full days. 

Streamlined Foreign Offshore Procedure     
The Foreign Offshore Streamlined Procedure does not impose any penalty against the taxpayer. In order to be eligible for the streamlined foreign offshore procedure, you must satisfy the following requirements:

  • The non-residency requirement as further detailed below;
  • Failed to report income and pay taxes from foreign financial assets or foreign financial accounts or file information returns for foreign financial assets;
  • The IRS must not have initiated a civil examination or criminal investigation of your returns for any taxable year, regardless of whether the examination relates to undisclosed foreign financial assets and
  • Such failures to report and/ or pay taxes or file information returns were the result of non­willful conduct.

Non-Residency Requirement
You satisfy the non-residency requirement if you are a U.S. citizen or lawful permanent resident and in any one or more of the most recent three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, you did not have (1) a U.S. abode and (2) were physically outside the United States for at least 330 full days. Under IRC section 911 and its regulations, which apply for purposes of these procedures, neither temporary presence in the United States nor maintenance of a dwelling in the United States necessarily mean that you have an abode in the United States.  

The IRS guidance on this requirement provides two examples which illustrate the application of this requirement as follows:

Example 1: Mr. W was born in the United States but moved to Germany with his parents when he was five years old, lived there ever since, and does not have a U.S. abode. Mr. W meets the non-residency requirement applicable to individuals who are U.S. citizens or lawful permanent residents.

Example 2: Assume the same facts as Example 1, except that Mr. W moved to the United States and acquired a U.S. abode in 2012. The most recent 3 years for which Mr. W's U.S. tax return due date (or properly applied for extended due date) has passed are 2013, 2012, and 2011. Mr. W meets the non-residency requirement applicable to individuals who are U.S. citizens or lawful permanent residents.

Individuals who are not U.S. citizens or lawful permanent residents, or estates of individuals who were not U.S. citizens or lawful permanent residents, meet the applicable non-residency requirement if, in any one or more of the last three years for which the U.S. tax return due date (or properly applied for extended due date) has passed, the individual did not meet the substantial presence test of IRC §7701(b)(3).

The IRS guidance on this requirement provides one example which illustrates the application of this requirement as follows:

Example 3:  Ms. X is not a U.S. citizen or lawful permanent resident, was born in France, and resided in France until May 1, 2012, when her employer transferred her to the United States.  Ms. X was physically present in the U.S. for more than 183 days in both 2012 and 2013.  The most recent 3 years for which Ms. X’s U.S. tax return due date (or properly applied for extended due date) has passed are 2013, 2012, and 2011.  While Ms. X met the substantial presence test for 2012 and 2013, she did not meet the substantial presence test for 2011.  Ms. X meets the non-residency requirement applicable to individuals who are not U.S. citizens or lawful permanent residents.

Non-willful Conduct
It is important to understand that the streamlined procedures are only available to non-willful taxpayers and unlike the UVDP, provides taxpayers with no criminal protections including recommendations of non-prosecution.  IRS’ guidance on the streamlined procedure defines non-willful conduct as “conduct that is due to negligence, inadvertence, or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.” The IRS’s Internal Revenue Manual explains that “the mere fact that a person checked the wrong box, or no box, on a Schedule B is not sufficient, by itself, to establish willfulness.”

The IRS has not provided further explanation into what conduct these terms exactly encompass, however in practice, some factors that the IRS may flag to establish willfulness include:

  • The frequent movement of cash in the accounts.
  • Large dollar amounts within the accounts.
  • Whether the asset was held with an offshore company layered within multiple companies.
  • Whether the jurisdiction holding the asset is known for bank secrecy.
  • Whether the money originated in the United States and was moved offshore.
  • Whether the asset was obtained through criminal activity.
  • The source of funds in the accounts.

Given that the Streamlined Procedures do not provide any criminal prosecution promises or protections, taxpayers wishing to use the Streamlined Procedure should be comfortable in their ability to demonstrate that their conduct was non-willful. If a taxpayer is concerned that they would be unable to show that their conduct was non-willful, they should consider using the UVDP.

Delinquency Return Procedures
For taxpayers that have failed to report foreign financial accounts and/or assets and do not need to use the UVDP or the Streamlined Procedure, can use the Delinquency Return Procedures to come into compliance with their foreign information return reporting obligations. The Delinquency Return Procedures are for taxpayer’s whose failures to report their foreign financial accounts and/or assets were due to reasonable cause.

The IRS provides two different Delinquency Return Procedures, the Delinquent International Information Return Submission Procedure and the Delinquent FBAR Submission Procedure. These Procedures are generally used for taxpayers that have previously timely reported and timely paid all income taxes but inadvertently failed to file foreign information returns.   These procedures can be used in conjunction with each other if a taxpayer has failed to file foreign information returns such as 5471, 8938, 5472, 3520, 926 and the like, as well as FBARs (Form 114). The IRS does not impose a mandatory penalty for either program if you are eligible.

Updated Delinquent International Information Return Submission Procedure
The Delinquent International Information Return Submission Procedure should be filed by those taxpayers who need to file delinquent or amended returns to report foreign financial assets and pay additional tax related to such foreign financial assets. The IRS updated the delinquent international information return submission procedure on November 5, 2020. It is no longer required to submit delinquent returns with a reasonable cause statement or to certify that foreign entities were not engaged in tax evasion. Under the new procedures, taxpayers file through “normal filing procedures”, and taxpayers “may” attach a reasonable cause statement. The updated IRS guidance states that:

[P]enalties may be assessed without considering the attached reasonable cause statement. It may be necessary for taxpayers to respond to specific correspondence and submit or resubmit reasonable cause information.

Taxpayers are eligible for the Delinquent International Information Return Submission Procedure if:

  • They have not filed one or more required international information returns,
  • They have reasonable cause for not timely filing the information returns,
  • are not under a civil examination or a criminal investigation by the IRS, and
  • have not already been contacted by the IRS about the delinquent information returns.

The benefits of using the Delinquent International Information Return Submission Procedures are, assuming that the IRS accepts the reasonable cause statement, is that no penalties will be imposed on the late-filed foreign information returns which could exceed hundreds of thousands of dollars depending on the foreign information return in question. 

Under the new guidance, there are no assurances that the failure to file delinquent international returns will be permitted without the imposition of penalties if the IRS examines the submission, even where all tax liabilities have been reported.   Taxpayer should not file under the Delinquent International Information Return Submission Procedures without being certain they qualify.  To limit the risk of up-front penalty assessment, it is still recommended to enclose a reasonable cause statement with the submission. 

Delinquent FBAR Submission Procedure
Under the Delinquent FBAR submission procedure, the IRS will not impose a penalty for the failure to file the delinquent FBARs if the taxpayer properly reported all of their income, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs.  This includes reporting the existence of foreign accounts on Schedule B of the Form 1040. In addition, in order to be eligible for this program, the taxpayer must not have been previously contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted. 

Quiet Disclosure
Taxpayers not wishing to use a formal voluntary disclosure program to come into compliance may consider a quiet disclosure. A quiet disclosure is one where the taxpayer files all outstanding returns or amends previously incorrect returns, and pays all taxes, penalties and interest before contacting the IRS or using the procedures of a formal voluntary disclosure as stated above. No explicit benefits are provided to taxpayers who use quiet disclosures and the IRS previously has publicly stated their preference against using quiet disclosures.  However, the IRS appear to recently change course on quiet disclosures in updated Internal Revenue Manual §9.5.11.9 (09-17-2020) which states “if the violation of the law was not willful, taxpayers should consider other options including correcting past mistakes by filing amended or past due returns.”

While there may be potential benefits in a quiet disclosure, they should carefully be weighed against the IRS’ historic distaste for its use to bypass the formal voluntary disclosure process, coupled with the fact that the admissions voluntarily disclosed would still be available as admissions in a later prosecution or litigation without formal voluntary disclosure protections.

1 IRM 9.5.11.9(4) (09-17-2020).

2 IRM 9.5.11.9(3) (09-17-2020).

3 IRM EXH 4.26.16-1.

4 IRM 20.1.5.14.1. Indications of Fraud

5 See footnote 6.

6  See footnote 6.